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The rest is yet to come – none of this is over….

by Aaron McCormack on April 3, 2012

Call it “end of the beginning”.  The mainstream has forgotten about Greece and the Euro debt crisis.  The mainstream takes each new piece of (thankfully) positive US economic data and adds to the recovery narrative.  The US stock markets are toying with multi-year highs that mirror where they were before the financial collapse in 2008.  And Ireland’s admittedly welcome deal to defer a €3.1bn debt repayment (probably in order to turn it into a different form of borrowing) has released pressure from the system there.

But, despite the myriad of symptoms and crises that have already manifested themselves across the world, the rest is yet to come.  Remember, these symptoms and crises have a common root case – and that is debt.  Debt is like water – once released it flows into all the nooks and crannies of economic life.  From government borrowing to banking collapses.  From people underwater on their mortgages to companies who cannot afford to hire workers.  Local government that can no longer afford to operate basic services to the individual who cannot pay their credit card.

Each one of the these events represent terrible changes and consequences for people.  At worst they lead to terrible and inescapable poverty for individuals and families.  In all cases they usually lead to lives and lifestyles never being the same again.  We can’t retire when we thought. We cannot take the holidays we wanted. We cannot send the kids to the school we wanted.  Neighbourhoods fall into decline. People continue to lose their houses.

Beneath the headline news, all this is still playing out.  The USA is enduring poverty levels not seen since the Great Depression.  European unemployment continues to climb to over 10%, whilst in the USA the unemployment rate is still DOUBLE what it was before the financial crisis.  In Ireland the continued challenges of house price collapse and underwater mortgages continues to haunt homeowners and the banking system.

The fix from the Fed, the ECB and the other Central Banks (like the Bank of England) has been to inject “liquidity” into the system.  In essence, printing/creating/borrowing more money to mask the over-borrowing that people, companies and counties engaged in.

But you don’t fix a debt crisis with more debt.  You may be able to help a country get over a temporary “normal” recession with further borrowing – a classical Keynsian stimulus effort where governments create demand to fill the gap left by people and companies who won’t spend.

A structural debt recession is a different beast.  The extra debt we are piling on at this point will have even more dire consequences.

This can play out in two ways….

In some countries the extra debt will lead to simple default.  Candidates include Greece, Ireland, Spain, Italy, Portugal and even France.  Simply put, at some point the soveriegn finances cannot add up any more as with a company that is bankrupt.

In other scenarios (perhaps the UK and the USA most notably) the long run effect of all this “liquidity” will be an eventual inflationary surge.  To counter this the central banks will have to wrench their gearsticks into reverse.  They do this by raising interest rates hard and fast.  When they do, citizens companies and local governments already close to the edge financially will teeter over the brink and eventually collapse.  There will be a spike in foreclosures and bad debts.  There will be another round of banking collapses and company closures.  Those laid off will add to the list of folks in trouble with mortgages and other debt.  Social safety nets will be further overwhelmed (as they currently are in Ireland, Greece and Spain for example).

This is a nasty spiral.  It comes from not acknowledging the root cause of our problem in the first place, and looking for the quick and painless fix that just doesn’t exist.

I hope to be terribly and spectacularly wrong.  But I fear that I am not.  Commentators will always tell you that people have called “the end of an era” or the “end of the empire” at many junctures in history but that they are normally wrong and this time is no different.

I believe that our countries have been making promises to citizens (pensions, healthcare, education, infrastructure, tax rates, safety nets) that they cannot keep.  They have borrowed to mask the problem rather than face us with the truth – in some ways it is hard to blame them for that.

The rest of this mess is yet to hit us folks.

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