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European Economy in Dire Straits, and the US Too. How So, Why So?

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The bad news out of Europe continues unabated, including debt and ratings downgrades, sliding economic growth, and exploding red ink.   It is becoming apparent that many of the countries of Europe have borrowed so much money from the banks of the other countries in Europe, that almost none of it can or will ever be paid back -- not with the ever falling economic growth in these countries, which will worsen as austerity measures are imposed.   In other words, even though the buyers of the bonds of these countries don't yet realize it, the fact is that most of these bonds will never be fully redeemed.   In other words they are toxic junk;   the loans will never be repaid, at least not for anything like their nominal and originally stated value.  

Most alarming of all is the enormous amount of money that the US and UK have borrowed from banks in various countries around the world.   (See the beautifully illustrative graphs at the link provided both here and below, courtesy of the BBC.   Scroll down to see them.)  

Why is this extreme and growing US indebtedness particularly alarming?   Because buyers for US Treasury bonds are steadily disappearing, and those who own them, like the Chinese central bank, are trying to sell what they have.  

So who is now the major buyer of US Treasury bonds?   Answer:   The U.S. Federal reserve, which simply creates the money out of thin air, with computer keystrokes, and uses this "funnymoney' to buy our nation's bonds.   But for how long can such an Alice-in-wonderland process continue?

Much of the hope in Europe rests upon carefully crafted bailouts which in turn rest, precariously, upon assumed rates of economic recovery and growth in order for loans to be repaid, and everything related . . to work out.   However, without those assumed and anticipated rates of growth, such plans will fall apart, and more rescue funds -- or outright defaults -- are in store for us.

The Specific Situations of Some of Europe's Basket Cases   (Recommendation to the reader: Except for the "Concluding Paragraphs" at the end of it, skim this section on first reading)

Ireland is an instructive case because it entered its difficulties earlier, and it has already received a bailout, and implemented the austerity measures that were meant to balance the equation.

Unfortunately, the plan is now in tatters with the recent revelation that the Irish economy is slumping more than expected under the twin weights of reduced lending and imposed austerity.   From the Irish Times:   "Ireland's debt rating under threat as economy contracts."

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Rating agency Fitch tonight warned it may downgrade Ireland and five other euro zone countries in the absence of a comprehensive solution to the region's debt crisis which it concluded may now be "technically and politically beyond reach."

Furthermore, the agency placed the ratings of Belgium, Spain, Slovenia, Italy, Ireland and Cyprus in credit watch "negative," which means a downgrade is probably within three months.

This move comes on the back of unexpectedly poor economic data for Ireland, which showed that its economy weakened considerably in the third quarter, shrinking at the fastest rate in more than two years.

GNP is a better measure than GDP in this case because GNP removes repatriated corporate profits that have left the shores.   Many companies use Ireland as a tax haven, so the monies that cycle briefly into and then right back out of the Irish system really should not be counted towards their economic progress.   With economic contraction, the Irish fiscal deficits will once again breach agreed-upon levels, and repaying debts also becomes that much harder.   It is a negative spiral that can be quite destructive and difficult to stop.

The bottom line here, which should surprise no one, is that austerity shrinks an economy and that economic shrinkage and crushing debt loads are incompatible.  

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Ireland's debt yields (i.e. the interest rates that its bonds pay) are instructive.   While it is true that Ireland's debt yields are down quite a lot from their maximum levels (which were over 23% for 2-year bonds and 15.5% for their 9-year bonds), the current yields of 7.9% and 8.6%, respectively, are utterly unsustainable for an economy that is shrinking!   Therefore it is only a matter of time before those high rates crush the finances of the Irish government.

Do you know why the generally agreed-upon limit for persistent government deficits is 3%?   It's because that's the basic rate of GDP growth that history has shown to be sustainable.   As long as deficits are growing at the same rate as the economy, then the debt-to-GDP ratio stays constant and everybody is happy.   If (or when, I should say) the economy grows more slowly than the rate of interest that is demanded from a government, it is a mathematical certainty that either the deficits will swell or austerity and/or tax hikes must be imposed.   There is no other way to balance the books.

On this basis, Ireland has major financial problems problem and its economic outlook is grim.

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Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've (more...)
 

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