Debt Crises and Market Turmoil: Is The World Going Bankrupt?

By SPIEGEL Staff

Europe and the US are hopelessly over-indebted. The crisis that started in the US real estate sector in 2007 has devastated state finances on both sides of the Atlantic and is threatening to wreck the euro and trigger a second global downturn. The world lacks the political leadership needed to end the turmoil.

A trader at the New York Stock Exchange last week. Zoom
AFP

A trader at the New York Stock Exchange last week.

The fear is back, in the stock exchanges and in the capitals of the industrial nations. There are growing signs everywhere of a new financial crisis, and the political leaders of the West are looking helpless and out of their depth.

The United States is struggling with an enormous budget deficit. And the euro zone's central bankers and government leaders can't find a strategy to end the permanent malaise of their single currency. The White House has achieved little more than to buy some time with a new debt compromise reached after theatrical political squabbling between Democrats and Republicans. Last Friday night, rating agency Standard & Poor's lowered its rating for the US from AAA to AA+.

Muddling through, postponing, playing down -- the motto of the crisis managers on both sides of the Atlantic has sent alarm bells ringing in stock markets. Britain's Economist magazine is warning of a double-dip recession in the US, a second downturn just three years after the last one. Many economists have been pointing out that last week's panic resembled the fear that swept financial markets after the collapse of US investment bank Lehman Brothers in September 2008.

Then as now, banks stopped lending each money. Then as now, banks' cash deposits at the central bank doubled within days. The European Central Bank reacted by assuring banks of unlimited liquidity in the coming months. It was an emergency measure that led to short-term relief but sparked anxious questions among bankers and stock market players. How long can the central bank keep up its market-soothing liquidity operations before it finally loses its credibility, the most important asset of a central bank? Is the financial crisis about to escalate? And will the world then be bankrupt?

It was less than three years ago that the global economy inched towards the abyss after the US real estate bubble burst. In order to save their over-indebted banks and insurance companies, Western governments borrowed huge sums of money themselves. They nationalized banks and implemented vast stimulus programs, while central banks flooded the economy with cheap money.

As former German Finance Minister Peer Steinbrück put it, "fire was fought with fire."

That helped to prevent a global economic crisis of the kind that brought the world to a standstill in the 1930s. But it also set ablaze the headquarters of the world's economic fire-fighters. Who will save the saviors? That question was already being asked back in 2008, and it has gained urgency now that government debt mountains are higher than ever.

Crisis Management Obstructed by Politics

The scale of new borrowing is less of a problem than the inability of governments to find a credible strategy for reducing their debts. In the US, the government and opposition have been locked in a dispute over whether the deficit should be removed through tax hikes or cuts in social spending. In Europe, the solvent governments of the northern countries are refusing to underwrite the debt of the struggling Mediterranean countries.

The West faces a dual crisis that has engulfed its most important political leaders. President Barack Obama has failed to mend a gaping rift in US society and to outmaneuver the conservative Tea Party rebels. In Europe, it has become more evident with each European Union summit that German Chancellor Angela Merkel, rather than being in control of the crisis, is being driven along by it.

The West hasn't been this weak since World War II, and never before has a crisis paralyzed Europe, America and Japan at the same time. The problems of the leading industrial nations aren't just sapping the political influence of the so-called Free World, they are also threatening the global economy.

There are growing fears in the US that the debt woes could drive up inflation to new record levels. In Europe, the future of the single currency is at risk.

Merkel can't avoid the key decision much longer: either the euro zone will be converted into a close fiscal union with financial transfers and commonly issued Eurobonds, or Europe's most indebted nations will have to leave the currency union -- with unforeseeable consequences for the remaining members.

The longer the Western debt crises smolder on, the darker the outlook for the global economy. Because the US economy is collapsing, American consumers are buying fewer goods from China and India. And because investors are piling out of euro and dollar investments, supposed islands of stability are starting to look shaky as well. In recent weeks, the Swiss franc and the Brazilian real have appreciated so strongly that exporters in those countries have been virtually unable to sell their products abroad.

Global Downtrend Feared

And so the world is at risk of sliding into a downward spiral. The debt crises are weakening economic growth, and the declining momentum in turn is making it even harder to escape the debt crisis.

Italian bank UniCredit has predicted a "synchronous downtrend in the US, Latin America, Asia and Europe." A downtrend that would also engulf the economy that has so far been getting through the crisis better than most others: Germany.

