Tuesday, May 04, 2010

Europe Isn't Out of Danger Yet

The Greek problem is just the tip of the proverbial iceberg. The Mother of All Bubbles: Huge National Debts Could Push Euro Zone into Bankruptcy - SPIEGEL ONLINE - News - International

The fear is that if Greece goes bankrupt, the other nations PIIGS - Portugal, Ireland, Italy, Greece and Spain - will follow suit. And the Euro would fall apart.
If the emergency surgery isn't successful, there will be much more at stake than the fate of the euro. Indeed, Europe could begin to erode politically as a result. The historic project of a united continent, promoted by an entire generation of politicians, could suffer irreparable damage, and European integration would suffer a serious setback -- perhaps even permanently.
And maybe you don't think that is a big deal, but consider that before the 20th Century, European fought a major war quite regularly. (I want to say every 50 years, or so, but I can't find the reference. Even our Revolution drew in France as part of an ongoing antagonism with England.)

And on this side of the Atlantic, the interest isn't only academic, or “motivated by compassion for the Greeks.” There is some chance that investors will finally decided that runaway spending doesn't work anywhere. Even here.

eithner fears that investors could also at some point lose confidence in the soundness of American government finances. According to a strictly confidential IMF document, referred to internally as an early warning exercise, the US's finances are still considered sound -- with, however, some qualifications.

Growing National Debt

The United States is still capable of fulfilling all of its obligations, the document states, but it also points out the worrisome rate at which the national debt is growing.
And debt does have an impact on a lot of things in society.
By studying financial crises over the centuries, US economists Kenneth Rogoff and Carmen Reinhart have calculated an average value at which the debt burden starts to become critical for a country: 90 percent of GDP. Above that level, economies achieve only half as much growth as those that are not as heavily indebted. This key indicator is currently at about 84 percent in the United States, but in two years the Americans are expected to surpass the 100-percent mark. In other words, time is of the essence.
Growth is what creates jobs (those things we don't seem to have enough of.) So more government spending to "create" jobs is likely to have exactly the opposite effect, in the long term.

Then there is inflation.
US President Barack Obama, in particular, is likely to be very tempted to fire up the money printing presses and, by devaluing the currency, to reduce the real burden of liabilities the United States has accumulated. Because foreign investors in China and Japan hold a large share of America's debts, they would be more adversely affected by depreciation than the Americans themselves.
Except that can cause a rush to the exits if lenders see it coming, and once started, inflation is hard to control, even in the best of times.

But whatever happens, I think it is clear that era of runaway government spending is finally coming to close. Whether it will end peacefully, or ends badly, is going to up to the political will in places like Athens and Washington, and whether the economy of the world can expand in the face of all this.

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