Change You Can Believe In…

By: Dr. Mike Campbell

In a recent letter to other G20 members, the President of the United States urged that a cautious approach to the thorny issue of sovereign debt reduction should be adopted. Mr Obama fears that if the world’s leading economies seek to reduce their debt problems by prematurely unwinding the (very expensive) stimulus packages that they put in place to stave off financial meltdown in the face of the crisis triggered by the sub-prime lending crisis, the global recovery could be put in jeopardy.

It seems that governments are caught in a damned if you do; damned if you don’t situation. The ratings agencies have raised the spectre of default on sovereign debt by Greece, Portugal, Spain and Italy which has put substantial downward pressure on the Euro. Whilst this makes Eurozone exports more affordable, it also shrinks the value of foreign exchange coming into the block. Moreover, it inflates the price that these nations must pay to borrow funds needed to meet their debt obligations. A one percent increase on the cost of borrowing one billion Euros equates to an additional annual interest payment of €10 million, purely for the privilege of borrowing the funds. Ultimately, this must be funded through a country’s exchequer either in raised revenue or from expenditure cuts. Given, in view of the Eurozone/IMF support network, that the true probability that a Eurozone nation will be allowed to default on its debt is minimal, the hiked rates triggered by the ratings agency (down) grading seems to be an unjustifiable additional cost in difficult times. A review of the underlying sovereign debt rating mechanism is clearly overdue.

The USA plans to reduce its deficit (which is astronomic) to 3% of GDP by 2015. The current level is 10.4% or roughly $14.6 trillion - and you think Greece has problems!