Government Debt: The Not-So-Silent Economy Killer

Europe has lost its head!

First, the weather is completely out-of-sync with the calendar. Perhaps it’s because of the volcano in Iceland… The dust is blotting out the sun. There’s no sun here today. Instead, the sky is pale grey. And it’s raining. The calendar say’s May 11th, but it could easily pass for February.

The euro markets lost their heads too. Yesterday, Europe exploded to the upside. Stocks went up. Bonds went up even more. Especially Greek bonds.

Why the good time? Because Europe decided to follow the US into full-scale combat with the future. Yes, the Europeans are as eager to prevent real change from happening as their American counterparts.

The change they most don’t want is what we’re calling ‘the Great Correction.’ It’s a combination of several corrections at once – including a correction of the welfare state.

Europeans live well. And thanks to so many transfer payments and so many government-provided services, they live well without really having much money to spend. Their incomes go to pay taxes and social charges.

Trouble is, they enjoy a standard of living that they can’t really afford.

This will sound familiar to Daily Reckoning readers. For many years, we pointed the finger at Americans, claiming that they spent too much money. Americans lived beyond their means. Individual households overspent and went into debt. That over-leveraging in the private sector in the US is now being corrected. At least, we think it is being corrected. (Recent figures are mixed…with some indications that private households are up to their old habits, trying to increase their standards of living by going into debt.)

In Europe, the phenomenon is a little different. It’s the public sector that is living beyond its means. Military budgets are small. Most government spending is focused on services and transfer payments. This social spending is responsible for a big part of the GDP and a big part of living standards. But as in the US, living standards are higher than people can afford. Governments provide more employment, more transfer payments and more ‘services’ than they have tax revenue to pay for. The result is public debt, which is getting worse every year.

Europe, generally – excluding England – does not have high levels of private debt. The debt is in the public sector. That said, government debt in Europe, on average, is no worse than it is in the US. The Eurozone, altogether, has government debt to GDP of 88%.

In terms of deficits, Europe is actually in better shape than the US. US deficits are running around 10% of GDP – or more. In Europe, the average deficit this year is expected to be 6.6%.

In Europe, the center is solid. But like the edges of a carpet, the periphery states tend to get a little worn. Greek public debt is expected to reach 150% of GDP next year. Its budget deficit is as large as that of the US.

You can’t sustain a debt of 150% of GDP – not unless you are Japanese. So, a correction was inevitable. Greece had to change course.

This is what caused a crisis last week, a ‘rescue’ over the weekend, and a sharp rally yesterday. America rescued its private sector. Europe is rescuing its public sector. Both are actually making the situation worse…but that subject is for a different day.

Rather than permit problems to correct themselves, the euro feds stepped in to aggravate them. That is, the euro feds are following the same program as the Americans. If people get into trouble because they have too much debt, the feds come to their aid with more debt!

In the event, EU financial officials worried that the Greek illness could be catchy. They were afraid that Portugal, Spain and maybe Italy would get whatever the Greeks had. So, they decided to inoculate the whole Eurozone with a $1 trillion program.

Where will the money come from? Just as in the US, it will come from people who don’t have any. All the Euro states are borrowing money already. Now they will have to borrow more to pay for people who borrowed too much.

The plan calls for loan guarantees and money from the IMF too. Plus, the European Central Bank will do its part. It will go into public and private debt markets to buy troubled debt, the equivalent of the Fed’s ‘quantitative easing’ program.

Yes, dear reader, the Europeans threw in everything they had. Under no circumstances did they want anyone to say it was ‘too little, too late.’

It was a “historic” occasion for the European Union, said French finance minister Christine Lagarde.

On that point, she was surely right. Up until now, Europe had shown some dignity…some skepticism…and some good sense. It had intervened to protect speculators from their mistakes, but reluctantly. Now, it has thrown in the kitchen sink, the oven, the refrigerator…and everything else.

But what’s this?

Asian markets seemed to slough off the Euro miracle this morning. And even the euro seems to be wondering if this rescue effort will be as smooth and effective as people thought. Markets are quite likely to continue second-guessing today…and then third-guessing tomorrow… The gains could prove very short-lived.

Why? Is it too little, too late?

No, it is not. It is too much…much too early.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning