Global Crisis Blog

The REAL Sovereign Debt Crisis

By Shlomo Maital

     In general, the truth lies not IN the headlines, but behind them, in the back pages. 

    The sovereign debt crises in Greece, as well as in Ireland, Portugal,  Spain, and before them, Iceland, capture the media’s attention.  Because of bailout and fiscal stimuls spending, public debt as a percentage of GDP will exceed 110 per cent in 2014, in the G20 countries.  Under Europe’s Masstricht  Treaty, signed in 1992,  60 % was regarded as an upper limit.  But an insightful brief article by Richard  Barley, in the Global New York Times (Feb. 17) goes behind the headlines.[1]   The REAL debt crisis, it emerges, lies elsewhere.

     During the boom times of the ’90s and ’00’s, “recklessly generous social contracts offered to their citizens in the boom years [social security, health care, etc.]”  created enormous contractual legal entitlement debts stretching 50 years into the future.  These contracts, motivated by politicians’ desire to gain votes, represent irresponsible unforgiveable risk, because no government will be able to fulfill these obligations.  Governments in the US, UK and elsewhere have misled their citizens, leading them to believe they will be ‘taken care of’ after retirement, when in fact the money for this will not be available.  Compared to the reckless risk mismanagement  of the banks, governmental risk mismanagement is orders of magnitude worse.

      Here are the numbers.  According to the International Monetary Fund (IMF), an impeccable source, as well as a study by economist Jagadish Gokhale for the U.S. National Center for Policy Analysis,   the net present value of age-related deficit spending, as a per cent of GDP  [i.e., the present value today of future pension and health obligations to retired persons ]   is: 

             Greece 900 %   Canada 600%  US  500%  UK 450%   Portugal 500%

 In other words,  these governments have accepted such huge age-related commitments, that they will doubtless be unable to pay for them.  If you are aged 50 or more,  start saving.  Those benefits you think you will get on retirement?  Probably, you won’t get most of them. 

      Here is some simple economic analysis about how this age-related debt crisis will play out.  * As governments try to pay for these expenditures by borrowing, they will issue increasing amounts of government bonds. (Politically, in the US social security is known as the ‘third rail’ for politicians — touch it and you die — after the electrified 3rd rail on train and subway rails).   * Higher supply of bonds causes their price to fall, and yields (interest rates) to rise steeply.

    If you are invested in government bonds, take into account that there will be tremendous long-run downward pressure on their prices.   Another implication is inflation.  Governments in the past escape burdensome debt by inflating the currency, reducing the real cost of that debt.  Will they do this again?  In an age of deflation, the shortsighted do not worry about inflation. Yet a future inflationary scenario is highly plausible, given the huge amounts of money now floating about in the system, and the debt scenario described above.    


[1]  “After Greece, the real sovereign-debt challenge”,  IHT/Global New York Times, Feb. 17.

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