If the vicious cycle is to be broken, the governments in Europe and the US must take action now, united and coordinated. No less than the world's economic stability is at stake. But so far, that particular risk doesn't seem to feature prominently in the concerns of the world's crisis managers.

Jean-Claude Juncker, Luxembourg's prime minister and president of the euro group of euro-zone finance ministers, is a veteran of EU policymaking. After the July 21 special EU summit in Brussels, he declared that the euro crisis had been sorted out, and that the second Greek bailout agreed to that day was "the last package." The triumph lasted barely 14 days. The crisis started worsening again last week. Financial markets have set their sights on Spain and Italy, two economies that are too big to be dismissed as peripheral problems like Greece, Ireland or Portugal.

The risk premiums on the government debt of the two countries rose to risky levels last week. Italian and Spanish bond yields were four percentage points above comparable German debt, seen as the benchmark of stability.

That makes borrowing more expensive, and governments simply can't afford such rates in times like these. When Ireland's interest rates reached similar levels last autumn, its neighbours urged the country to seek a bailout from the €440 billion ($625 billion) EU emergency rescue fund, the European Financial Stability Facility (EFSF).

Pledges Don't Calm Markets for Long

But Italy and Spain are too big. It has once again become clear that the euro was launched as a fair-weather currency. And that the euro zone's rescue mechanisms, despite all the additions and improvements, remain little more than inadequate, stopgap measures.

Once again, government leaders are falling behind the financial markets and economic realities in a race that will determine the fate of the euro. It is particularly worrying that their announcements and pledges appear to have an ever decreasing shelf-life.

Last year, when they rushed to the aid of Greece and set up a rescue fund for the high-debt nations on the edge of the currency bloc, they managed to calm markets for a few months. But since then, the breathing space following EU announcements has been whittled down to weeks, even days.

Europe's rescue efforts are not just behind the curve. The measures they end up taking turn out to be insufficient. "Too late and too little," said former EU Commissioner Günter Verheugen, referring to the failure of EU leaders to secure a long-term solution for their ailing currency.

Merkel opposes increasing the volume of the rescue fund. "Every increase would only be an invitation to speculators to go on finding out how much more the euro zone is ready to give," said one German government expert.

Berlin Officials Say EU Fund Can't Save Italy -- Even if It's Trebled

Officials in Berlin say the fund could cope with a bailout of Spain but wouldn't be able to handle Italy even if its resources were trebled. Worse, that assessment also applies to the permanent European Stability Mechanism (ESM) that is due to replace the EFSF in 2013. This admission is unlikely to strengthen confidence in the euro.

"You can't bail out an economy like Italy," said one high-ranking government official. The financial requirement would be too huge. Italy's EU partners couldn't even provide a guarantee for the country's government debt, currently totalling €1.8 trillion, as some economists have proposed.

The alternative is simple: Eurobonds. But at present, German officials are only mentioning that possibility in whispers. The common issuance of government debt is still a taboo in top government circles -- for the time being.

The German government fears that such bonds would entail major disadvantages for Europe's largest economy. The yield on them would be higher than on current German sovereign bonds, because the euro zone as a whole wouldn't be as creditworthy as Germany is on its own. If the interest rates on Eurobonds were just one percentage point higher than German government bonds, it would cost the German government an additional €20 billion per year in the medium term.

That is why Merkel and Finance Minister Wolfgang Schäuble are insisting that Italy find its own way out of the crisis by cutting government spending and enacting reform. But Berlin is under pressure, not just from the other EU member states, but from Washington. The US is pushing Germany to agree to Eurobonds. Obama is calculating that if Europe gets to grips with its crisis, his own fight to cut US debts will become easier.

