A Tax Perversity

You may believe that all corporate tax disputes are alike. After all, a dispute generally begins when a firm calculates its liability. Then it forwards a tax payment to a government treasury office.

So what usually happens next? The treasury office assesses the underlying calculation, determines the payment to be insufficient, and demands more money. The company then disputes the assessment and files an appeal in tax court.

That’s not an unusual scenario, is it? But sometimes scenarios do vary. Earlier today, for instance, Apple filed an appeal with European authorities over a tax liability that a government treasury office refuses to collect.

Huh? A treasury office that refuses to comply with its own government authority? How is that possible? Although it’s an incongruous situation, it starts to make sense when one realizes that the government entity hearing Apple’s appeal is different than the government entity that is refusing collection.

You see, the European Union is hearing an appeal about a tax payment that it ordered to be paid to the government of Ireland. Although the Emerald Isle is a member of the European Union, it maintains its own treasury office, independent of the Union. That relationship sets the stage for conflicts of interest between the two government entities.

In this situation, the Irish have been accused of establishing a tax haven for global firms that wish to do business within the European Union. By offering American, Asian, and other firms a foothold in the Union at a lower corporate tax rate than is offered by other E.U. nations, the Irish attract many global business offices and thus broaden their economy.

This puts the European Union in the uncomfortable position of having to level the playing field between its member nations by insisting that each nation maintain comparable levels of corporate taxation. Last year, E.U. regulators found that Ireland was under-taxing Apple, and ordered the Irish to collect over $15 billion in back taxes.

$15 billion, of course, is a major sum for any nation. And for a small country like Ireland, it’s a stupendous windfall. Yet, in order to defend its right to establish such tax arrangements with other global firms, the Irish government has joined forces with Apple to fight the Union’s tax determination.

Win or lose, it certainly is a strange sight for a relatively small government to wage a vigorous battle to avoid collecting billions of dollars in taxes, isn’t it? Indeed, the situation illustrates the perverse incentives that are at play within the Union.

Regardless of the merits of the European Union’s case, one cannot help but wonder whether its tax policy is a bit misguided. After all, every nation in Europe may benefit if the E.U. spends a little less time prosecuting its own member nations for failing to collect taxes, and a little more time trying to eliminate the contradictions that generate such perverse incentives to begin with.

A Valuation Nightmare

Did you notice the news story that shook the foundations of our global economy last week? Although it didn’t receive much attention in the popular press, one doesn’t need to possess a PhD in Accounting or Finance to appreciate the potential threat that now confronts us.

You see, for the first time in the history of European finance, private corporations issued bonds with negative interest rates. Specifically, the corporations Sanofi and Henkel announced that they will charge investors to borrow money from them.

Although European government entities have issued securities with negative interest rates, never before have private corporations done so. Presumably, investors are now so nervous about the future of the European Union that they are willing to accept such terms from Sanofi and Henkel.

Why did this event shake the foundations of our economy? Because our global financial system is predicated on the assumption that it is worthwhile to invest for the future. Under normal circumstances, when a borrower pays interest to a lender, the interest payment represents an acknowledgment that the borrower is investing the principal in a project that is generating future value.

So what happens when interest rates turn negative? In essence, investors are incentivized to spend all of their money immediately, or to store their money in their proverbial mattresses, rather than investing in the private sector. And the calculation known as Net Present Value (NPV), which relies on positive interest rates to discount future payments to their current values, fails to function.

Furthermore, if we no can longer estimate the present value of future cash flows, many tangible and intangible assets will no longer possess calculable values. Commercial landlords, for instance, will no longer be able to estimate the values of their properties on the basis of their future rent receipts. And banks will no longer be able to estimate the values of their loans on the basis of their future repayments.

In other words, we’d experience a valuation nightmare. So why did the Sanofi and Henkel announcements garner so little public concern? Perhaps it’s because the financial press is assuming that their negative interest rates will prove to be isolated incidents.

If other private corporations start to issue debt at negative interest rates, though, there’s no question that we’ll start to hear about it. After all, if the practice of investing for the future is no longer perceived to be a generator of value, it’s difficult to envision how our economy will ever grow.

