Is The World Going Bankrupt?

• Is The World Going Bankrupt? By SPIEGEL Staff.

The fear is back, in the stock exchanges and in the capitals of the industrial nations. There are growing signs everywhere of a new financial crisis, and the political leaders of the West are looking helpless and out of their depth.

The United States is struggling with an enormous budget deficit. And the euro zone's central bankers and government leaders can't find a strategy to end the permanent malaise of their single currency. The White House has achieved little more than to buy some time with a new debt compromise reached after theatrical political squabbling between Democrats and Republicans. Last Friday night, rating agency Standard & Poor's lowered its rating for the US from AAA to AA+.

Muddling through, postponing, playing down -- the motto of the crisis managers on both sides of the Atlantic has sent alarm bells ringing in stock markets. Britain's Economist magazine is warning of a double-dip recession in the US, a second downturn just three years after the last one. Many economists have been pointing out that last week's panic resembled the fear that swept financial markets after the collapse of US investment bank Lehman Brothers in September 2008.

Then as now, banks stopped lending each money. Then as now, banks' cash deposits at the central bank doubled within days. The European Central Bank reacted by assuring banks of unlimited liquidity in the coming months. It was an emergency measure that led to short-term relief but sparked anxious questions among bankers and stock market players. How long can the central bank keep up its market-soothing liquidity operations before it finally loses its credibility, the most important asset of a central bank? Is the financial crisis about to escalate? And will the world then be bankrupt?

It was less than three years ago that the global economy inched towards the abyss after the US real estate bubble burst. In order to save their over-indebted banks and insurance companies, Western governments borrowed huge sums of money themselves. They nationalized banks and implemented vast stimulus programs, while central banks flooded the economy with cheap money. As former German Finance Minister Peer Steinbrück put it, "fire was fought with fire."That helped to prevent a global economic crisis of the kind that brought the world to a standstill in the 1930s. But it also set ablaze the headquarters of the world's economic fire-fighters. Who will save the saviors? That question was already being asked back in 2008, and it has gained urgency now that government debt mountains are higher than ever.

Crisis Management Obstructed by Politics

The scale of new borrowing is less of a problem than the inability of governments to find a credible strategy for reducing their debts. In the US, the government and opposition have been locked in a dispute over whether the deficit should be removed through tax hikes or cuts in social spending. In Europe, the solvent governments of the northern countries are refusing to underwrite the debt of the struggling Mediterranean countries. The West faces a dual crisis that has engulfed its most important political leaders. President Barack Obama has failed to mend a gaping rift in US society and to outmaneuver the conservative Tea Party rebels. In Europe, it has become more evident with each European Union summit that German Chancellor Angela Merkel, rather than being in control of the crisis, is being driven along by it.

The West hasn't been this weak since World War II, and never before has a crisis paralyzed Europe, America and Japan at the same time. The problems of the leading industrial nations aren't just sapping the political influence of the so-called Free World, they are also threatening the global economy.There are growing fears in the US that the debt woes could drive up inflation to new record levels. In Europe, the future of the single currency is at risk.Merkel can't avoid the key decision much longer: either the euro zone will be converted into a close fiscal union with financial transfers and commonly issued Eurobonds, or Europe's most indebted nations will have to leave the currency union -- with unforeseeable consequences for the remaining members.The longer the Western debt crises smolder on, the darker the outlook for the global economy. Because the US economy is collapsing, American consumers are buying fewer goods from China and India. And because investors are piling out of euro and dollar investments, supposed islands of stability are starting to look shaky as well. In recent weeks, the Swiss franc and the Brazilian real have appreciated so strongly that exporters in those countries have been virtually unable to sell their products abroad.And so the world is at risk of sliding into a downward spiral. The debt crises are weakening economic growth, and the declining momentum in turn is making it even harder to escape the debt crisis.

