Global debt bomb

The question is often asked:  “What happens if governments continue to pile on more and more debt?”  We are beginning to get an answer to that question as the markets are reacting to the Greek government’s unwillingness to make the hard choices necessary to put its fiscal house in order. 

            First a little background.  Eurozone governments have a treaty obligation to not incur deficits of more than three percent, yet the deficit forecast for 2010 for all major Eurozone economies is far in excess of that number.  Greece (12.2%), Ireland (14.7%), and the U.K. (at 12.9%) are even in double digits.  The average Eurozone deficit is projected to be 6.9%, more than double of the agreed upon limit.    

            Greece has reached a crisis stage, in that its debt is now selling at a deep discount compared to other E.U. countries.  Ireland has a bigger deficit but its total net government debt is only 38% as contrasted with Greece’s 95%.  More importantly, the Irish, unlike the Greeks, are instituting a credible plan to cut government spending and get their economy back on the growth track.

             The more fundamental problem with most of the world’s largest economies is that they have allowed government spending to grow faster than economic growth, which can only lead to long-run economic disaster.  Many governments are proposing tax increases, but they cannot tax their way out of this problem because most of their tax rates are already above their long-run revenue-maximizing rate.  Further tax increases will only result in even slower economic growth and an increase in the underground economy, making the fiscal situation worse rather than better.  The responsible choice is a radical cut in government spending growth, with the alternative being economic stagnation or worse likely coupled with a high rate of inflation.