Brexit: A Generational Divide

You’ve undoubtedly already heard the hubbub about Great Britain’s shocking decision to leave the European Union. But did you notice the stunning generational divide that underlies the voting results?

An overwhelming three quarters of all voters aged 18 to 24 desired to remain in Europe. And a clear majority of voters aged 25 to 49 did so as well. But older voters favored the opposing position, with almost two thirds of senior citizens preferring to leave, and a clear majority of voters aged 50 to 64 also opting to depart.

Former United States Secretary of Defense Donald Rumsfeld once derisively referred to the established Western European nations as “Old Europe,” while praising the emerging nations of the East as “New Europe.” Apparently, the Brexit vote revealed a similar split between the citizens of “Old Britain” and “New Britain.”

Why does this cleavage matter? Because global history is full of ostensibly irreversible cultural attitudes that were washed aside by a deluge of generational change.

Consider the issue of gay marriage in the United States, for instance. In 1996, a Democratic President signed the Defense of Marriage Act (DOMA) into law. That act defined marriage as the union of a man and a woman, and explicitly gave every state the right to refuse to recognize gay marriages. And yet, for its time, it was considered a relatively moderate law because it implicitly permitted individual states to sanction such unions.

Just twenty years later, though, gay marriage was recognized by Supreme Court as a fundamental human right. Why the change? Younger generations, advancing into adulthood, overwhelmingly supported the progressive position.

Indeed, gay marriage proponents ultimately prevailed by convincing the younger generations of the wisdom of their position, and then by simply waiting for those generations to come of age. So what lesson may their experience convey to the disappointed young Britons who wish to remain in the European Union?

To put it simply: time is on your side. Be patient, and recognize that the inevitable generational tide is flowing in your direction.

Brexit: What Happens Next?

Next week, on June 23, the citizens of Great Britain will vote in a referendum that asks whether their nation should “Remain a Member of the European Union” or should “Leave the European Union.”

So … what will happen if they vote to Remain? And what will happen if they vote to Leave?

The simple truth is that no one really knows what will happen next. The European Union’s agreements do not contemplate the possibility of a member leaving the organization. Thus, they do not specify the impact of such a referendum.

Nevertheless, the New York Times reports that a vote to Leave will trigger a two year period of negotiations with the European Union to agree on a dis-association process. But it also reports that, as a result of such negotiations, Britain might “remain in the European Union’s common market.”

The Common Market, of course, predated the emergence of the Union. Technically, it no longer exists. But today there exists the European Economic Area, as well as the European Free Trade Association. Both organizations include nations that maintain their own national currencies and other aspects of independence from the Union, and yet are indirectly affiliated with the Union.

Furthermore, even nations that have adopted the Euro currency, and that aren’t voting on whether to Leave the Union, maintain aspects of independence from the Union. Several nations, for instance, have received reprieves from the critical budget deficit limitations that support the solvency of the Euro currency.

So what will actually occur as a result of this Brexit vote? Well, if the vote is to Leave the Union, negotiations to revise political and economic relationships will commence. And if the vote is to Remain in the Union, such negotiations — which routinely occur among all Union members — will continue.

Thus, the referendum is simply an opinion poll that might establish a transitory sense of direction to such negotiations, until some future event modifies that direction. In other words, although the vote represents an important barometer of British opinion at the current time, it will hardly settle the question of the future of the European Project.

Is The Global Economy Rigged?

Although the Republican Presidential primary has now effectively concluded with the presumptive nomination of Donald Trump, the Democratic Party is still witnessing a slugfest between Hillary Clinton and Bernie Sanders. And for Sanders, that means a continuing stream of opportunities to declare that the global economy is rigged in favor of the international banks.

But is that true? Is the entire global system of governmental regulation designed to protect big lenders? And to beat up on small borrowers?

Last week, mixed evidence emerged from the European Union’s PIGS economies (of Portugal, Ireland, Greece, and Spain) in regards to this question. Although the Greek federal government received support for negotiating favorable terms on its borrowings, individual debtors on the Iberian peninsula fared more poorly.

