In an op-ed piece in Wednesday’s Financial Times, German Finance Minister Wolfgang Schauble defended Germany’s focus on reining in German and European fiscal deficits:
“To the question of what caused the recent turmoil in the eurozone, there is one simple answer: excessive budget deficits in many European countries. It comes therefore as a surprise, to me at least, that one of the most passionately debated economic issues of the day should be whether Germany is acting prematurely in reining in its deficit and thereby choking the rebound at home and in our neighbours’ markets. My response is an emphatic no.”  Later in the article Mr. Schauble wrote, “Behind the calls for us to pursue a more expansionary fiscal course lie two different approaches to economic policymaking on each side of the Atlantic. While US policymakers like to focus on short-term corrective measures, we take the longer view and are, therefore, more preoccupied with the implications of excessive deficits and the dangers of high inflation.”

The Eurozone and the UK now recognize the necessity for a more “austere” approach to government debt growth.  The U.S. has not – and likely won’t until the market forces its hand.  So there is now a clear policy divide for the markets to contemplate.  In Europe, there appears a willingness to accept some short-term pain for the good of long-term stability.  Here at home, there remains a stubborn adherence to inflationism. 

The markets are still sorting out new post-Greek crisis realities.  For some time, the markets have gladly sided with the inflationists.  Are the vigilantes quietly coming out of hiding?  I would expect the markets to increasingly appreciate that the Europeans are moving in the right direction while we are resisting. 

Prior to Greece, the markets perceived rapid government debt growth was a stabilizing force.  More recently, the marketplace is coming to grips with the reality that runaway fiscal deficits are destabilizing and problematic.  How this appreciation manifests in the markets over the coming weeks and months will be something to watch and analyze.  Higher Treasury yields?  Do tighter financial conditions throughout the U.S. Credit market stop recovery in its tracks?  A weaker dollar?  And could renewed dollar weakness – in concert with European stabilization and Asian expansion - help reignite some global reflationary forces?  There are at least a few ways Treasurys could disappoint.