Contagion and Eurosclerosis

By John Lumbard.

The debt of Portugal has fallen in value so much that a buyer can now get a yield of 16% on long term, ten year bonds.  Portugal won’t have to actually pay 16% until it has to borrow again (most likely when an old bond issue matures and has to be replaced), but at rates like that you can be sure that the increased cost of borrowing will cause even more borrowing.  It’s a swift ticket to bankruptcy—or rather default, because nations don’t have to worry about going through a bankruptcy process.

Wall Street and the media have been obsessed with the idea that the panic that hit Greece and now Portugal will spread further, causing a spiral of higher interest rates, compounding debt, and severe austerity that plunges the entire world into recession.

That’s not going to happen—Europe is already in a recession, but the US economy has been getting stronger—and in the near term the continent’s leaders will continue to grasp for short term solutions and kick the can down the road.  This has nevertheless been a heavy blow to the European Welfare State Model, and it’s obvious that the nations which spent beyond the limits of affordability are headed for significant pain.  So it’s more than a little surprising that our media have made so little effort to draw parallels with our own debts and deficits.

As a bloc the euro zone is less indebted than the U.S., and its government deficit is lower.  And we run up our debts in the same ways.  According to Census data published by the Wall Street Journal, 48.5% of Americans live in households that receive some form of government benefit, up from 30% in 1983.  And we share Europe’s great future problem, which is that we’ve promised larger benefits than we will possibly be able to afford once the Baby Boomers have retired in numbers and stopped paying significant taxes.

We also have patronage jobs, special tax breaks, tax fraud, subsidies, Medicare fraud, red tape, bureaucracy . . . . As with the troubled countries of Europe, these issues cause deficits and debt, and they also create inefficiencies and disincentives hurt employment in ways that are not obvious—but which are very powerful.

The immediate concern for Europe is the need to reassure investors so that they’ll continue to lend money to governments and banks, and interest rates won’t rise.  Numerous countries have been flouting an EU mandate to keep budget deficits within 3% of GDP, so many observers are suggesting tighter limits—0.5% of GDP—that are enshrined in the constitutions of each nation.

Most Americans (74%, according to a July poll by CNN) and most congressmen and senators (328 from both parties, in recent votes) want to do the same thing here—but in a way that allows additional spending during recessions and wars.  You can be sure that Congress is going to open up those floodgates from time to time, but a balanced-budget amendment to the Constitution would nevertheless slow the growth of the nation’s debt.   In 1997 a similar bill came within a single vote of passing both houses, because our legislators knew that they had not balanced** a budget since 1960.


**The 1969 budget was “balanced” with the help of deceit;  that was the year they introduced the “unified budget” gimmick, which claims FICA receipts as if they are taxes.




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