Economic growth is currently slowing across the world’s major economies including the United States, Europe and China.  The major problem is that the world economy has accumulated an enormous amount of debt over the last two decades.  Government debt ratios as a per cent of GDP are very high and continue to grow as governments run further deficits. 


  Government Debt as a % of GDP Government Deficit as a % of GDP 10 Year Government Bond Yield
Japan 230.00% -9.50% 0.80%
Greece 160.80% -9.10% 25.60%
US 103.00% -8.10% 1.60%
UK 82.50% -8.30% 1.70%
Europe 82.50%    
Germany 81.50% -1.00% 1.60%
Spain 68.50% -8.50%


Source: Bloomberg

Governments in Europe are being asked to reduce deficits in order to repay debt.  Unfortunately reducing deficits will only compound the problems of slowing growth and high unemployment.   The problem is being accentuated by rising interest rates in countries such as Spain making it more expensive to fund their deficits.  Being part of the Euro limits Spain’s flexibility to implement the policies being adopted by the US and the UK to buy their own debt and keep interest rates low.

To solve the excess debt problem savers, who have effectively lent too much to those that could not afford to repay it, will have to help reduce the debt payment burden.  One way to do this is to create some inflation and effectively deflate the debt.  Another is for the richer nations such as Germany guaranteeing the debts of the weaker nations such as Spain through instruments such as Eurobonds. 

The German government currently does not want to adopt either of these approaches and continues to push for fiscal austerity.  Unfortunately austerity is likely to create more pain and instability and is increasingly not being seen as the right solution.  At current interest rates Spain will find it very difficult to continue to finance its deficits and may have to leave the Euro.  However, the Germans do not wish this either which leads to the possibility of some solution / compromise over the coming months.

Jonathan Windust