Are European Debt Problems Fixed, or Just Papered Over?

Is Europe's economy really healing, or are the Band-Aids pulling loose? Officially, the Continent's fiscal health is on the mend, but each time someone with political clout declares that the European debt crisis is history, some ugly financial news emerges shortly thereafter to undercut those claims.

For example, no sooner did Spanish Prime Minister José Luis Rodríguez Zapatero claim that the European debt crisis was over than Moody's downgraded Spain's sovereign debt.

Oops.

Like many other eurozone nations, Spain is struggling with the grim aftermath of the collapse of a long housing boom: a deep recession and an unemployment rate around 20%. As its economy stumbled, Spain racked up a total public-sector deficit equal to 11.2% of gross domestic product in 2009, almost four times as much as the European Union's guideline of 3%.

While the government in Madrid plans to slash the country's budget gap to 6% next year by cutting spending at its ministries by 15% to 16%, the Spanish citizenry are voicing their disapproval of the austerity program in angry protests. And public resistance to official plans to drastically trim central government spending isn't limited to Spain: Anti-austerity agitation is widespread throughout Europe.

Fiscal Fixes Lead to Political Crises

Greece continues to be wracked by political strife as organized labor resists the extreme austerity demanded by the lenders who bailed the nation out of its debt crisis. Greece received $140 billion from other eurozone countries and the International Monetary Fund while running a deficit equal to a staggering 13.6% of its GDP. It has a plan for lowering that to 8.9% in 2011, but fierce political resistance is undercutting even that modest goal.

Another nation that saw property values plummet, Ireland, faces a deepening fiscal -- and thus, political -- crisis.

Credit agency Moody's recently cut its ratings on Anglo Irish Bank's debt, a downgrade that sent Irish credit spreads to new highs. As a result, the cost of insuring Irish debt from default hit a new peak.

The Dublin government earmarked 25 billion euros to bail out Anglo Irish, a sum that will push Ireland's 2010 budget deficit to almost 25% of gross domestic product. Like every other eurozone country running potentially ruinous deficits, Ireland plans to pare its spending to comply with the EU limit of 3% by 2014.

France, which weathered the global recession far better than most of its EU brethren, is also facing massive resistance to relatively modest reductions in social spending. Government plans to raise the retirement age from 60 to 62 triggered widespread strikes that disrupted airports, train stations and schools. Even at 62, France's retirement age would still be the lowest among developed economies. Germany is planning to boost its retirement age from 65 to 67, the same target that the U.S. Social Security system established some years ago.

Even without these belt-tightening programs, the fiscal backdrop in Europe is dismal: The eurozone is contracting outside the "core economies" of France and Germany.

Not Even Powerhouse Germany Is Immune

While Germany's unemployment is an enviable 7.6%, roughly the same level as it was during the global meltdown in 2008, and its economy grew a healthy 2.2% in the second quarter, the eurozone powerhouse is not without its own unique problems.

Gemany's 2010 growth was largely dependent on a strong rebound in exports because German consumer spending has long been anemic. The problem with relying on exports, though, is that so many of those products are intended to flow into the markets of Germany's eurozone partners -- the same countries that now face massive austerity cuts to government spending and faltering economies.

Germany also has its own serious debt woes. The Association of German Banks recently reported that its 10 biggest lenders may need to raise about 105 billion euros ($133 billion) in capital because of new banking regulations, and that need for extra cash on hand will limit their ability to make loans. German banks also have huge exposure to the shaky sovereign debt of Greece and other troubled EU nations.

Globally, Banks Face Massive Refinancing

It's not just German banks on the hook for hundreds of billions in new financing and bond issuance. Financial institutions around the world will face a major challenge over the next few years: Trillions of dollars in debt must be "rolled over," or refinanced. Globally, banks owe about $5 trillion to bondholders and other creditors that will come due by 2012, according to the Bank for International Settlements (BIS).

But European lenders own a substantial share of that burden: About half of the liabilities -- some $2.6 trillion -- are in Europe.

The BIS has several fundamental and far-reaching concerns about this significant eurozone debt load. One is that banks desperate for refinancing will be competing with governments, which will also have to roll over gigantic sums in the global bond market. Competition for bondholders' favors will result in higher credit costs for business and consumers, with predictable consequences: reduced economic activity.

Sponsored Links

The BIS's second great concern is the gargantuan sums that have been promised to citizens in eurozone social welfare programs. As Europe's working-age population shrinks and the number of retirees rises, the ability of governments to pay the benefits and service the huge debts that have been accumulated is in question. These issues are documented in detail in a BIS report issued earlier in 2010: The future of public debt: prospects and implications.

The choices facing governments with rising social welfare and debt costs are bleak: Cut benefits, raise taxes on a dwindling base of workers, or both.

Eurozone leaders are undoubtedly anxious to calm any fears that the region's interlocking banking and sovereign debt crises are still unaddressed. But credit agencies, demographics, public protestors and the bond market are all issuing warnings that official pronouncements and empty plans for future spending cuts are at best Band-Aids being hastily plastered over Europe's longer-term structural problems.