06 February 2010

European Economic Problems A Harbinger For America

Don't talk to me about the "European Economic Model" that has been all the rage for the last couple of years. That way lies only stagnation, debt and decline.

I've been eyeballing this story for a while now, although I haven't blogged on it yet. But now I will because it has started screwing with my battered 401(k).

The complication is the Euro currency. Several countries share the same currency although they remain sovereign and their economies are not as integrated as those of our American states. I always wondered how that would work when the chips are down.

And the chips, it seems, are low. Greece, Spain, Ireland and Portugal, have gotten themselves in a bind with a burst bubble economy, resulting in high persistent unemployment; high and growing public debt; pension obligations; a bloated, inefficient, unionized public sector; and declining tax revenues. Sound familiar?

What happens if investors quit buying the government bonds, and the countries are staring at a default? Sound familiar?

The question is whether the European Central Bank would bail out the defaulting countries? Also, would the economic problems be contagious and spread work-wide? Greece, at least, is facing the prospect of severe government cutbacks and austerity measures during a recession.

High taxes, low growth, high unemployment, and sharply curtailed government services are what is in store. None of which makes for happy voters. Again, sound familiar?

NY Times: Debt Crisis in Euro Zone Is Severe Political Test for Bloc

Anxieties about the health of the euro go to the central dilemma of the European Union: the grip of states over economic policy makes it hard to deal collectively with a crisis.

Washington Post: Debt crisis unsettles European economy

Yet investor doubts over the will of Greece, Portugal and other nations to right their accounts have sparked a crisis of confidence that is seeping into stock and corporate bond markets across Europe and beyond. It is especially hitting banks and other institutions with broad exposure to the sovereign debt of the "PIGS" of Europe -- Portugal, Ireland, Greece and Spain.

The crisis unfolding in Europe has some parallels to the debt crises that hit Latin America and Asia in the past, particularly in how Greece's problems have spread so quickly to other countries in the region with similar economic woes.

WSJ: In Greece and Spain, Austerity Stirs Concern

As Greece embarks upon a round of austerity measures aimed at slashing its budget deficit, the prospect of cutbacks is making ordinary Greeks nervous about the future. Concern over the future is now spreading to other weak Southern European countries as well.

Greece is currently the weakest of the euro-zone economies, with a budget shortfall for 2009 of close to 13% of gross domestic product—way over the 3% limit set by the European Union for countries that share the euro single currency.

In Greece, worries over public finances have sparked a series of ratings downgrades since last year, raising the cost of borrowing for the Greek government. The difference between the interest rate on a Greek 10-year bond and a German—a measure of financial markets' confidence in Greece—reached more than four percentage points last week.

The Greek economy is expected to shrink 1.1% this year and 0.3% next year, according to the European Commission. Unemployment, around 9% at the end of 2009, is forecast to reach 10.2% this year.

Greece's economy accounts for only 2% of the gross domestic product of the countries that use the euro currency. However, its troubles have now caused worries that other Southern European countries might also have trouble financing their public debt.

Financial markets in Spain and Portugal suffered a battering due to fears that they—like Greece—might struggle to finance giant budget deficits.

MarketWatch: Concerns about the health of Greece, Portugal and Spain showed no signs of flagging Friday as Portugal decided to increase spending and a strike in Greece dragged on for a second day.

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