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Global Debt Crisis Reaching Critical Mass

Editor's note: This article originally ran in The Independent Report on March 23rd.

First came the Dubai debt crisis. That was followed by the Greek debt crisis. But they are just the first ripples in what is a global tidal wave of debt.

Despite their relative burdens, both nations have minor debt problems compared to many other nations, even large Western economies. 

Greek public debt is about 120% of gross domestic product. And its current deficit is a whopping 13% of GDP. That is twice what the previous government had been admitting prior to last October's election. The difference shocked, and rocked, world markets.

Economists note that a nation's deficit should not exceed 3% of GDP in any given year.

Greece hopes to achieve the Herculean task of reducing its deficit to 3% of GDP in just three short years. That's a tall order, and one that many are betting against.

In fact, Wall St, – which helped Greece hide its debt for years through the use of arcane financial instruments – is indeed betting against the Mediterranean state. 

As Greek Prime Mininter George Papandeou noted to Charlie Rose, this is like "taking out insurance your neighbor's house, and if it burns down, then you get the money... That is, you want to bet on the failure of someone, or in this case a whole economy, like Greece."

German Chancellor Angela Merkel also voiced similar concerns. "Institutions bailed out with public funds are exploiting the budget crisis in Greece and elsewhere," she noted.

It's little surprise. That's just how Wall St. works. It's plainly ruthless.

The trouble for Europe, and the world in general, is that Greece is not an isolated case. It has lots of company; Portugal, Ireland, Italy and Spain also have painful deficits and staggering debts. This group of nations is collectively referred to as the PIIGS, a fitting acronym.

Iceland, another debt-ravaged nation, has already melted down and there’s also concern about the Baltic states, whose balance sheets are a mess. 

For example, the government of Latvia recently collapsed in the midst of enormous economic turmoil. Unemployment has now hit 20% and the economy contracted by 18% last year.

The weaker Eurozone nations are looking to the more economically powerful Germany and France to save them. But the dirty little secret is that both of those nations are also wallowing in their own enormous debts.



The burgeoning debt crisis has spread around the globe, like a contagion.

Last fall, The Business Insider ranked "The 10 Countries Most Likely to Default." Here's that list, in order, along with the cumulative probability of default: 

1. Venezuela - 60% 
2. Ukraine - 55%
3. Argentina - 49%
4. Pakistan - 36%
5. Latvia - 30%
6. Dubai - 29%
7. Iceland - 23%
8. Lithuania - 19%
9. California - 18%
10. Lebanon - 17%

We've already seen the implications of the debt problems in three of these nations; Latvia, Dubai, and Iceland. 

Yet, the other nations on the list have barely generated any interest or coverage by the financial news media. Instead, the group of nations known collectively as the PIIGS are getting all the attention.

However, the economies of Argentina (#24 in GDP), Pakistan (#28), Venezuela (#32), and Ukraine (#40) are considerably larger, and their burdensome debts more worrisome, than either Latvia, Dubai, or Iceland. 

As noted, Iceland has already gone bust once. Only an emergency $6 billion bail-out from the International Monetary Fund enabled its economy to keep functioning. That's a pittance compared to the debt problems faced by other nations around the globe.

The pressing question for Iceland is whether it could happen again. Iceland's central bank already expects the economy to contract more than 3% this year after a steep fall in 2009. Further loans by the IMF have been held up, and meanwhile Iceland's economy remains in tatters.

The people of Iceland resent being stuck with a bill for the misdeeds of a handful of foreign bankers supposedly under the watch of foreign governments. They want their government to focus on helping its own citizens get through the crisis before repaying foreign obligations that resulted from the malfeasance of bankers.

The citizens of Greece seem to feel similarly; protests and riots have swept the nation. The Greek people are both angry and scared.

It's worth noting that most of the nations getting all the attention for their debt problems have relatively small economies and debts. 

According to the CIA World Factbook, Greece has the world's 34th biggest economy, at $339 billion. Portugal is #50, with a $232 billion economy. Ireland, at #56, has a $177 billion economy. And little old Iceland, with its tiny $12 billion economy, is #142.

There are much larger problems on the world stage.

Japan has the world's fourth largest economy, registering $4.1 trillion. It has a staggering debt amounting to 200% of GDP. Think about that for a moment.

The UK, the world's seventh largest economy at $2.1 trillion, is facing a massive debt burden and a depressed currency. Famed investor Jim Rogers has predicted that the British pound could collapse within weeks. The UK faces a deficit that is 12.5% of GDP (similar to Greece), and a national debt equaling 72% of GDP. But when private debt is added, things get a lot worse.

A study by the McKinsey Global Institute found that the UK has the world’s worst private and public debt in comparison to GDP, with a ratio of 470%. Yet, due to artificially low interest rates, the problem may actually be getting worse.

