The Mother of All Bubbles Huge National Debts Could Push Euro Zone into Bankruptcy

AFP

Part 5: How Empires Fall


In March, the rating agencies Standard & Poor's and Moody's warned that even the US's perfect triple-A rating could be jeopardized if the country's financial situation didn't change drastically soon. The third main rating agency, Fitch, had already issued a warning in January. So far, none of the three agencies has announced an actual downgrade of the country's credit rating. Economists suspect, however, that the fear of the incalculable consequences for the economy might have prevented them from doing so.

At any rate, experts like Harvard economic historian Niall Ferguson warn that confidence in the United States could be lost at some point, and that this could come as a complete surprise, with a single piece of bad news serving as a spark and potentially triggering a global conflagration.

The "alarm bells should be ringing loudly" in the United States, says Ferguson. He points out that historically, large empires like the Roman Empire and the Chinese Ming dynasty also fell into decline because they had overextended themselves economically.

Warnings like this help explain why US Secretary of State Hillary Clinton defines the crisis as one of historic dimensions. She has argued that the deficit and debt should be viewed "as a matter of national security, not only as a matter of economics."

Safe Haven

Surprisingly enough, the dollar has managed to make its way through all the turbulence seemingly unscathed. On Wall Street, US securities, particularly American treasury bonds, are still considered a safe haven for investors' money.

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.

Unless the United States takes drastic steps immediately, the public debt will amount to more than 300 percent of GDP by 2050, according to calculations by the Center on Budget and Policy Priorities, the leading fiscal policy think tank in Washington.

The prospects are not one iota better on the other side of the world in Japan. Its economy is even more indebted, with the debt burden amounting to almost twice the country's annual economic output. However, hardly any of Japan's creditors are abroad. Instead, most are government institutions and Japanese citizens, so that at least their fate lies in their own hands.

Increasing Burdens

Nevertheless, the Japanese debt crisis will likely be just as difficult to resolve. Some 22 percent of all Japanese are older than 65 today, and in two decades, when a large percentage of baby boomers will have entered retirement, that number is expected to climb to 30 percent. The burdens that will be imposed on pension funds and the healthcare system by an aging society will cause debt service to continue to rise dramatically in the future, particularly in Japan, but also in several European countries.

In Britain, new borrowing has already reached Greek dimensions. The national debt has grown by more than half in only two years, and this year, the budget deficit is expected to make up close to 13 percent of GDP. Rescuing institutions like the Royal Bank of Scotland has come with a price. According to recent figures, the government has already spent about 200 billion pounds (€230 billion, $306 billion) to support the financial industry.

And now the country will go to the polls on Thursday. There are many indications that the result will be a hung parliament, so that the new government will lack the strength to make unpopular decisions.

"Many industrialized countries face enormous fiscal policy challenges to rectify their escalating government debt," a current study by Deutsche Bank Research concludes.

Relatively Unscathed

So far, Germany has come through the crisis relatively unscathed, compared with other Western industrialized nations. While Britain and the United States are showing deficits of more than 10 percent of annual economic output for 2009 and 2010, Germany's budget deficit only totaled 3.2 percent in 2009, which is only slightly higher than the euro zone's 3-percent ceiling. This year, the deficit is likely to climb to about 5.5 percent.

Unlike most other countries, Germany entered the deepest recession of the postwar era with a balanced budget. As a result, the federal government had to take on less new debt to support the economy and banks during the crisis, as well as to fund the higher costs of rising unemployment.

But the absolute figures of German indebtedness reveal the true scope of the challenge. State institutions have borrowed some €1.7 trillion, with more than half of the total attributable to the federal government, which exceeded the €1 trillion threshold last year. The country's states owe a total of €526 billion and municipalities are €112 billion in debt.

To date, there has been no question on the financial markets that Germany's federal government, as well as its state and local governments, will live up their obligations. Germany, with a triple-A rating, is considered a borrower with a credit risk of almost zero. German government bonds set the benchmark in Europe. As a result, all three levels of government can borrow money at relatively favorable rates.

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barryschatz 05/03/2010
1. Government does not expand output
"The economy has to grow, so that the government can collect enough tax revenue and thus reduce its debt. The trick, in other words, will be to save money while at the same time expanding aggregate output." Only private enterprise expands output. Government consumes output. Any money government manages to save (i.e., not consume) will be left in the hands of the private sector to expand output. Woolly assumptions like this one are largely responsible for the Greek tragedy and those which will shortly follow.
BTraven 05/05/2010
2.
Zitat von barryschatz"The economy has to grow, so that the government can collect enough tax revenue and thus reduce its debt. The trick, in other words, will be to save money while at the same time expanding aggregate output." Only private enterprise expands output. Government consumes output. Any money government manages to save (i.e., not consume) will be left in the hands of the private sector to expand output. Woolly assumptions like this one are largely responsible for the Greek tragedy and those which will shortly follow.
But in situations like now where enterprises and people do not want or are not capable of investing and spending money the government must do it for them. Saving money in the recession makes the situation worse.
barryschatz 05/08/2010
3.
Zitat von BTravenBut in situations like now where enterprises and people do not want or are not capable of investing and spending money the government must do it for them. Saving money in the recession makes the situation worse.
So where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
BTraven 05/11/2010
4.
Zitat von barryschatzSo where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
Fortunately, there is no rule which decisively says that a country overindebted therefore the psychological aspect decides whether a state can be regarded as trustworthy or not. In order to calm the markets the 3 percent rule was introduced. It seems, however, that nobody could imagine that such a rule could be an handicap since every violation will be interpreted distrustfully by analysts. And there is not even a paper which scientifically reasoned why we need such a rule. More tomorrow.
BTraven 05/11/2010
5.
Zitat von barryschatzSo where can government find the money to spend? You seem to believe that government owns the money factory. Consider the distinction between money and currency. Whenever government prints more currency, money is devalued. This is simply legalized counterfeiting. The beneficiaries who first receive the newly printed currency (this will be the banks, of course) benefit from spending it quickly while, say, 2 apples cost a euro. Their spending puts the freshly printed currency into circulation. Then everybody notices there are a lot more euros than before (i.e., supply has suddenly increased) and, as with any sudden supply increase, the thing being supplied suffers a decrease in its value. With money devalued, 2 apples now cost, say, 2 euros. In Zimbabwe today this is understood by everybody. In the Wiemar Republic this was understood by everybody, but that was 90 years ago. As the saying goes, "Those who fail to learn from history are condemned to repeat it." Government borrowed too much during the good times so it could live beyond its means. The eurozone countries have badly flouted the 3pc debt limit, including Germany. In the fog spewed by the politicians' blame game, it must be remembered that those who controlled the purse strings caused this mess. Now you suggest that they carry on doing the same, borrowing their way out of the problem created by borrowing too much, tempting sovereign bankruptcy, hyperinflation, Weimar redux? Your wish shall be granted.
Concerning your example – despite the money central banks have printed to keep the economy running there is no inflation yet because ordinary people has not been given the money. The money provided have hardly reached normal consumers. I only know one measures where money was made available directly to customers – it is the car scrappage scheme. The "new money" circulates in the banking sector. As long as bankers do not speculate on raw materials I cannot see how they could cause an inflation.
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