A Fistful of Kronor

European leaders wouldn't be so befuddled about how to solve their economic crisis if they simply looked north.

Europe's economic turbulence has been raging for more than two years, fueled by political leaders' continuing failure to come up with real solutions to the euro crisis. Time and again, they claim to have solved it, only to see bond prices tick up and growth projections tick downward. Don't be fooled by the August calm. When the continent returns from its collective Mediterranean vacation next month, the crisis will rear its head once again.

European leaders might learn a thing or two from the recent experience of my country, Sweden. In the beginning of the 1990s, Sweden was struck by a severe financial crisis, much like what Spain and Ireland are experiencing today. After almost a decade of strong economic growth, fueled by cheap credit and rapidly rising housing prices, the market suddenly collapsed, which caused severe problems in the Swedish banking system.

Before the crisis broke out, in 1990, Sweden boasted a budget surplus of 4 percent of GDP. Then something unexpected happened. In just three years, the country's public finances took a dramatic nosedive, resulting in a record deficit of 13 percent of GDP in 1993.

At the time, many, such as the Social Democratic economist Bo Södersten, heralded the mess as a sign that Sweden's welfare state had collapsed. People needed to work more, it was said, and be less dependent on handouts from the government. The IMF urged Sweden and Finland, a country in a similar situation, to clean up their budgets.

Structural reforms were arguably needed. High marginal taxes rates were hampering economic growth, and the labor market was not flexible enough, which pushed the unemployment rate up. Generous welfare benefits also decreased the incentives to work. But problems with Sweden's welfare state could hardly explain why a seemingly thriving economy descended into a full-blown crisis, with rapidly rising unemployment, falling GDP, and an exploding budget deficit.

So what happened?

In the 1980s, a huge bubble was created in Sweden's real estate market, coupled with a rapid increase in construction. Financial deregulation led to an explosion of credit, and the private sector became heavily indebted. The economy also overheated because the government devalued the Swedish krona without trying to slow down the economy in the go-go years. People started to buy homes on speculation, and banks easily provided new loans, not only for homes but also for cars, boats, and art. Sound familiar?

In Sweden's case, the boom and speculation ended with a terrible crash and a banking crisis in 1991. As a consequence, private investment and consumption collapsed, and the economy slowed sharply. Instead of borrowing money, companies and households started to save. It was Sweden's severest economic slowdown since the Depression of the 1930s.

Thanks to a rereading of Irving Fisher's classic essay on debt deflation, economists like Hans Tson Söderström, president of the influential SNS think tank, realized what had happened. Households and businesses -- not the government -- were overly indebted. The huge budget deficit of 13 percent of GDP was a result of the depression, not a cause of it. Tax revenues declined as a consequence of the fall in GDP, creating the government's fiscal problem.

When the real estate bubble burst, the private sector was forced to consolidate its balance sheets. It took several years to deleverage. Households and companies substantially and simultaneously reduced their level of debt, which immediately caused aggregate demand in the economy to fall.

It is this kind of painful adjustment that several eurozone countries are now experiencing. As with Sweden in the 1990s, Spain and Ireland ran budget surpluses amid real estate bubbles during the boom years. Their public debt was low, well below the eurozone average. However, problems became acute because the private sector was heavily indebted. In the common currency's first decade, Germany in particular exported cheap credit to Southern Europe, and interest rates were at historic lows. As in Sweden -- and more recently the United States -- cheap credit fueled housing booms and an unsustainable economic path. Put another way, the current budget woes of countries like Ireland and Spain aren't mainly a result of political incompetence; they are an automatic reflection of the private sector's debt reduction.

Public debt spiked in Sweden during the 1990s, but this phenomenon was only a transfer from the private to the public sector. For the economy as a whole, this collectivization of debt was necessary to avoid a further deepening of the crisis. If you want to avoid a complete collapse in employment and production, everyone cannot simultaneously save -- so the Swedish government tolerated big deficits for a number of years. Then, when the economy started to pick up in the middle of the decade, mainly thanks to a large deprecation of the krona, the Social Democratic government launched an austerity program. But -- and this is important -- the harsh measures were introduced only once the economy had started to rebound after several years of negative GDP growth. Good years, not bad, were the right time to cut back.

