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Call it the summer of debt.

Since late July, global markets have been through a big sell-off that at one point took the S&P 500 index down nearly 20 per cent from its late April-early May highs.

Debt was the big theme, from the spectacle of the debt-ceiling battle in the U.S. to new fears about debt problems spreading in Europe.

And even now, as markets have stabilized and come back a bit, nervous investors are waiting for the next shoe to drop.

The U.S. and European economies are showing signs of weakness, even as investors hope for a miracle from the Federal Reserve, which already has said it would keep short-term rates at essentially zero for the next two years.

And political leaders on both sides of the Atlantic seem unable to get a grip on the problems—or tell voters how intractable they really are.

How intractable? Recessions that follow financial crises tend to be deeper, and the debt problems that caused those crises shift from the private sector to the public sector.

Subpar economic growth makes it harder for governments to solve their debt problems. So, the dark debt cloud may hang over the .U.S, Japan, and many European countries for years.

To get some perspective, I spoke to Raghuram G. Rajan, a professor at The University of Chicago Booth School of Business and former director of research of the International Monetary Fund.

Rajan gained notoriety by speaking truth to power at Federal Reserve chairman Alan Greenspan's final Fed retreat at Jackson Hole, Wyoming, in 2005. In the paper he presented, Rajan warned that banks and Wall Street firms were taking on too much risk and that changes in the financial markets "may also create a greater (albeit still small) probability of a catastrophic meltdown."

"…I felt like an early Christian who had wandered into a convention of half-starved lions," he wrote later, especially since some of the other papers "focused on whether Alan Greenspan was the best central banker in history, or only among the best." Let's just say Rajan wasn't the most popular figure at the cocktail parties.

But he did go on to write an excellent big-picture analysis of the crisis, Fault Lines, which won the Financial Times and Goldman Sachs 2010 Business Book of the Year award.

Now, he says, the conflagration may be over, but the embers are still burning.

"Recoveries from crises that result in over-leveraged balance sheets are slow, and are typically resistant to traditional macroeconomic stimulus," he wrote recently in his blog. "Over-leveraged households cannot spend, banks cannot lend, and governments cannot stimulate."

That prolongs the agony. As Carmen Reinhart of the Peterson Institute for International Economics and Kenneth Rogoff of Harvard University wrote earlier this year: "…Large public debt overhangs do not unwind quickly, and seldom painlessly… The debt-reduction process goes on for an average of about seven years."

Rajan told me the financial crisis did not cause the debt crisis, which has been brewing since the mid-1970s. "The crisis was the nail in the coffin, but it's been building," he said.

And believe it or not, Rajan said Europe's problems were worse than those of the US. "One of the advantages the U.S. has is that the size of the government is still relatively small—40 per cent of GDP, vs. 50 per cent to 55 per cent in Europe," he said. That includes state and local government spending.

"Relative to other advanced countries, the U.S. is still more circumspect on government spending," he said. Chalk that up to Europe's bigger safety net and slower-growing or even shrinking populations.

Rajan said the European debt crisis is "classic contagion in the sense that everything's linked." And as time goes on, he said, we're moving up the ladder from the weak to the strong.

Last year's problem was Greece, Ireland, and Portugal, three of the Eurozone's smallest economies. The European Union came up with an emergency fund of up to 440 billion euros (about $634-billion U.S.) to "ring fence" those economies—and, it was hoped, cauterize the wound.

But Greece's problems were worse than they appeared, and this year the worries have centered on Spain and Italy, the Eurozone's fourth- and third-largest economies, respectively, with combined GDP of $3.5-trillion. German and French banks have nearly $900 billion in exposure to those two countries' economies.

Spain had a housing bubble and bust similar to ours. Unemployment is 21 per cent and growth is almost zero, giving the government little help in its efforts to rein in deficits. Private household debt there also is very high.

Italy's ratio of public debt to GDP of nearly 120 per cent is one of the highest in the world. It's also a stagnant economy, with minuscule GDP growth. And public corruption? It could have been invented there.

"The big concern was about Spain. [But] even as Spain showed some signs of stabilizing, Italy started making noises," said Rajan. "Who's strong enough to guarantee Italy?"

Any volunteers? How about Germany? By far the healthiest major economy in the Eurozone, Germany has had strong growth powered by exports and a deficit less than 2 per cent of GDP.

But Germans have balked at always having to bail out the weaker countries. They claim, not unreasonably, that they tightened their belts when they needed to and worked hard to compete with China and other emerging markets. So, why should they pay for countries that didn't?

It's a tough question for chancellor Angela Merkel, which may be why she has ruled out a common euro bond or making massive infusions from the German treasury to debtor countries. If she tried either, voters might boot her from office.

"Europe is asking Germany potentially to take on many years of higher debt and pay higher interest [rates]," Rajan told me. But, he added, Merkel knows that "if Europe collapses around Germany, Germany will collapse, too."

So Germany is between the proverbial rock and a hard place, and its economic growth has slowed sharply, giving Merkel even less maneuvering room. That's why no big initiatives are likely forthcoming.

"They want to do just what is necessary and nothing more," said Rajan. Translation: muddle through.

Maybe they'll be able to do that, or maybe they won't. Or maybe there has to be a big crisis to force politicians to do what the public isn't ready to do. That could entail a big rescue package, some elements of default, some form of euro bond, or even some countries leaving the Eurozone—or a combination of the four.

"If any country leaves, it's going to be the small peripheral countries, rather than the big central ones," said Rajan.

But investors won't rest easy until the situation is actually resolved. And given the dynamics, that will likely take years — and will require a more durable economic recovery, which isn't on the horizon now.

The market may rally and then sell off as the debt crisis waxes and wanes, and we may see bull market runs, as we did from 2009 through earlier this year.

But is this really a prescription for a sustained, "secular" bull market, either here or anywhere else? I don't think so.

Howard R. Gold is editor at large for and a columnist for MarketWatch. You can read more commentary at He blogs on politics at