Playing Poker with Trillions: A Prison of Debt on Both Sides of the Atlantic

The one sovereign stalks the other, while the pressure of the markets contends with the pressure of the street. In Europe, in particular, this has become an unequal battle. Since Jan. 14, 2009, when Standard & Poor's downgraded Greek government bonds, the markets have determined the direction and pace of European integration. They want bigger and bigger bailout funds, they want to safeguard their claims, they want a European Central Bank that buys up government bonds indefinitely, they want slashed government budgets, they want labor market reforms like the ones in Germany, they want wage cuts such as those in Germany and, at the same time, they want these incapacitated countries mired in recession to offer the prospect of healthy growth.

And this is happening in a Europe in which the sovereign nations don't truly know how much Europe they really want. The people who govern Europe don't know either, which puts them at the mercy of the markets. They have no common model for Europe, and they suspend the most basic democratic ground rules to remain capable of acting. They have to use tricks and bend agreements to prevent the euro from breaking apart.

The gulf between those who govern and those who are governed, a problem in any democracy, is complicated in Europe by the mistrust between Europeans and bodies that seek to tame the crisis in their name.

Mistrust among European governments also determines the courses they chart. The German government, in particular, has more confidence in the markets than it does in the governments of Europe's crisis-ridden countries, and it finds the power of interest rates more convincing than promises of reform. Mistrust also stems from the relationship between governments and their voters, so much so that it's become common to delay important decisions until after elections and to keep them out of campaigns. There isn't much confidence in the economic judgment of the people. If lawmakers can hardly understand which bailout funds they are voting for, how many billions they are pushing in which direction, how great the risk of inflation is, what terms like target, derivative, leverage and securitization mean, how much can citizens be expected to comprehend? A citizen who hopes to understand the underlying problems of the euro crisis would, at the very least, have to read the business sections of major German newspapers like the Süddeutsche Zeitung or the Frankfurter Allgemeine Zeitung every day. Watching one talk show a week isn't enough.

Even Good Debt Needs to Be Serviced

The democratic decision-making process reaches its limits in this fundamental crisis, but even in the decades when debt was being accumulated, it was clear that democracies have a troubled relationship with money.

There was always justification for new debt. The catchphrases included things like more jobs, better education and social equality, and the next election was always around the corner. Debt was justified at the communal level to expand bus service or build playgrounds, at the state level to hire more teachers or build bypasses and, at the federal level, to buy tanks and fund economic stimulus programs.

There is good debt and bad debt, but even good debt needs to be serviced constantly. A closer look at which countries acquire and pay off debt, and to what degree, reveals unsettling correlations: The more often governments change and the more pluralistic they are, the faster the debt increases and the more difficult it becomes to pay if off. The more democracy, the looser the money. The only place money gets even looser is in dictatorships.

To hold an administration responsible for the debts of its predecessors, there are debt limits in democracies. In Helmut Schmidt's day, for example, there was a provision in the German constitution stipulating that total debt could not exceed total investment. In Europe, the provisions of the Maastricht Treaty, which is aimed at ensuring the stability of the common currency, limit the amount of debt a government can accumulate to no more than 60 percent of gross domestic product.

Debt Limits Have Never Worked

So far, such debt limits have never worked in any country. Under new laws in Germany, the federal government, starting in 2016, will only be allowed to incur new debt amounting to 0.35 percent of GDP. Euro-zone member states have agreed to a similar rule, but it can only take effect if all national parliaments agree.

In some countries, there are already sparks of resistance against the limitation of new debt. The Italian government refuses to implement austerity measures demanded by the ECB and to approve a clause stipulating automatic spending cuts. After mass protests, the Portuguese government reversed cuts that had already been announced. Spain will fall short of an agreed deficit target of 6.3 percent, with its deficit actually predicted to come in at 7.4 percent. Euro-zone countries are in fact not allowed to incur new debt of more than 3 percent of GDP.

What makes those hoping to clean up budgets in the crisis-ridden countries skeptical is the downward spiral triggered by such drastic budget cuts, structural reforms and wage reductions. Private and public demand is sinking while the economy shrinks, leading to higher unemployment, less government revenue and higher debt. In Spain, after four austerity packages, the unemployment rate has increased from 8 percent in early 2007 to 25.8 percent today, while the country's debt ratio has doubled. In Portugal, unemployment has gone up by close to 100 percent in four years, with the debt ratio increasing from 72 to 114 percent. In Greece, after budget cuts amounting to more than 10 percent of the country's total economic output, unemployment has almost tripled and the debt ratio has risen from 113 to 160 percent.

These horrific numbers are not just driving people into the streets, but are also creating conflicts between politicians and economists. There it is again, the old dispute between the supporters of supply-side and Keynesian economics. Only when budgets have been balanced, taxes are low and wages are brought down can growth return, says the one side; those who cut public and private demand so radically are driving countries into recession and driving debts up instead of down, says the other. Average growth in Europe has declined continuously and was only 1.4 percent in 2011, while the economy is expected to shrink this year.

For many debt-ridden countries, growth is one of four possibilities to reduce debt. Balancing budgets through cuts and tax increases is another. The third option is a debt haircut, which means declaring bankruptcy and no longer servicing at least a portion of debts. The fourth path is inflation, that is, allowing the debt to melt away on the quiet at the expense of savers and consumers. But three to four percent inflation can hardly be justified politically in Germany, although the prospects are better in the United States and other countries. For this reason, and in response to German pressure, European countries are now trying out tough austerity programs.

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• Part 1: Prison of Debt Paralyzes West
• Part 2: An Unequal Battle
• Part 3: A European Depression and a Pending Japanese Disaster