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1. Euro bonds
Trojan Horace 08/08/2011
If Germany spending 20 billion will stop the Euro going down the toilet it might look like a bargain in a year or two compared to trying the create a new German currency and having no one left to buy Germany's exports but China.
2. Who is producing ?
arcrisi 08/09/2011
Europe and USA have thrown their manufacturing power to other low wages countries. Unemployment grows and economy falls. Is anybody really producing that are consuming ? I can see many, many office employees but almost not any factory workers. There will be remaining only services, and it would be as they finish to polish the shoes themselves... until the shoe polish is finished and there is no one that can produce and replace it.
3.
crabbapple 08/09/2011
Der Speigel quotes two of the more left wing personalities on the American Landscape, Riech and Krugman. Contrary to what you may hear from some sources the Tea Party members are normal middle class Americans tired of seeing their taxes raised to pay for incredibly expensive and unsuccesfull programs their politicians dream up to get votes. Rather like Northern Europeans grow weary of bailing out their Mediterrean cousins we grow weary of the constant "we need more money" demands of the left. How about for once we try spending less and we stimulate the economy by tax reforms and even cuts and cutting regulations. I know it is not the socialist way but it works.
4. We Need Political Leaders
rustylink 08/09/2011
Politicians who favor or permit governments to spend more than they can afford must be sanctioned. Enterprises and governments that spend more than their receipts should be allowed to go bankrupt. Central banking and financial authorities should not attempt to bail out the improvident, and those who failed to take the elementary precaution of anticipating possible increases in interest rates or reduced rates of economic growth. Help for the unfortunate can be justified but not for those who deliberately take ridiculous risks for selfish financial or electoral advantage. Foolish attempts to help out incompetent or irresponsible bankers and governments will only encourage the improvident to continue to take unnecessary risks and act stupidly. Allowing an a badly run enterprise or government in Europe to go bankrupt may well strengthen the Euro. Such bankruptcy will allow their resources, once redistributed, to be used more efficiently and effectively. Politicians and electorates must learn that if tax receipts are insufficient to cover the costs of programs and assistance they cannot in the long run be financed by promises and constantly increasing sovereign debt. Transferring irresponsible levels of debt to a central bank or fund in no way changes the character of improvident transactions. It merely makes a it possible for poor leadership and bad management to continue to avoid being held responsible. Worse, protecting such bad management and leadership from the consequences of their lamentable choices makes an even worse disaster highly probable. It is unacceptable that necessary decisions and policy changes are postponed at the expense of taxpayers. Electorates also have a responsibility. Politicians who buy their votes by deficit spending, bankers who reward incompetence and poor judgement with huge bonuses deserve, and must, be sanctioned. The social and economic health of Europe and North American societies depend on competence being rewarded and incompetence penalized. Only in this way can progress, economic and social, be assured. Governments must not be led by short-sighed politicians who consider satisfying any and all demands. Good government consists of establishing priorities and choosing between desirable objectives those that can be achieved with the available means. Good leadership requires accepting the inevitable displeasure of some, even a majority when facts cannot be made palitable. Greater expenditure require more taxes. Expenditure financed by financial deficit is a policy that is equivalent to running a criminal Madoff Ponzi Scheme and as such destined to inevitable auto destruction.
5. The Tea Party isn't representative of the Middle Class
ReneGayde 08/10/2011
I take exception with crabbapple’s assumption that “the Tea Party members are normal middle class Americans”. The Tea Party is yet again a Republican Party attempt to dupe the Middle Class in the United States, much as it did with the “Silent Majority” and the “Moral Majority”, into believing that they have a concern for the interests of the Middle Class. The Middle Class in the United States has little or no representation in the various federal, state, and local levels of government. The Republican Party of the last forty years has consistently shown that it only represents the interests of the wealthy and their corporations and financial institutions, which have received increasing tax breaks and less governmental regulation. The Republicans want all money spent by the government to go to corporations “because they can handle it better” (Senator Gary Hart, Matters of Principle – “Priorities and Character”, 8/8/2001), which translates into “we want our cut up front”. The Democratic Party has tended toward representing the interests of minority interests and the interests of the ever increasing disenfranchised, which are predominately economically poor and thus pay little or no taxes. The Democrats want the money to go to entitlement programs, where it can be absorbed by an obsolete, dysfunctional, corrupt bureaucracy with little of the funding reaching those who are in need and are the intended recipients. Thus the Middle Class has been the pawn of both parties and has been forced to pay an ever increasing tax burden to provide for the programs of both parties, while their pay has been reduced relative to the economic increases that the wealthy have enjoyed and their jobs have been steadily eliminated by automation or being shipped to third world countries where the wealthy can “hide” more of their profits from being taxed. I am afraid that the United States of America has seen its allotted two hundred years in the sun and we are bearing witness to the beginning of the decline and demise of this great democratic republic experiment. Shame on all of us.
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Graphic: The world's most indebted nations. Zoom
DER SPIEGEL

Graphic: The world's most indebted nations.

Graphic: Bond yields in Europe's crisis-hit countries. Zoom
DER SPIEGEL

Graphic: Bond yields in Europe's crisis-hit countries.


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Graphic: Inflation is rising in the world's second-largest economy.


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