Politics hamper efforts to solve world’s debt crisis

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KEVIN CARMICHAEL
WASHINGTON— From Thursday's Globe and Mail
Published Wednesday, Jul. 06, 2011 9:45PM EDT
Last updated Thursday, Jul. 07, 2011 8:16AM EDT

Political bickering in the U.S. and Europe is threatening to derail the economic recovery, as leaders confront the challenge of how to pay down their massive debts.

U.S. President Barack Obama warned Wednesday that budget politics in the United States risk something “worse” than a recession, in an extraordinary sign of his frustration over Republicans’ refusal to lift the U.S.’s debt ceiling without significant concessions.

“Our credit could be downgraded, interest rates could go drastically up, and it could cause a whole new spiral into a second recession – or worse,” Mr. Obama said during an event in Washington in which the President took selected questions via Twitter.

Christine Lagarde, the International Monetary Fund’s new managing director, used her first news conference to highlight the importance of dealing with the European crisis. She told reporters the sovereign debt woes in Europe, the U.S. and Japan ranked as the issue that most worries her. “I think we’ve been burned once,” Ms. Lagarde said in reference to the fallout from the decision to allow investment bank Lehman Brothers to fail in 2008. “Better be shy this time.”

The debt crises on both sides of the Atlantic face key tests before the end of the week. In the U.S., the fight could come to a head Thursday as Mr. Obama meets congressional leaders. On Friday, the IMF will decide whether Greece has done enough to warrant a new tranche of emergency funding.

Faced with a multicountry debt crisis that some say could lead to a breakup of the euro zone, European leaders continued to be distracted from their struggle to find a solution to Greece’s fiscal mess, as a lingering dispute with credit rating agencies flared anew.

Their anger at firms such as Standard & Poor’s and Moody’s, both of whom this week raised serious questions about the viability of Europe’s effort to keep Greece and Portugal solvent, replaced some of the vitriol that European officials have directed at each other through the escalating debt crisis. German politicians especially have been resistant to bailouts, dragging out the rescue efforts. These tensions could emerge again next week, when euro-zone finance ministers have a regular monthly meeting that is expected to be dominated by the debt crisis.

Three years ago, with the world economy rapidly contracting, few paid heed as governments spent trillions to make up for lost demand. The strategy worked: A long economic depression reminiscent of the 1930s was averted, and by last year, the global economy was growing again.

But the climb out of the pit left by the financial crisis is shaky. In the countries that are leading the way, including China and Brazil, inflation is an emerging problem. Meanwhile, the U.S. and European economies are growing too slowly to meaningfully lower high unemployment rates. One of the reasons for that is debt, which is so high that governments are reluctant to implement further stimulus.

In some countries, like Greece, years of profligate spending in the run-up to the recession also are coming back to haunt governments. The United States waged wars in Afghanistan and Iraq without raising the money to pay for them. Japan’s economy has been stagnant for the better part of two decades and the country’s debt is now the equivalent of two years of its economic output.

The common thread linking all those regions is the inability of politicians to come up with solutions. The problem is most acute in Europe, where the domestic considerations of each of the 17 partners in the euro zone routinely block progress on a final solution to keep Greece, Ireland, Portugal and some other peripheral members of the euro zone from going bankrupt.

“We really wish investment bankers and not politicians were charged with finding a way to resolve this crisis,” Carl Weinberg, chief economist at High Frequency Economics, a research firm based in Valhalla, N.Y., said in a report Wednesday. “We need the best financial ideas in the world thrown at this problem, not the least politically damaging or the most politically expedient.”

Portugal’s borrowing costs surged more than a percentage point on Wednesday after Moody’s said it no longer considered the country’s debt a safe bet for investors. The problem for Europe is concerns about the stability of one country quickly spread to others, as the cost of borrowing for Ireland and Italy also climbed.

Conditions are little better on the opposite side of the Atlantic, where politicians are locked in a standoff over what to do about the U.S.’s astonishing $1.6-trillion (U.S.) budget deficit.

The U.S. too is facing a downgrade from credit raters if the White House and Congress fail to find a compromise to raise the legislatively imposed debt ceiling by early August. Failure to do so would constitute a default because the Treasury Department would be unable to issue new debt to pay the government’s creditors.