So what of Greece? Well, the International Monetary Fund (IMF) decided to advocate for a very lenient restructuring of its federal debt. According to the IMF, Greek repayments should be delayed until the year 2040, and should then be stretched out until the year 2080.

2040 to 2080? Under such an agreement, debt repayments wouldn’t even begin for the next 24 years, and wouldn’t end for another 64 years. In a world where a 30 year property mortgage is considered a long term loan, a debt amortization schedule of 64 years would be extremely favorable to any borrower.

Meanwhile, individual Spanish and Portuguese borrowers are pushing hard to force banks to pay them interest on their mortgage loans. Because variable interest rates have dropped below zero in those nations, these borrowers are arguing that interest payments should flow from lenders to borrowers, instead of the customary reverse direction.

And how are their governmental officials reacting to their demands? Not very favorably. Although banks in Denmark have begun paying interest to their borrowers under similar circumstances, government officials in Spain and Portugal are asserting that no mortgage rate should ever fall below zero. In other words, even when commonly accepted market indicators of interest fall into the negative range, the officials are declaring that lenders should never pay interest to borrowers.

Thus, on the one hand, a relatively small debtor nation like Greece can now look forward to some relief from the global banks. But on the other hand, tiny, individual borrowers in small nations like Spain and Portugal are being treated differently.

So is the international banking system rigged against the proverbial little guy? In Europe, apparently, the answer appears to depend on the relative size of the little guy. Small nations like Greece often borrow relatively large amounts of money; they appear to be enjoying some protection.

But individual mortgage borrowers? No such luck. As noted by Bernie Sanders, the system may indeed be arrayed, if not rigged, against them.

Is Trust Necessary?

Why was it so difficult for the members of the European Union to reach an agreement over the fiscal bail-out of Greece? If you listen to European politicians, the challenge was simply a matter of trust.

According to German Chancellor Angela Merkel, “”the most important currency has been lost and that is trust.” Likewise, a Bloomberg Business article reported that “Riled by six months of personal attacks and contradictory messages from Athens, euro-area policy makers are forcing (Greek Prime Minister) Tsipras to overcome the credibility gap they said was a key hurdle to more loans. They’re no longer willing to take him at his word.”

But there are always two sides to every dispute. Nobel Prize winning economist Paul Krugman, for instance, believes that the German negotiating stance was “a grotesque betrayal of everything the European project was supposed to stand for.” He asks, “Who will ever trust Germany’s intentions after this?”

An editorial in the British news organization The Independent echoed Krugman’s argument, adding that “Germany (has) emerged as the fiscal hardliner, demanding cast-iron guarantees that Athens would observe stringent austerity measures.”

This lack of trust on both sides appears to have generated a terrible amount of ill will, with the New York Times publishing editorials about Germany’s “destructive anger” and the British news organization The Daily Mail writing about Greeks who compare Germany’s current behavior to its brutal Nazi history. So how can this challenging dearth of trust be overcome?

The answer to that question might be found in another grueling set of negotiations that recently concluded between the United States and Iran. U.S. Secretary of State John Kerry is taking the position that trust is unnecessary and cannot be relied on to enforce negotiated agreements.

Kerry explains, “There’s nothing built on trust. You don’t have to trust the people you’re dealing with, you have to have a mechanism put in place whereby you know exactly what you’re getting and you know exactly what they’re doing.” He adds, “You don’t trust. It’s not based on trust. It’s based on verification.”

Does Secretary Kerry’s Trust / Verification paradigm sound familiar to you? It’s precisely the language that was used by US President Ronald Reagan and Soviet President Mikhail Gorbachev to explain their approach to negotiating nuclear arms treaties. As illustrated by a classic YouTube video clip, this approach allowed the leaders of America and the Soviet Union — mortal enemy superpowers — to establish a warm personal relationship while negotiating critical treaties to avoid global destruction.

Would it be possible for European leaders, sunk deeply in a morass of bitter rancor generated by mistrust, to simply stop worrying about trust and focus on verification activities instead? Given the dreadful state of the relationships between these leaders, it can’t possibly hurt for them to try a different approach.

