By Robert Romano
So addicted to credit are Europe’s most troubled governments that without credit expansion, their economies can no longer grow. This is seen in Greece, where no longer able to spend more than it takes in, in the second quarter, its economy contracted by 7.3 percent.
This addiction is problematic, because so large have the debts of Greece, Portugal, Ireland, and Italy become that credit expansion itself — via annual deficit-spending — has become unsustainable. Yields on one-year Greek government bonds have moved north of 117 percent, and without the European Central Bank’s printing press, the country can no longer afford to pay its bills. Default is likely the next step.
Call it Keynes’ growth contradiction: Beyond sustainable levels, public debt drains economic output.
Under John Maynard Keynes’ economic theories, in the midst of an economic downturn, the government is supposed to engage in monetary and fiscal expansion to offset the loss of “aggregate demand” in the economy.
This belief since the 1930’s has led to an explosion of government spending and borrowing all over the world. In fact, the theory has proven so popular among policy makers in the U.S. that the national debt has increased every single year since 1958.
Eventually, it led to the creation of conditions that made the global credit expansion of the 1990’s and 2000’s possible — sowing the seeds for the inevitable crash that followed.
While Keynes’ theory accounts for economic output as it relates to levels of government spending and the size of the government-created money supply, it fails to consider what happens to those same economies when public debt reaches such exorbitant levels — as has happened today in Europe, the U.S., and Japan.
Europe’s ongoing debt crisis, Japan’s lost decade, and the anemic American recovery today all suggest there is a real upper limit on how large public debt can get before it becomes detrimental to growth. It is the point when nations can no longer afford to borrow more money to spur growth, because the government’s borrowing needs have become larger than the market’s capacity to service them.
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