Italian bank UniCredit has predicted a "synchronous downtrend in the US, Latin America, Asia and Europe." A downtrend that would also engulf the economy that has so far been getting through the crisis better than most others: Germany.If the vicious cycle is to be broken, the governments in Europe and the US must take action now, united and coordinated. No less than the world's economic stability is at stake. But so far, that particular risk doesn't seem to feature prominently in the concerns of the world's crisis managersOfficials in Berlin say the fund could cope with a bailout of Spain but wouldn't be able to handle Italy even if its resources were trebled. Worse, that assessment also applies to the permanent European Stability Mechanism (ESM) that is due to replace the EFSF in 2013. This admission is unlikely to strengthen confidence in the euro."You can't bail out an economy like Italy," said one high-ranking government official. The financial requirement would be too huge. Italy's EU partners couldn't even provide a guarantee for the country's government debt, currently totalling €1.8 trillion, as some economists have proposed.

The alternative is simple: Eurobonds. But at present, German officials are only mentioning that possibility in whispers. The common issuance of government debt is still a taboo in top government circles -- for the time being. The German government fears that such bonds would entail major disadvantages for Europe's largest economy. The yield on them would be higher than on current German sovereign bonds, because the euro zone as a whole wouldn't be as creditworthy as Germany is on its own. If the interest rates on Eurobonds were just one percentage point higher than German government bonds, it would cost the German government an additional €20 billion per year in the medium term. That is why Merkel and Finance Minister Wolfgang Schäuble are insisting that Italy find its own way out of the crisis by cutting government spending and enacting reform. But Berlin is under pressure, not just from the other EU member states, but from Washington. The US is pushing Germany to agree to Eurobonds. Obama is calculating that if Europe gets to grips with its crisis, his own fight to cut US debts will become easier.Chinese central bank governor Zhou Xiaochuan urged Washington last week to act responsibly to deal with its debt. The state Xinhua News Agency said the political wrangling in Washington had been a "madcap farce" and it described US debt as a "ticking bomb." The Chinese economy, the world's second largest, is already at risk of overheating, with dramatic consequences for the world, because it has been the driving force behind global growth. China has been growing at double-digit rates for years -- by 10.3 percent last year alone. German firms in particular have been benefiting from the huge Chinese market, which is starting to slow. An important sentiment indicator measuring the mood of corporate purchasing managers fell in July. The Shanghai Stock Exchange has been stagnating. And real estate prices fell 13 percent year-on-year in the first half. In its latest "Global Trade Alert," the London-based Center for Economic Policy Research warns that protectionism is on the rise among industrial nations.

The world is closer to an economic crash than at any time since the outbreak of the financial crisis, even though governments are in many respects in a better position than they were in 2008. True, many Western states have amassed gigantic piles of debt. But unlike three years ago, there has been no disorderly insolvency so far that threatens to tear banks into the abyss. On the contrary: Western governments have the means to get to grips with their debt crises. However, the usual crisis diplomacy with telephone conferences and pledges of "decisive action" won't suffice to calm markets. Effective decisions are needed now, on both sides of the Atlantic. In the US, the government and opposition must agree on a sustainable plan to reduce the debt -- spending cuts will be as necessary as higher taxes, and politicians must make sure that the measures don't choke off economic growth. That isn't easy but it's not impossible either, as former President Bill Clinton showed in the 1990s. Similar plans are available today. The question is whether the divided political establishment can find the strength to implement them.

If the euro is to survive, the donor countries will have to shoulder even greater financial risks than they have already. And the debtor nations will have to surrender their sovereignty in budget matters to Brussels bureaucrats for years to come. The lesson from the latest crisis can be phrased in three words: solid state finances.It has become evident that debt-to-GDP ratios of 80, 90 or 100 percent will sooner or later cast doubt on a country's creditworthiness. Even supposed paragons of fiscal virtue such as Germany must be careful. The German debt ratio of 83 percent is too high, given the ageing population. Who is supposed to pay down that debt in the future?Scaling down debt isn't easy, as can be seen in Britain. The government of Prime Minister David Cameron has imposed more rigorous spending cuts than any other traditional industrial nation. The austerity program is coming at a high price. The cuts are hitting domestic demand and have all but wiped out economic growth. Every country that embarks on fiscal cuts faces a similar fate, and it takes years for the measures to bear fruit. States that have restored their budgets to health tend to grow faster than profligate ones. So the economic prosperity of the West hinges on whether governments are capable of thinking in new dimensions of time. They finally need to start thinking further ahead than the next election. Hmmmm......This is the "CHANGE" America voted for.Read the full story here.