America and Europe: Trading Places

One society is a melting pot of different cultures and constituencies, embracing a philosophy of personal responsibility and limited government. The other is a homogenous society, placing emphasis on social and governmental support systems.

Which one is America? And which one is Europe?

The conventional wisdom is that the first description defines the United States, and the second one defines the European Union. Recent events, though, have turned conventional wisdom on its ear.

All societies, of course, undergo extended periods of evolution and transition. Interestingly, the American and European cultures now appear to be engaging in a game of trading places.

Tolerating Unemployment

Last week, American investors punished their domestic equity markets for an economic employment report that under performed their expectations. Although the unemployment rate in the United States has now declined from its recent peak of 10.2% to a far more moderate 7.6%, many pundits believe that this rate remains intolerably high, and thus investors sold shares in response to the news.

And yet any job growth at all, in contrast, would undoubtedly thrill European investors. Last week, the unemployment rate in the euro zone climbed to 12%, a record high. And in nations such as Spain and Greece, as well as among young workers, the rate is more than double this level.

In the past, unemployed European workers could rely upon a sympathetic citizenry and a generous social safety net to guide their way through economic down turns. In the current era of recessionary Europe, however, such levels of social goodwill and governmental support appear to be unavailable to them.

Building The Safety Net

Consider, for instance, the European system of health care services. In Greece, the birthplace of European democracy and a core member of the euro zone, the public health system is nearing collapse. The medical crisis has become so severe, in fact, that Doctors Without Borders — a nonprofit organization that usually focuses on providing care to residents of emerging nations — has begun to deliver charitable services in the country.

On the other hand, despite a contentious and deeply controversial development and approval process, the Affordable Care Act of the United States — a.k.a. “Obama Care” — is on track to launch a national marketplace of health insurance exchanges in January 2014. Although not a universal program of medical services per se, the new American system will provide for a level of access to health coverage that will far exceed levels found in nations like Greece.

Comprehensive health care coverage in the United States … but not in the cradle of European democracy? It’s a surprising sign that the two societies are in the process of trading places.

Forming Social Cohesion

Furthermore, the economic hardships of the European Union are generating levels of social strife that haven’t been experienced since the darkest days of the Second World War. Protestors are routinely comparing German Chancellor Angela Merkel to her infamous predecessor Adolph Hitler, and her Christian Democratic Union political party to his notorious Nazi movement.

Meanwhile, back in the United States, what are demonstrators chanting on the streets of America’s great cities? Slogans in favor of universal marriage! Apparently, political support for the extension of marriage rights to gay citizens has soared among American citizens during the past decade, including among many relatively conservative demographic groups.

Half a century ago, the assassination of an American president on the streets of Dallas, Texas touched off a firestorm of racial and ethnic strife that plagued the society of the United States for three full decades. Today, Europe appears to be entering a similar period of social disunion, at the very time that American society continues to heal itself.

Choosing Priorities

In the meantime, what are the priorities facing American politicians? Are they focusing on goals and objectives that are likely to bring even greater cohesion to the nation and its citizens? Or do they intend to focus on issues that may tear the nation apart?

A brief review of the political headlines appears to indicate that the former, in fact, is true. Apparently, a bipartisan group of lawmakers is negotiating to guarantee the permanent assimilation of illegal immigrants. Meanwhile, President Obama has invited a group of Republican senators to dinner to discuss a “grand bargain” that ensures the long term stabilization and funding of Social Security, Medicare and Medicaid.

Conversely, European leaders continue to argue about the wisdom of forcing bank depositors to share the fiscal burdens of banking bailouts. And national leaders like David Cameron of Great Britain are authorizing referenda that raise the possibility of the dissolution of the European Union.

One political union is clearly a collection of socially cohesive individuals, whereas the other is (in reality) an assortment of combatively warring interests. Who could have ever predicted that the first is the United States of America, while the second is the European Union?

The Cyprus Crisis: Was It Inevitable?

