Sovereign Debt: Reality Finally Hits “Rich” Countries
How is the financial crisis of 2008/09 different from previous crises?
- While many of the key emerging market economies have balanced books and manageable debt loads, most of the G8 nations are faced with dire prospects.
- The fiscal difficulties the leading Western nations find themselves in are of a truly unprecedented magnitude.
- Western economies are continuing to pile up structural deficits with a depressed tax base and ballooning unfunded liabilities.
- There is a good chance that the disparities across Europe will become the breeding ground for the renewal of nationalistic sentiment.
- The economic and financial power balance has slowly shifted to what is so patronizingly called "emerging markets."
For many months now, newspapers, magazines and TV shows have been brimming with stories about the sovereign debt crisis. Such crises are not new. We have seen sovereign defaults and the economic collapse of sovereign states over the centuries, stretching back into the times of the Greek and Roman empires.
And the world's economies have recovered from these previous collapses. So why are we so worried about the mounting debt loads of the United States, the nations making up the European Union or even Canada? Aren't things just going to sort themselves out over time?
After all, when the world emerged from World War II, every major sovereign state was under a taxing load of debt. And yet, VJ-Day on September 2, 1945, marked an astounding turnaround — and the start of the Era of Great Prosperity.
Unfortunately, today, two generations after World War II, the situation is very different. This is not a time of upbeat optimism after the defeat of a totalitarian system that threatened the world.
The prospects for growth in the major global economies are dim, and the structural issues that need to be dealt with are immense. Overcoming them appears to be close to impossible.
What is different now is the global nature of the crisis. Irresponsible ballooning of sovereign, corporate, personal and institutional (can you spell social security?) debt has occurred in numerous countries.
The traditional sources for bailouts (can you spell United States of America?) are in a state of indebtedness that makes it extremely difficult for them to step in.
The recipe for recovery lies in stopping the binge spending of states and private households alike. That means reverting to balanced books and setting growth on a more sustainable path. In a world where we have all grown accustomed to spending today and dealing with the resulting bills later, the need for austerity measures is not easily understood.
The recent general strikes in Greece and Spain are a prime example of how difficult the task of governments will be to convince voters of the necessity to tighten their belts.
And this is just the beginning. It will take a gargantuan effort just to eliminate the structural deficits — before even a single penny of the staggering debt loads can be repaid.
What is also different is demographics and the related shift in economic output. The traditionally strong economies of the G8 — most importantly, the United States and Germany — are weakened by an aging population, a smaller workforce and less economic output.
Manufacturing has migrated to China, India and other emerging markets. Recovery from the stress of 2008/2009 is much more difficult than the remarkable recovery we saw across the globe after World War II.
As a matter of fact, the power balance has slowly shifted away from the traditional Western developed economies to what is so patronizingly called "emerging markets." Over the past couple of decades, these markets have matured rapidly and are now the home of all of the so-called industrial world's manufacturing jobs.
Their populations are younger and willing to work at low wages — and their public finances are in such good shape that most of them no longer need the assistance of the IMF and donor agencies.
While many of the key emerging market economies have balanced books and manageable debt loads, most of the G8 nations are faced with dire prospects. Structural deficits of the public purse exist everywhere, and well beyond the point where stimulus spending runs out.
Aging demographics come with increasing funding gaps for social security, public pensions and health costs. With a smaller portion of the population engaged in producing GDP in the real economy, those who produce income will have to be taxed more.
Their funds will be used to support structural deficits that have not been taken care of, as well as the part of the population that is drawing funds from the welfare state. The private sector is not going to pick up fast enough to replenish the fiscal coffers.
In order to survive, private enterprise will continue to increase efficiencies, migrate manufacturing to low-cost jurisdictions, reduce the workforce in saturated economies and write off the cost of restructuring.
The result is depressed tax revenues from corporations and increased unemployment in Western economies that force a transformation into pure service and consumer economies, while emerging market countries continue picking up manufacturing jobs.
The fiscal and economic difficulties that the leading Western nations find themselves in are of a truly unprecedented magnitude. It is difficult to imagine that governments will be able to successfully navigate the issues and make the changes that are required to change direction.
In a four-year democratic election cycle, there simply is not enough time. This leads to a picture of Western economies continuing to pile up structural deficits with a depressed tax base and ballooning unfunded liabilities towards a rapidly aging population. Can they actually do that? We think not.
Europe will face political risk from the fact that its population, which has grown accustomed to benefits from an unsustainable welfare system, will be asked to suffer cuts in public sector wages and social security benefits.
Implementing these changes will be extremely difficult in a heavily unionized environment — and in one that sees the gap between the rich and poor increase. Social unrest, such as that seen in Greece and Spain, is just a taste of what might lie ahead.
There is a good chance that the disparities across Europe will become the breeding ground for the renewal of nationalistic sentiment and a move towards giving the ultra-right more power. This does not bode well for the future of the European Union or the euro.
In the United States, you can add already-unprecedented unemployment levels, racial tensions, regional gaps, a porous southern border and a large population of illegal immigrants to the fact that the population has constitutionally supported easy access to firearms of all calibers, to conclude that this is a very volatile and potentially dangerous brew.
The scary prospects of social unrest turning into violent riots staged by heavily armed "discouraged workers" or drug gangs posing as migrant workers in order to divert attention from their main business and other nightmare scenarios become more than just a remote possibility.
This kind of development has the potential to create a significant political crisis in the United States, which in turn could put global recovery and geopolitical stability into a tailspin.
In this scenario, the United States, currently the leading force in global politics, will come under increased global pressure. Former and current enemies (including Al Qaeda) will continue to benefit from U.S. domestic and international weakness.
The United States will have trouble maintaining its global military leadership role, as it won't be able to appropriately fund not only its military, but more importantly, non-U.S. bases.
China might step in to seek a deal with the United States for Eastern Hemisphere control as a vacuum develops. In this scenario, what becomes of Taiwan, Japan and other U.S. allies in the region — not to mention resource-rich Australia and New Zealand?
The deck of cards on the global balance of power looks like it is being re-shuffled in favor of what we today still so ironically call emerging economies. Investors already consider the seismic shifts that are about to occur.
All of this will reinforce the need for stability and security in a world that is increasingly difficult to predict. Financial centers like Switzerland will be able to benefit from this renewed quest for security — and so will Canada.
Until recently, it was one of the most underrated global financial centers, but one that possesses a truly impressive record of recovery from the global financial crisis.