Troubles in Europe - Foreshadowing of What's to Come?

Long before the Greek debt crisis became the latest news story, a much more troubling issue in the United States had caught my attention. This issue is primarily linked to the U.S balance sheet and just how much debt they have been accumulating ever since the crash of '08. As it stands right now, the U.S has accumulated a debt to GDP ratio of approximately 90%. This $13 trillion (please pause for a second and really think about what even just a trillion dollars means - this is a thousand millions, a thousand times over) is the culmination of the many years of budget deficits in the U.S. The most recent buildup in debt can be primarily attributed to the TARP initiative, the war in Iraq and Afghanistan and the several tax cuts and economic stimulus spending to help try and stabilize/rejuvenate the U.S economy. Not to mention, the U.S has also taken over several major corporations like AIG and Freddie Mac/Fannie Mae to save them from destruction. The latter are essentially trillions of dollars of what some would deem toxic assets. Massive takeovers like this are just more endless holes for the government.

Now the main issue here is not just the spending, but also the state of the U.S economy and how the recovery has fared thus far. From what the weekly economic data has indicated, this recovery is mediocre at best and the U.S is still in a state of much fragility. Considering just how much of the private debt has been absorbed by the public sector and all of the economic stimulus spending (including major tax cuts), any reasonable person is justified in thinking that the economy has more than enough push to help get back on its feet. Some may point to data like the recent 14% increase in new home sales as a sign of great recovery but I argue that this is very much influenced by the rush of homeowners who decided to take advantage of the recent tax cut that was about to expire. The truth is, the U.S is in dire need for the economy to have a steady boom phase because in the very near future, the government will have to begin paying back the rest of the world to whom it is indebted. For if the economy continues at its current pace, an increase in taxes and cuts in spending will surely result in a double-dip recession, one much worse than the lows of 2008.

If you have kept up with the news, Great Britain has just put in place major spending cuts (billions of pounds across the board) to help relieve their heavy debt burden. These are the types of cuts that the U.S government will soon have to implement in order to ever pay back this growing debt load. To put the amount of U.S debt into perspective, lets consider a bizarre scenario... Let us remember that at this point in time, the U.S has federal budget deficit, a major trade deficit, and as we know, a very large debt burden. For the United States to pay back its debts in the next five years (including interest on its loans), they would hypothetically need to implement a tax initiative that would incorporate a universal 20% tax on every good and service produced in the nation (this would be the only tax in the economy). For this to work, they would also need to spend absolutely nothing during this five year span.

Now of course this scenario is absolutely unrealistic and not the slightest bit feasible but I use this example to express just how much of a struggle this debt repayment will eventually be. This is especially true when you factor in how much the economy is likely to shrink when higher taxes and spending cuts are introduced. As each year passes, GDP will compress and government revenues will be difficult to sustain.

Now fear not, the U.S does have a couple of other alternatives. They may have the option to restructure their debt or essentially default on their loans. If this does not work though, and revenues do not return to surplus levels, they will have to resort to printing money. Now I do not want to expand on all of the negative effects this would bring but it is worth mentioning that hyperinflation is already a potential threat and this would almost surely result in the collapse of the greenback.

For the reasons explained above, I find it very surprising that more attention isn't paid to the growing debt burden in the West. As the problems in Europe continue to be revealed, I am certain that the U.S will begin to feel the effects of Europe's crisis and the attention will soon turn to the worlds largest economy.

In my later posts, I will go on further to explore the problem with debt (in general) and explain why I believe the foundations of the global economy are destined to produce systemic failure worldwide.

- The Watchdog