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Economic Forecasts

Greek Crisis Only Tip of the Debt Iceberg

In fact, most of the industrialized world is carrying way too much debt.

Excessive debt is a global phenomenon. The crisis in Greece and the huge bailout fund put together to reassure investors in Europe may be dominating the news today, but the problem is much wider. “The sovereign debt of the developed countries has to be watched very carefully -- how it’s managed, how it’s serviced -- over the next year,” says Joseph Quinlan, chief market strategist for the Bank of America’s U.S. Trust.

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Most developed countries overborrowed in recent decades. In the U.S., federal debt soared from an amount equal to 45% of GDP in 1989 to 69% this year. Japan went from 14% to 106%. The U.K., from 30% to 75%. The U.S. figures don’t include state and local debt or future liabilities, such as money borrowed from the Social Security Trust Fund, funds needed for other safety net programs or money for civil service pensions. With those obligations added in, the U.S. debt reaches 95% of GDP.

Worse, for most developed countries, the holes continue to deepen with each year of deficit spending. The amount of debt relative to GDP will climb sharply by 2013.

Only a few nations -- Norway, Saudi Arabia, Bahrain and some other Mideast oil producers -- operate in the black.

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And some emerging markets aren’t in as deep. South Korea, Brazil, Chile, Colombia and Indonesia, for example, have instituted tough fiscal restraints. Canada, too, has successfully curbed its spending. China’s debt pales compared to its reserves.

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For the more profligate developed countries, the time to pay the piper is nearing. It’s fast becoming untenable to service the mountain of debt they have incurred.

Economic growth will inevitably slow, as spending drops on infrastructure, social welfare programs and more. For those countries such as the U.K. that rely more heavily on government programs as an engine of growth, withdrawal will be especially painful.

Also, taxes will rise. It’ll be impossible for most governments to save their way back to fiscal health. Increasing government revenues will be part of the mix.

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Look for a scramble for exports, heightening trade tensions, as countries crave more growth from sales abroad to offset a dampening of domestic demand.

Currency devaluations are likely, as the U.K., Japan and others seek an edge for their products. The euro, already slipping in value, will likely continue to weaken.

Foreign creditors will wind up taking haircuts as loans are restructured, Even if outright defaults are mostly avoided, write-downs will hit the big global banks.

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Greece probably can’t avoid default. Its bailout package is conditioned on the country shrinking its budget deficit from 14% of GDP to just 3% by 2014 -- a herculean task. Spain and Ireland are in perilous shape. Portugal is only a bit better. Italy and Japan have the advantage of their debt largely being held domestically. Not the U.K. It’s the most vulnerable of the larger economies. For now, the U.S. is still a safe haven, but that’s little cause for celebration.

“That’s like saying you’re not well off, just less bad off. To the extent that demand for U.S. dollar-denominated assets is driven by turmoil in Europe, not our own fundamentals, we should be very leery about how (sustainable) that is,” says Carmen M. Reinhart, professor of economics and director of the Center for International Economics at the University of Maryland.

If the U.S. deficit keeps rising at an unsustainable pace, adds Olivier Garret, CEO of investment research and advisory firm Casey Research, “at some point the market is going to say we don’t want U.S. debt.”

Eventually, all the big debtors will pay a price of one kind or another.

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