Economic Crisis: Now Back to Europe

Silvio Berlusconi, Italy’s prime minister spoke to the Italian Parliament yesterday about the economic and financial situation facing Italy.

Mr. Berlusconi “pointed the finger at speculators, global economic weakness and general problems in the eurozone.”

These words were an almost exact copy of those issued by the Greek government, the Irish government, and many others from within the eurozone over the past year or two.

Gotta stay on message…the problem is “out there”!

Now that we have a modest pause in the news coming from the United States concerning sovereign debt and all that, we can return to the European sovereign debt situation…which is far from resolved.

When are people in Europe (remember that there are no leaders in Europe, “In Europe the Issue is Leadership”, going to realize that “kicking the can down the road” is not going to get them out of the situation they are in.

In fact, as southern Europe continues to burn, the banking system in Europe is having to endure greater and greater stress. (See, for example major articles in the New York Times, and the Wall Street Journal). Only very short term loans seem to be available between banks but even these loans require borrowers to pay a premium over similar borrowing costs in the United States.

The cost of borrowing 10-year money in Italy has now risen above the “crisis” level of 6 percent this week and Spain is now borrowing at interest rates not seen since the creation of the Euro. Even Belgium and France are facing near term highs in borrowing costs.

As I wrote yesterday, the problem is that there is too much debt outstanding in Europe (and America) both in the private as well as the public sectors. We, in the Western world, have lived off of the debt idol for too many years (Link).

How do we determine whether or not there is “too much debt outstanding”?

In my opinion, an exact answer cannot be given. We try and measure this by using statistics like government debt to GDP ratios, or, government deficit to GDP ratios, and the like. But, we are dealing with human beings and ratios like these can only provide hints at debt loads and clues to times when debt burdens become excessive and unsustainable.

When do people start to realize that they have to make decisions about how they allocate their income rather than just keep spending on everything they want? When do governments realize that they can’t fund every good social cause presented to them? When do businesses realize that they just can’t continue to raise their return on equity by adding more financial leverage to the balance sheet?

There is no exact answer to these questions. Economics is not an exact science no matter how much economists like to project this image to the world.

And, the Keynesians argue that added spending stimulus will cause consumption expenditures to increase and this will get the economy going again, or, incentive for businesses to increase capital investment will get the economy going again.

Keynesian models have never adequately handled the issue of debt and financial leverage. One reason is that debt levels and financial leverage are not always limiting factors in consumer and business spending. In fact, during the early stages of a period of credit inflation, the greater availability of debt and financial leverage may have a positive influence on consumer and business spending.

That is, debt levels and financial leverage may be positive influences on economic activity…before they become a negative influence.

This is one of the problems in trying to understand human behavior.

But, back to the situation in Europe. The world has changed. The old models are not working and new ideas must be introduced into the efforts being made to get control over the crisis.

Maybe this is not going to happen until the “old guard” of top government officials is replaced by someone new. Continuing to try and govern using the assumption that the problem is “out there” is not going to work.

The problem is with the governments and their officials and until this is recognized I don’t see Europe getting its act together.

And, the longer it takes for the eurozone to get its act together the greater the opportunity for the BRICS and other emerging nations to prosper and overtake the “ancient regime” now governing Europe.

The United States cannot ignore this dilemma for it faces similar problems. And, the government of the United States is emulating Europe by claiming that the cause of its problems is “out there” and by postponing any real solutions until a later date.

The world has changed. As the West went through a philosophical and social change after the Second World War, we are now going through another sizable and traumatic change. But, to stick with existing models of the world and, consequently, say that the problems are “out there” will just “kick the can further down the road”. It will solve little or nothing.

About John Mason 79 Articles

Professional history: Banking--President and CEO of two publically traded financial institutions; Executive Vice President and CFO of another. Academic--Professor at Penn State University and at the Finance Department, Wharton School, University of Pennsylvania. Government--Special Assistant to Secretary George Romney at Department of Housing and Urban Development; Senior Economist in Federal Reserve System. Entrepreneurial--work in venture capital and other private equity; work with young entrepreneurs in urban environment.

Visit: Mase: Economics and Finance

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