The strange thing about Sweden's 1990s experience is how little today's government appears to have learned from it. Instead of being a voice of reason on the euro crisis, Finance Minister Anders Borg -- ranked by the Financial Times as No. 1 in Europe, among his colleagues -- has joined his conservative friends in Germany in promoting policies that further depress the troubled economies.

And it's not just Sweden. Many Northern European politicians speak as if the crisis were created by budget deficits, and not the other way around. In Finland, a member of the eurozone, the leader of the popular True Finns has raged against crisis countries being "spendthrift." This despite the fact that Spain and Ireland (though admittedly not Greece, and hardly Portugal) had orderly public finances before the Lehman Brothers crash in 2008.

Of course, the fly in the ointment is that, unlike Sweden, eurozone members don't have the luxury of being able to devalue or depreciate their currency. They are stuck with the euro and have to follow the European Central Bank's one-size-fits-all policy. And they lack a proper lender of last resort, a fact that has driven interest rates on Spanish and Italians bonds to dangerous levels.

In the 1990s, the Swedish government also had the capacity to temporarily swallow losses in the banking system. A "bad bank" was created, which later became liquidated without any loss for the taxpayer. Today, the problem has become too big for any single country to tackle alone. Therefore, Europe needs common solutions to restore stability in the banking system.

But the first step is to make a correct diagnosis of the disease.



The Incredible Shrinking GOP Foreign-Policy Expert

Mitt Romney's choice of Paul Ryan to be his vice president isn't surprising -- it's sadly indicative of the lack of worldly Republicans today.

If one needed even more indication that the Republican Party simply doesn't consider foreign policy to be a pressing issue in the 2012 election, the selection by presumptive nominee Mitt Romney of Congressman Paul Ryan for his No. 2 slot is perhaps the best and final piece of evidence. Not since the Thomas Dewey-Earl Warren ticket sought the White House in 1948 has there been a Republican duo with such minimal foreign-policy experience -- and with such little apparent interest in the issue.

When you consider how little time and energy each man has devoted to foreign policy and national security issues, it suggests that Romney pretty clearly thinks that having a coherent foreign-policy vision for the United States is not a prerequisite for seeking the White House.

This represents something of a seminal and troubling shift in American politics. For generations, Republicans dominated the foreign-policy discussions in presidential campaigns, lording over Democrats who were portrayed as either lacking in seriousness on national security or simply weak. The shift this year is due to a couple of things: first, the major focus on the economy; second, President Barack Obama's strong public opinion advantage on national security. But there's something else going on here. It's not just that Romney and Ryan don't appear to care much about foreign policy; it's the entire Republican Party that is taking a pass on the issue. Quite simply, foreign-policy gravitas is in remarkably short supply in the modern GOP.

Once upon a time, Republicans habitually nominated presidential candidates with sterling national security credentials: Dwight Eisenhower, the military hero who moved the United States away from its isolationist impulses; Richard Nixon, who tamped down the Cold War and reached out to China; George H.W. Bush, who brought a distinctly realist foreign-policy approach to the White House; and John McCain, whose instincts on national security might not always have been correct, but whose experience with military and diplomatic issues was well established. Even Barry Goldwater and Ronald Reagan had, um, "distinctive" foreign-policy visions, and when a neophyte to the world of international affairs, George W. Bush, got the Republican Party's top nod in 2000, he at least chose Dick Cheney -- a running mate with strong national security credentials -- and surrounded himself with serious foreign-policy voices.

Romney has quite ostentatiously eschewed that tradition, but one could argue it's as much a matter of necessity as it is political calculation. The fact is that even if Romney had wanted to pick a prominent foreign-policy voice to be his veep, the GOP cupboard is surprisingly bare.