Italy, the 11th biggest economy in the world, has a GDP of nearly $1.8 trillion. It has a troubling debt problem that hasn't fully gotten the world's attention – yet.

And Spain, the world's 13th largest economy, with a GDP of nearly $1.4 trillion, is another debt-saddled country weighing heavily on the EU.

The Maastricht Treaty's Excessive Deficit Procedure sets deficit and debt targets of 3% and 60% respectively for all EU countries. By that measure, many of these nations shouldn't even be allowed in the EU, much less the Euro Zone.

Then there's the US. It currently has a budget deficit that is 10% of GDP, and the 2011 deficit is projected to rise to 11% of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. Imagine that.

This reality scares the foreign governments and pension funds that have long supported US deficit spending. Eventually the market will force higher rates to compel these investors. And higher interest rates will be a drag on the economy, restricting investment and recovery, much less any possible growth. As it stands, China has already begun selling Treasuries, a very bad sign.

The US government and the Federal Reserve are propping up the US economy, but their Atlas-like efforts are bound to eventually fail. The weight of reality is simply too heavy. Rising interest rates will make servicing the utterly massive US debt crippling.

With interest rates at artificially low levels, due to the manipulations of its central bank, the US and its citizens – like many of the aforementioned nations – have been able to borrow at interest rates that do not reflect their true financial situation. That has encouraged overspending, indebtedness, and malinvestment.

Typically, the US would expect, or hope, to grow its way out debt. But exports account for just 13% of the US economy. And absent government spending and intervention, the US economy is actually shrinking. 

In what can only be viewed as absurd, 71% of the US economy relied on consumer spending in 2009. But those consumers are retrenching as they worry about debts, jobs, the economy, and their own financial security. Americans are simply hanging on, not spending. So the economy will only shrink, unless the government keeps on spending. And it will.

Our economy is predicated on growth and nothing else will do in this system. In the absence of consumer spending, the government will continue jumping into the breach – to our detriment. It may appear well-intended, but it will be political in nature. The politicians are expected to do something. But you can't cure a debt crisis with more debt.

That game can only continue for a limited period, as the federal debt will increase faster than any resulting economic growth. As it is, the federal debt will likely equal, or even exceed, the GDP by the end of this year.

Trying to spend the nation out of its economic malaise presents a problem for a government mired so deeply in debt. 

The government could afford massive Keynesian spending policies during the Great Depression because it didn't enter that crisis with the kind of massive debt it has today. Total US debt (both public and private) was 260% of GDP during the 1930s, but has now reached 370%. 

Back then, our debts remained relatively fixed in size, while it was the GDP that fell away from under the debts.

But our current debt continues to grow, and it weighs heavily on the economy. In essence, our debt and our GDP are moving in the wrong directions.

The US needs to significantly reduce spending, especially since its economy is contracting. But about two-thirds of the federal budget is comprised of just five things: Medicare/Medicaid, Social Security, military spending, and interest payments on our debt. 

Even if deficit spending were to cease immediately (which it won't), as soon as interest rates rise from their record-low levels (which they will), those debt payments will become massive and debilitating.

For decades, the US, like many other nations of the world, hid behind a fallacy of growth by not factoring in all the debt created in the pursuit of that growth. All of this debt has resulted in a lack of savings to fund private investment.

Total US debt, both public and private, doubled from 2000 to present, ballooning from $26 trillion to $53 trillion.

However, the nation's total private net worth is $51.5 trillion, according to the Federal Reserve. By this measure, the US is now officially bankrupt. Since the US cannot possibly pay off its epic debts, its only choice is to inflate and devalue its currency.

But the above figure doesn't even begin to reflect the scope of our nation's true debt problem. As of 2009, the unfunded liabilities of Social Security and Medicare amounted to a staggering $106.8 trillion. Obviously, that's an obligation that can never be paid. 

As bad as things are here in the US, we are not alone in facing a growing debt crisis. As noted, the problem is spreading like a global contagion.

According to a recent report by McKinsey Global Institute, the UK debt to GDP is about 470%, Japan 460%, Spain 340%, South Korea 340%, Switzerland 315%, France and Italy about 300%, Germany 275%, and Canada 245%. All are records of debt to GDP. 

As a result, the subsequent global deleveraging will be a very painful process and take years to resolve. Unfortunately, what we are going through will rival the Great Depression and is truly historic in nature.

For decades we lived under the illusion that debt was growth. But now that illusion is shattered. As a nation, we spent years living above our means, and now we will spend years living below them.

Sean Kennedy is a journalist and the author of "The Independent Report," a non-partisan, non-ideological analysis of economic news, fiscal and monetary policy, inflation, the national debt, energy issues and other market events.

Follow him at http://twitter.com/IndyReport









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