Monday, February 8, 2010

Why Sovereign Debt Concerns Are Rattling the Stock Market

Today, the Dow Jones Industrial Average fell another 104 points. As with the down trend of the past two weeks, worries about sovereign debt problems were a major factor in today's drop. The market is down more than 7% from its 2010 peak. We'll be in correction country if the Dow drops another 250 points. Why would the profligacy of medium sized countries like Greece, Portugal, Spain and Ireland matter so much?

Because these days we're so highly dependent on government supported banking systems and economies. If governments fail, there is no backup, no Plan B. We'll have to reach for our bootstraps. But in a world now addicted to morally hazardous government handouts, bootstraps have deteriorated from neglect. Lots of folks no longer have personal safety nets. The abyss looks deep and dark.

Part of the problem is that profligacy isn't limited just to medium-sized and small countries (like Dubai). It's also become fashionable with major powers, like Japan, the U.K., and . . . ahem, we'll just look down in our laps and not name the other really big country that's borrowing an awful lot these days. If a really big sovereign debtor starts to waffle, look for a swan dive from the markets.

What can be done? In these days of governmental dysfunction, that's a damn good question. One that doesn't have a damn good answer. Politically speaking, it's ten times easier to increase government spending than decrease it, and a hundred times easier to cut taxes than raise them. The political cycle, with elections at relatively short intervals, punishes politicians for inflicting short term pain even if they provide long term gain. Long term problems like the growth of national debt are backburnered by expediencies required for re-election. The very real distress of tens of millions of Americans during the current recession justifies stimulus spending, even at the expense of increasing the federal deficit. But not indefinitely and certainly not with spending focused primarily on propping up a banking sector that is parsimonious with loans but not executive compensation. There are limits to everything--that's the most crucial lesson of the real estate and credit bubbles of the early 2000s. And there limits to deficit spending by America.

In the 19th Century, a Chinese name for America was "the Golden Mountain" (derived from the California Gold Rush, which attracted thousands of Chinese miners). Today, America is still golden, with the dollar being the world's reserve currency and America's military serving as the global police force. Most of the world wouldn't want another currency as its reserve, nor would it want another nation to protect international shipping lanes and suppress unrest. The U.S. Navy safeguards Europe's and East Asia's oil supplies, which come in large part from the Middle East. U.S. ground forces brought peace to the former Yugoslavia, after Western Europe failed. Mostly because of the strength of American arms, the Allies suppressed Saddam Hussein's aggression in the Persian Gulf. America has played the largest role in the past decade's struggle against terrorism.

The world needs America. But not at any price. We don't know where the tipping point--the point at which China, Japan and the rest of America's international creditors will turn off the spigot--will be. Recall that 100 years ago, the British Empire issued the world's reserve currency and safeguarded international shipping lanes. Today, the U.K., which may be splintering even on the island of Great Britain, is a quaint tourist destination that too greatly seeks the evanescent prosperity that sometimes comes from over-investment in the financial sector. We Americans know we need to get our house in order. We also sense, and even know, that we won't necessarily succeed. The stock market foreshadows the consequences of failure. And there is no Plan B.

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