Debt-plagued PIIGS worry EU

Dennis Morrison, Contributor

Barely a year after global financial markets were pulled from the brink of collapse, there have been simmering fears that a European sovereign debt crisis could plunge the world into another round of financial unrest. By late last week, stock markets in all major regions were gyrating violently with indications that Greece was approaching a debt default that could be the tipping point for defaults in Portugal, Ireland, Spain, the other members of the PIIGS group of heavily indebted-countries, and Italy as well. Such an event, it is felt, would likely lead to the unwinding of the European Monetary Union and its currency, the euro, with devastating consequences for the European Union, the world's largest economic bloc.

After vacillating about the seriousness of the Greek threat to Europe's financial structures, European governments are now speeding up their approval of an emergency loan package to staunch the threat of default. They are proceeding - in spite of the opposition in Germany and elsewhere to the US$140 billion bail-out to Greece - fearful of the risks of contagion to other countries that could spread panic and inflict steep losses on banks and consumers. With consumers already intimidated by the great loss of wealth in the crisis of 2008 and 2009, there is no doubt that another round of financial troubles would undercut the hesitant ongoing economic recovery not only in Europe, but also in the US.

Increased consumer spending

The susceptibility of global financial markets to fear and panic was evident in the US in the recent days as the stock market lost significant ground, even with increased signs of economic recovery. Over the past few weeks, the American economy has recorded higher-than-expected numbers of new jobs, rising manufacturing output, and a pick-up in housing sales and overall consumer spending.

Emerging markets, too, have been seeing accelerated growth, having avoided the worst effects of the recession. Yet, nervousness about a renewed financial crisis and recession is evident in the skittishness of markets globally that came to boil last week.

The advent of a European-generated financial crisis and debt defaults is, indeed, a major departure from the economic history of the last 40 years. Threats to global financial markets from debt defaults over that period had originated most frequently from Latin America, with Brazil and Argentina standing out as notorious fault lines. In the mid-1990s, Mexican debt posed big risks to US banks, which eventually drove the Clinton administration to sponsor a bail-out.

Other threats have come from Asia, first in Japan, where the bursting of the asset bubble in the early 1990s upended that country's financial system, but without seriously spilling over into global markets. There was, too, the Asian financial crisis in 1997, which raised red flags briefly, but the impact of which was felt mainly in economies of the so-called 'Asian Tigers'. But the scale, reach, and intensity of debt defaults in Europe, and the crisis that would emanate, would be a far cry from any past Latin American or Asian-induced financial run, which is evidenced by the turbulence in global stock markets in the past two days.

Bric countries unscathed

It is ironic how the so-called BRIC countries [Brazil, Russia, India and China], except for Russia and many other developing countries, were unscathed by the financial crisis, and in the aftermath of the great recession of 2008-2009, are leading the recovery of the global economy. That is not to say, however, that they would be immune to the fallout in economic activity in Europe that would follow another major crisis in that continent's financial system. China, in particular, has depended on export-generated growth to propel its economy and would be heavily affected, although the effects would be somewhat diminished because of the reorientation of its economy towards internally driven demand that is under way.

While the dire economic situation of Greece is the trigger of the looming financial crisis in Europe, the causes reside more profoundly in the damage done to US and European economies by the loosening of regulation of financial systems in the 1990s. Swept up in the fervour of free-market capitalism, governments looked the other way as bankers turned financial markets into casinos. Now, they are saddled with gargantuan debts that were accumulated to avert financial meltdown, and with tax revenues crippled by the recession, are confronted by unsustainable fiscal deficits arising from the costs of servicing these debts.

Unmanageable risks

More and more, it is clear that the unsustainability of fiscal deficits and public debt in the US and Europe carries with it risks to these economies that are unmanageable. The unimaginable prospect of Britain and other triple-A-rated countries being downgraded is stark evidence of the depth of the potential economic fallout. On the other hand, the magnitude of the corrective measures carries with it the danger of economic depression, which Greece is about to navigate, having agreed to make unprecedented spending cuts of 15.3 per cent of GDP in the next two years. At that rate of adjustment, it is almost inevitable that its economy would shrink by double digits, setting off full-fledged social unrest.

Increasingly, the possibility of a strong, sustained recovery of the world economy seems remote, especially as the US is not the motor which once could be depended upon to fuel global production. It may, however, have to lead the offensive to turn back the slide into another financial crisis.

Dennis E. Morrison is an economist. Feedback may be sent to columns@gleanerjm.com.