Short-Term Fixes For Debt Crisis Won’t Fix Real Problem

July’s global business headlines were dominated by Greece’s high debt levels and the public’s negative reactions that followed. Short term measures have been implemented which has shifted the focus to other countries such as Italy, which is experiencing similar debt levels, but 6 times larger and therefore much more important. We have expanded on this some more below.

Although Italy has other strengths compared to Greece such as lower fiscal deficits, higher private sector savings, a strong banking systems plus lower unemployment levels, Italy does have high debt levels. This makes the country vulnerable. Without retaining investor confidence with high interest rates in return for lending money, it will be extremely hard for Italy to raise new funds.

Being part of the Euro has been a double-edged sword for countries like Italy and Greece. Although their borrowing costs decreased following joining the Euro, as they became part of a larger, sturdier union, having the same currency as other stronger countries in Europe has also created various problems. Had they retained their own currency during these economic downtimes, their export competitiveness would have increased; it would have boosted tourism and provided a shock absorber to their economic woes. However, within the Euro, such natural rebalancing factors haven’t been able to happen.

Along with Europe, some of the recent financial headlines have also been dominated by the US – the world’s largest and richest economy – experiencing its own debt crisis. The US debt ceiling was reached recently – a huge US$14.3 trillion – however, again it is important to note that the US is a huge economy – the largest in the world. Congress has since raised the debt limit by at least $2.1 trillion.

Similar to a household that spends more than it earns, a country with too much debt and a growing interest bill must find ways to bring in more income and review spending habits. Decisions must be made about where cuts can be made and by whom. Country solutions often include raising taxes and cutting spending on services. Neither of these helps economic growth prospects – especially with an already weak economy. They are also not very favourable for current politicians as the next elections approach.

Overall, the resolution we are seeing in these countries at present are just short-term fixes rather than real solutions. To get these economies back on a sustainable footing for long-term recovery and growth, outgoings simply have to be lower than incomings.

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