For a while, it appeared that the political leaders of the European Union were beginning to solve their monetary problems. Despite fiscal crises and social unrest in Greece, Spain, Italy, and other member nations, the union of sovereign states had survived one crisis after another without splitting apart at the seams.

But who could have anticipated that tiny Cyprus would have precipitated the most significant monetary crisis yet? As the island nation teeters through a banking crisis that may plunge it into bankruptcy, many have concluded that the Euro zone itself is heading towards a breakup.

Some economists are now concluding that the fundamental design of the European Union is flawed, and is thus exacerbating these economic challenges. Is it possible that such flaws actually made a crisis inevitable?

Remember The ECU!

The European Union, of course, wasn’t created in its current form. Although visionary founder Jean Monnet spoke wistfully of a United States of Europe, the entity was originally founded as a trade bloc for the coal and steel industries in France, Germany, Italy, and the Benelux nations of Belgium, Luxembourg, and the Netherlands.

It later evolved into the European Economic Community (EEC), a free trade association of the same six sovereign nations, with each maintaining its own currency and monetary policy. And later, a basket currency known as the European Currency Unit (or ECU) emerged in virtual form.

A virtual basket currency? How did that work? Well, let’s assume that a firm was owed a certain amount of French francs. Instead of receiving its entire payment in francs, it could choose to receive an equivalent collection of French francs, German marks, Dutch gilders, etc.

It was a useful policy that permitted firms to diversify their currency holdings while operating throughout the EEC. In essence, it created a pan-European common currency, without forcing nations to incur the risk of merging their incompatible monetary systems and currencies.

Truly Necessary?

In retrospect, the incompatibilities between national economies and systems appear to be strikingly obvious. After all, why would any one have expected the German and Cypriot economic systems to have blended into a single unified entity? Or the Spanish and Estonian systems, for that matter? Or the Irish and Greek systems? Yet all of these states committed to utilizing a common European currency.

Let’s take a moment to think about this commitment. Germany, after all, is an immensely wealthy industrial powerhouse that exports advanced technological products around the world. Cyprus, on the other hand, is a Mediterranean island that is primarily known as an offshore banking haven for Russian business people and other global residents.

Was it truly necessary for all of these nations to adopt the same currency? What long term benefits could such a union have possibly conferred on these parties? Although the decision may have generated a fair amount of short term pan-European pride and international goodwill, such feelings might have continued to develop under the structure of the EEC and the ECU any way.

NAFTA: A Case In Contrast

For a comparable case of a trade bloc of members that never chose (and, in fact, never even discussed) the possibility of evolving into a monetary union, consider the North American Free Trade Association (NAFTA). From the time of its initial formation in 1994, NAFTA’s trio of member nations (Canada, Mexico, and the United States) have been content to eliminate trade barriers and coordinate economic policies without blending their independent monetary systems.

Can you imagine the chaos, disorder, and controversy that would ensue if Mexico were to abandon the peso and adopt the United States dollar? Or if Canada were to consider “bailing out” the American government’s $16.7 trillion accumulated deficit? It’s difficult to even visualize a scenario where any of these nations might wish to do so.

Furthermore, although all three NAFTA members have also signed free trade agreements with other nations, NAFTA itself has remained a bloc of only three sovereign states. Representatives of the three countries agree that the bloc would become unwieldy if it were to expand and encompass other nations.

The End Game

Although encountering noteworthy political opposition, European leaders are continuing to insist that the European Union and the common currency zone will survive this latest crisis. It remains to be seen whether they can manage to achieve this goal; furthermore, it is even appropriate to wonder whether it would be beneficial for any one to do so.

It is, in fact, quite possible that an inevitable fracturing of the European Union has already begun. Reportedly, the level of uneasiness about the very existence of the Union itself continues to rise among the citizens of the member nations.

In other words, an “end game” may have already begun to play out throughout the capital cities of Europe. And with it may emerge the unwinding of the Euro zone, accompanied by the re-emergence of the Cypriot pound, followed by the Greek drachma, the Spanish peso, and the Italian lira.

