The world’s debt trap

“There’s a 60 percent probability that most advanced economies will fall into a recession, while authorities are running out of options to provide emergency support.” — Bloomberg News today, describing the views of Nouriel Roubini

This forecast from a sometimes-prescient and widely quoted economist brings to mind a question that many people now find irrelevant.

Which should we policymakers choose, option A or option B? How about doing whatever is necessary to balance the government’s budget? Increasingly, policymakers believe that is their only option. In some countries, these policymakers may be right. For them, options A through Z are to raise taxes or cut spending. This is what happens when (1) tax revenues are weak, (2) money is needed to make payments on government debt, and (3) the country in question does not or cannot print its own currency and cannot make reserves for its own banks.

Here in the United States, point (3) above does not apply. Hence, the federal government can issue any amount of securities, with the Fed purchasing them if necessary, as long as Congress is willing to keep increasing the debt limit. Unfortunately, however, the stimulus package of 2009 is wearing off, and Congress and the President have not acted quickly enough to increase spending or reduce taxes. As a result, combined government employment at the local, state, and federal levels has been falling. Unemployment remains ultra-high. Hence, we look forward with great concern to President Obama’s upcoming address on jobs creation. Many constructive proposals are likely to be on offer.

On the other hand, all three points in the third paragraph of this post seem to apply to most of the countries in the Eurozone. They are in some kind of a trap, perhaps a debt trap.

They believe they cannot stimulate their economies. Hence, growth and job creation are slowing or turning negative, with unemployment already at high levels. This situation leads to falling income- and sales-tax revenues.  Since these national governments do not have their own currencies, they do not enjoy the help of a national central bank, such as the Fed, that can and will keep purchasing government debt at targeted interest rates. Hence, the European Central Bank (ECB) has been forced to step in repeatedly to buy European government bonds, now over the protests of a few high-level officials, who have claimed that such purchases, at least as they are currently being conducted, are illegal.

This trap is worsened by its international scope. When numerous countries face economic stagnation at the same time, exports tend to weaken everywhere. (For example, today, the German government reported a 3.3 percent drop in industrial orders from other Eurozone members, along with a 10.2 percent drop in orders from other countries, though domestic orders rose 3.6 percent. FT article here [registration required].) A weak export sector cannot significantly contribute to an economic recovery or a rebound of tax revenues.

This bind leads not to one bailout, but a series of bailouts, a process that has begun to play itself out in several European countries. These bailouts often merely “extend and pretend,” keeping things going under the pretense that a solution will be at hand, if only enough budget cuts can be made.  Come to think of it, the world faces an austerity trap.