I spoke to Nat and Curtis today on WLTX regarding this issue which is fast becoming a hot topic. Here is the clip.
What is going on with the European debt issue and how does it affect us here in the US?
Countries issue debt or bonds when they spend more than the revenues they bring in. If these countries don’t have reliable future income due to changing demographics (less tax revenue) and the increased burden of entitlements (increased spending), bond investors become concerned that they will not be paid back in full. Interest rates have to climb to make it attractive for these investors to buy these bonds. Unfortunately, if they increase too much, it only worsens the situation as interest on the debt becomes elevated and at some point the credit markets seize up. No one wants to buy debt of a sinking ship. Investors need confidence that they are buying bonds from a financially strong issuer.
Many US investment banks and mutual funds have exposure to this debt (as well as credit default swaps on this sovereign debt) so if there is a collapse in the credit markets, European banks fail and/or bonds of Eurozone member continue to take a beating, it will affect us here at home. Plus the austerity measures and increased interest rates are pushing Europe into recession which will affect our exports (as well as China’s) dampening global growth. Furthermore, an increase in debt and uncertainty over a resolution has a negative impact on our financial markets.
How will this ultimately be resolved?
Members may disengage from the Euro in order to reinstate their own respective currencies so that they can start the printing presses and inflate their way out of their debt problems. A decline in their currency relative to the Euro would give a much needed boost to exports, which account for a large portion of their GDP.
Another possible solution may be the institution of a common Eurobond, although this option has met stiff resistance from Germany, the wealthiest member of the Eurozone, and one most likely to bear the funding burden of the indebted members.
Ultimately, the strength of a coalition of Eurozone member countries will depend on a concerted monetary and fiscal policy that balances short term growth with long term spending cuts. In this fashion the Eurozone coalition will operate similar to the United States. Otherwise, the Euro common currency experiment may fail as members adopt a more protectionist tone and act in their own interests by revoking their membership, returning to their own currencies and resuming their respective fiscal policies.
Isn’t this happening in America? Won’t we be in the same situation if we don’t get our debt under control?
Yes. The United States has a debt ratio of roughly 100% of GDP and this is only going to multiply as the cost of our entitlement programs, primarily Medicare, mount. It is an unsustainable situation. For now, we are like the prettiest of the ugly step sisters at the ball. Our recent economic data has been somewhat positive and the US dollar has strengthened due to the uncertainty over in Europe. We do face additional downgrades to our debt and there needs to be some immediacy regarding a long term solutions to our debt woes or we will be facing a similar situation to what is going on in Europe.