Return Of The 75% Tax Rate

Have you noticed the streak of contrarian philosophy that occasionally runs through France’s political leadership?

In March 1966, for instance, President Charles de Gaulle withdrew his military forces from NATO, an alliance that was created to protect the European democracies from a Soviet invasion. Although Soviet army tanks rolled into Czechoslovakia just two years later to crush a pro-democracy movement, the French army remained independent and clung to a go it alone strategy.

Conversely, France assumed a leading role last year in persuading a hesitant NATO to employ military force to support protestors in Libya. Although the British joined the French in leading the campaign, other nations were content to remain in secondary roles, with the American military adopting the role of leading from behind.

Last week, the French tendency towards contrarian philosophy emerged in the field of taxation policy as well. At a time when nations from America to Singapore are competing for global business by maintaining low rates of taxation, France’s leading candidate for President announced a policy that favored a 75% income tax rate.

“A Patriotic Act”

Socialist Presidential candidate Francois Hollande, who has been leading in the polls to topple current President Nicolas Sarkozy, surprised many of his own advisers by advocating a 75% top marginal rate on personal income taxes. He explained his position by noting that it is patriotic to agree to pay a supplementary tax to get the country back on its feet.

Regardless of our position on tax policy, we can all certainly agree that the French economy could use a boost. Some believe that its persistent weakness in the wake of the recent global recession, particularly in comparison with the economic strength of Germany, has destabilized the European Union.

Germany’s current economic strength is usually attributed to its decision, codified in its Agenda 2010 legislation, to reduce the constraints that its government had placed on the private sector and to permit its labor market to adopt a more free market oriented model. The implementation of a 75% rate of taxation in France, though, would appear to shift the French economy in the opposite direction.

The American Experience

It’s safe to say that the top marginal tax rate in the United States will remain below 40% for the foreseeable future. It has remained at 35% since the Bush administration modified the Clinton era rate of 39.6% in 2003; more recently, Republican Presidential candidates have advocated for rates as low as 9%.

Throughout the decades of American prosperity in the 1950s and 1960s, though, the top tax rate never dropped below 70%. And even when the Tax Reform Act of 1986 briefly arranged for the top rate to drop to 28% during the final years of the Reagan administration, the Act offset the historically low rate by eliminating many tax deductions and establishing a complementary capital gains rate at a relatively high “matching” level of 28%.

Advocates of low marginal rates in the United States, though, repeatedly point to the Reagan era to support their case. On the other hand, advocates of high rates point to the prosperous decades after World War Two, as well as the Clinton era, to justify their own positions. Clearly, they cannot both be correct …

… or can they?

A Question of Proportion

Let’s take a closer look at the history of America’s top marginal tax rates from the time of the initial imposition of the income tax in 1913 to the current day. But instead of looking at the top rates in absolute terms, let’s look at annual swings in proportional terms.

The increase in tax rates from 31% in 1992 to 39.6% in 1993, for instance, increased the rate by a bit more than a quarter of its 1992 value. That was the only time, subsequent to the Great Depression, that the top rate had increased by such a large proportion.  Even though the change in absolute terms was “only” 8.6%, the 1992 rate was so relatively low that the proportional increase was arithmetically very large.

Conversely, although the reduction in tax rates from 38.5% in 1987 to 28% in 1988 may have “only” represented a 10.5% decrease in absolute terms, it represented a decrease of more than a quarter of its 1987 value in proportional terms. And it followed similar proportional drops of over a quarter in 1982 (i.e. from 69.13% to 50%) and almost a quarter (i.e. from 50% to 38.5%) in 1987.

A Quarter At A Time

In other words, both President Reagan and President Clinton appeared to opt for incremental changes of roughly a quarter (proportionately speaking) per annum. Even though the two political leaders shifted the rate in opposite directions, their modifications each helped trigger periods of great prosperity.

What should Francois Hollande conclude about the American experience? Considering France’s current marginal tax rate of 40%, an increase of a quarter of its proportional value may prove effective, but it would leave the rate at a level below 50%. In other words, a leap to a rate of 75% in a single year would be unprecedented in scope, at least by modern American standards.

