However you look at the emerging crisis in southern Europe, it doesn't look good.
European nations such as Greece with high levels of public debt face a terrible dilemma.If they slash public spending to rein in their government debt and budget deficits it might assuage investors and reduce the risk of default. But it will also scupper economic growth. Living standards will fall and more people will be cast out of work.
Consider the latest GDP numbers for the Euro zone.
Growth was stagnant overall, rising by just 0.1 per cent. Even the biggest and strongest economy in Europe, Germany, was flat, and the so-called Club Med economies of southern Europe are in a very bad way.Economic growth in Italy went backwards, Spain remained mired in recession, and Greece sank deeper into that mire.These economies are all under pressure to rein in public debt yet government outlays are one of the few props to demand. If governments must cut spending to control soaring sovereign debt levels, where's the growth going to come from?
And how quickly the fiscal tune has changed.
Cast your mind back a year or so. Keynes was back in fashion. Fiscal stimulus was de rigueur.The world's leaders pledged unprecedented sums of public money to combat recession. They bailed out banks and failing financial institutions with taxpayer funds and investors applauded.But financial capitalism is fickle. The clamour for public spending has been supplanted rapidly by public debt aversion and concern that nations heavily in hoc won't be able to find a market for their government bonds.So sovereign debt risk has become a market opportunity to be exploited.Greece is under speculative attack. In the mid-1990s the billionaire investor George Soros led a hedge fund assault on the Malaysian ringgit, busting the currency and precipitating the Asian financial crisis.Hellenic debt has become the Malaysian ringgit of the new century.Banks and hedge funds have been piling into the derivatives market to bet on Greek debt default in the hope that their speculation creates a self-fulfilling momentum; bid up the cost of insuring against Greek debt default until the market panics and investors stop buying its bonds -- or the premium becomes so high that Greece that goes broke.
As the New York Times has pointed out, some of the financial institutions now speculating on Greek debt default include banks that, a few years ago, did deals with Greece that allowed it to defer debt repayments and disguise its true level of public debt. How do you say "amoral" in Greek? It's possible -- even likely -- that the strategy may be too clever by half.There may be a bubble in the market for credit default swaps. Europe and the United States cannot afford to let Greece default on its debt, lest it become the Lehman Brothers of sovereign risk.The fear is that if Greece fails the contagion will spread, infecting other nations with high levels of public debt as well as broader credit markets, making it hard for companies and financial institutions to raise money.A new wave of the global financial crisis brought on by self-fulfilling prophesies of public debt default.Already, more than a dozen corporate bond auctions have been cancelled because the market jitters about sovereign risk have flowed through to the corporate bond market, blowing out the cost for businesses seeking to raise funds.So Greece is being thrown a lifeline. But with so many countries with so much debt, how many lifelines will need to be thrown?Even from the other side of the globe, the tensions in Europe are palpable. The richer nations of Europe such as Germany and France don't want to poison their own public balance sheets by aiding the sick men of Europe.
All of this was predictable. Never before have so many countries tried to raise so much public debt simultaneously.It was inevitable that weaker economies would be targeted for speculative attack and that investor relief that the State had stepped in to rescue capitalism would morph into anxiety about the sustainability of nations' fiscal positions and soaring levels of sovereign debt.The core problem is that there is too much debt; transferring the risk from private institutions to public finances didn't make the problem go away.
So now the risks are manifest.
Worst case scenario: a contagious sovereign debt crisis that causes a new global credit crash.Next worst, that pressure for governments to rein in spending undermines the nascent global economic recovery and causes a double-dip recession.Should this risk be avoided, measures imposed by debt-laden sovereigns to cut spending will limit the strength of the post-recession recovery. The cure for sovereign debt fears may be the cause of economic stagnation.Western Europe is now tasting the bitter medicine foisted upon the developing world in years gone by: fiscal austerity.Thousands of workers are taking to the streets of Athens to protest big cuts in wages, pensions and public spending.A Greek tragedy but it won't end there: Italy, Ireland, Portugal, Spain and much of Eastern Europe facing the same unpleasant task, and it will spark political upheaval and social unrest. Western citizens aren't used to the privations foisted upon the peoples of Argentina, Africa and Asia during previous crises.It used to be fashionable to talk about "the north-south divide" -- the social and economic chasm between the wealthier developed countries and the poorer developing countries. But the emerging economies of Asia have come out of the global financial crisis relatively unscathed while rich nations have suffered.As the world panics about sovereign debt risk in Europe, it's as if the north-south divide is being turned upside down.