Gone are the days when the Republican bench had a deep lineup of national security heavyweights. Few of Romney's options for vice president had any real international experience, absent Ohio Sen. Rob Portman's one year as U.S. trade representative and Florida Sen. Marco Rubio's 19 months on the Senate Foreign Relations Committee. If Romney truly wanted to bring on board a big foreign-policy hitter, his choices were remarkably limited -- and not so au courant.

Right now, the most prominent internationalist voices in the Republican Party are McCain and Lindsey Graham -- who though are different men, tend to speak with the same voice. Condoleezza Rice (whose name was briefly floated by Matt Drudge as a VP pick), certainly had the policy chops, but her moderate views on social issues would have made her a non-starter with the far right. And with the impending departure of Richard Lugar (forced out by a Tea Party Republican) and following Chuck Hagel's exit from the Senate, the age of prominent and thoughtful foreign-policy Republicans seems to be in a twilight phase.

So why this is happening? Part of it is the usual policy drift that occurs in parties that are out of power. Indeed, Romney's attacks on Obama, which largely consist of a critique rather than an actual coherent foreign policy, are telling in this regard. If Republicans have a vision of foreign policy that consists of something greater than "we're not Barack Obama," they're keeping it well hidden. Add to that Congress's extraordinary dysfunction. In the Senate, global issues have had something of a bipartisan sheen, but in today's polarized environment, there isn't much advantage or even opportunity to working across the aisle. With the departure of Lugar, who was criticized on the right for working too closely with Democrats, that dynamic is likely to get worse before it gets better. Finally, there is little political benefit for Republican politicians (or Democrats for that matter) to take as high a profile on foreign-policy issues as was the case during the Cold War. If one wants to rise up the ranks of the Republican Party, there is little evidence -- certainly from this presidential ticket -- that being knowledgeable on foreign policy is a necessary prerequisite.

Then there is the growing ideological orthodoxy of the Republican Party's foreign-policy views. Romney's own campaign team is dominated by many of the same neoconservatives who stocked George W. Bush's foreign policy and national security apparatus. In fact, just last week, when Robert Zoellick was named to head the Romney campaign's planning for potential national security appointments, the move was met with howls of outrage from prominent neocons. As an old-school realist, Zoellick is anathema to many on the right, but the ferocious pushback on his selection was a telling indication of the sway of the far right inside the GOP foreign-policy camp. As is the case on so many domestic-policy issues, the incentive for Republicans is to toe an ideologically rigid line -- and this enforced conformity doesn't lead to the emergence of strong, iconoclastic foreign-policy voices.

Cynics might argue that foreign-policy experience simply isn't as important as it was in the past. After all, it has been 24 years since anyone with a background in national security issues has won a presidential election. Perhaps Romney and Ryan, like previous presidents, can learn on the job. But if the last 70 years of U.S. foreign policy teaches us anything, it is that having a leader experienced in global affairs matters -- and it matters a lot. The presidencies of George W. Bush, Jimmy Carter, Lyndon B. Johnson, and Harry Truman are cautionary tales about what happens when a president lacking a clear foreign-policy vision takes office, especially when confronted, like Bush, with unexpected crises.

Say what you will about Obama's foreign-policy expertise when he ran for president in 2007 and 2008, but unlike a lot of actual foreign-policy "experts," his take on the Iraq war showed that he possessed relatively good national security instincts. The same cannot be said of Romney so far, and the selection of Ryan only adds more reason for trepidation. That both men are being advised by many of the same people who brought us the war with Iraq and Bush's first-term unilateralist foreign policy is hardly reassuring.

In the end, foreign policy is unlikely to be the decisive factor in this year's election. But after the speeches are over, the bumper stickers peeled off the cars, and the lawn signs picked up, there is the very real possibility that Romney will be sitting in the Oval Office, being advised by his 42-year-old vice president. As the old saying goes, elections have consequences. Punting on foreign policy during a presidential campaign might be politically expedient, but commanders in chief don't have such luxuries.

Win McNamee/Getty Images