Meltdown

The specter of another financial meltdown haunts the global economy.

When this trading week opened, stock markets tumbled from Asia to Europe to North America. Financial risk assessments were grimmer. Spreads on sovereign debt papers widened.

Two major factors drive this fearful episode, both of which I discussed extensively in this space last week. Both factors involve unmanageable sovereign indebtedness.

The first one is the Eurozone crisis. For months, European monetary authorities have tried hard to get a grip on Greece’s financial woes. The country is basically insolvent. Its public debt grew while its economy did not. Despite the tough austerity program Athens put in place over intense domestic political resistance and a huge bailout package put together by the EU and the IMF, it is now conceded that Greece will most likely fall into “partial default.”

While that is going on, ratings agencies have downgraded Irish debt to junk status. Spain and Portugal seem headed in the same direction. Italy’s financial troubles ramped up. That country is generally considered too big to fail. It is, by the same measure, also too big to save.

The second factor is the US debt ceiling imposed by the Congress. In two weeks, the US government is calculated to hit that ceiling. When that happens, Washington will run out of money to pay its bills. President Obama warned that among the first to be hit will be social security payments.

The Obama administration proposes cutting the public deficit by $4 trillion over a decade and some tax increases in exchange for raising the debt ceiling. The Republican-controlled US Congress finds that unimpressive. They want more spending cuts and no tax increases.

After weeks of intense negotiations between the Obama presidency and the US Congress, no breakthrough is visible. Failure to win an adjustment in the legally imposed debt ceiling will compound the adverse condition of the US economy. The fallout on the global economy will be wide.

Neither the US nor the European debt crisis is amenable to a quick resolution. Both will involve long periods of austerity and structural adjustments. The consequence will be lower growth at best and economic stagnation at worse.

A full financial meltdown remains a possibility too.

The effort of the European Union and the US government to contain the financial crisis was described as akin to kicking a can down the road. One particularly astute analyst, however, provided an even more acute analogy. He proposed characterizing the response as akin to rolling a snowball down a hill. As the ball gains in size, it will begin to roll out of control, growing even more as it does so.

Many fear that the snowball of public indebtedness has now begun to run out of control.

When one European official carelessly allowed himself to say that Greece will probably go into “partial default”, things just went awry. That is, without doubt, a realistic thing to say. It is also a disastrous thing to admit. Immediately, there was massive selldown of stocks in the global markets.

There is, after all, no such thing as a “partial default.” A default is a default. The possibility of not getting paid raises the risks of lending. The credit lines will freeze. Interest rates will become punitive.

More important, that remark about a “partial default” resonates as an admission that the problem has blossomed to a point that governments can no longer manage it. That undermines confidence in the whole effort to bail out Greece and stave off bankruptcies in the other affected economies.

The grave question on the table now is: Are political systems as they are now organized capable of managing the financial system as it has now become?

That is, I recall, a question (or variants of it) that was raised in the wake of the 2008 global financial meltdown. When some form of tenuous recovery happened after a series of “stimulus packages” were rushed into place like so many sandbags put up against onrushing waters, the question was conveniently set aside. Any attempt to answer it will involve making politically painful decisions that run against the contemporary political values we hold.

Note the epicenters of the current financial crisis are mature market economies with fully functioning democratic institutions. In Europe, a monetary union was forged but fiscal policymaking was left to the individual nation-states. In the US, the “stimulus packages” and the two “quantitative easing” programs enacted by the US Fed might have momentarily mitigated the worst outcomes of financial meltdown — but they also hastened pushing public indebtedness up to the politically defined ceilings.

When, for instance, Zimbabwe hit an inflation rate of 4,000 percent, the country did not threaten global financial stability. It was a minor economy with a tin-can tyrant that might be allowed to rot in hell.

When Greece, Ireland, Italy, Spain and Portugal teeter on the brink of default, by contrast, the entire global financial system shudders. When compounded with the possibility of a US default on its debts, panic becomes an acceptable sentiment.

The financial crisis now staring us in the face emanates from democratic market economies where governments found it convenient to appease voters by building prosperity on borrowed money. Now, they can only work themselves out of the problem by ignoring the populist impulse of their constituents and imposing harsh austerity measures against their will.

In the near term, we will likely see a revolving door of governments coming and leaving in quick succession. The matter of governing economies from “commanding heights” rather than from the valley of populist sentiment will remain an intractable challenge.