Global Debt Crisis: Europe’s 50% Solution

Do you believe that last week’s agreement by European Union (EU) leaders will finally solve the Greek government’s debt crisis? It’s awkward to express exuberance about it; after all, the Greeks will continue to experience many years of fiscal austerity before their government’s debt is reduced to manageable levels. And if the bitter pill of austerity prevents economic prosperity, the Greek nation may not experience sustained growth for a generation.

At the moment, though, our global markets appear to believe that the agreement represents a huge step in the right direction. At the end of last week, the Dow Jones Industrial Average was on track to complete its strongest October in history. And many analysts hailed the agreement as an historic success, though some cautioned that investors should wait and see how the terms are implemented before celebrating its consummation.

Lost in much of the hoopla, though, was an important clause that had not previously appeared in similar government debt agreements. Interestingly, the clause illustrates how the European approach differs from the American approach on a fundamental level.

Let’s Make A Deal!

The challenges facing Greece and its EU partners are quite imposing. Each nation member is legally required to limit its federal government debt to 60% of its national GDP, but because of the ongoing economic malaise, the overall EU debt level has soared to 80% of GDP. And Greece’s debt level is the highest of all nations; it soared to 142% in 2010 and is forecast to remain above 130% of its GDP next year.

Because a Greek default on its debt would deliver a huge blow to its creditors, and because many of its creditors are European banks that are considered “too big to fail” by their governments, a Greek default is now considered an existential economic threat to the EU itself. European leaders have been struggling for months to devise a way to support the Greek government without taking the politically unpopular step of bailing out its profligate (and, arguably, fiscally irresponsible) member state.

Last week’s solution encompassed a commitment by the EU leadership to guarantee up to $1.4 trillion of the government bonds of fiscally weak European states. In exchange for this support, the Greek government agreed to new austerity measures that would reduce its debt load to 120% of GDP by the year 2020; furthermore, all European banks would be required to increase their capital reserves by $147 billion.

Perhaps most surprisingly, EU leaders convinced global private banks that have invested in Greek government debt to “voluntarily” forgive 50% of the outstanding principal on their loans. This clause was indeed a unique one; in contrast, the United States government failed to convince any of the holders of the debt of bailed-out American financial institutions to agree to any reductions in principal balances.

Merkel vs. Paulson

What are the accounting implications of a “voluntary” 50% reduction in principal by the private banks? Well, the firms will write off significant asset balances, which will reduce their equity book values accordingly. And because their capital reserve requirements are increasing in compliance with last week’s agreement, a larger share of their dwindling asset balances will necessarily be diverted to satisfy those requirements, thereby leaving fewer funds available for lending and investing activities.

On the one hand, some may predict that this will inevitably lead to less business activity and slower economic growth. On the other hand, skeptics may scoff that global banks have not been aggressively seeking out new growth opportunities any way, and thus the new regulations will not significantly impact growth.

German Chancellor Angela Merkel has been widely praised for demanding the 50% write-down from private sector banks. Her negotiating position, in fact, provides a dramatic contrast to that of former U.S. Treasury Secretary Hank Paulsen, who didn’t demand any such write-downs and reportedly sunk (literally) to his knees to beg Democratic legislators to fully bail out all “too big to fail” banks during the market collapse of 2008.

President Merkel?

It’s tempting to conclude that Chancellor Merkel did a better job of protecting taxpayer interests than Secretary Paulson. However, it will take a while for the long term results to become evident.

On the one hand, if the EU’s massive asset write-down cripples European banks (and thus the EU economy) for years, then Merkel’s victory may be viewed ultimately as a pyrrhic one. Conversely, if the U.S. government ever defaults on its debts, then Paulson’s decision to bail out 100% of the debt of the “too big to fail” institutions may be perceived eventually as a foolhardy choice.

At the moment, though, Merkel’s approach is undoubtedly the more popular one with voters in both the EU and the U.S. In fact, with such unproven candidates as Herman Cain riding high in the opinion polls at the moment, Merkel herself might have been able to win the American Presidential election if she had been eligible to run for that office.