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Gwyn Morgan

You don't recover from a debt crisis with more debt Add to ...

The normal format for global gatherings is for the leaders to avoid personal engagement until they arrive, followed by rubber stamping of a communiqué previously worked out by their advance entourages. The Canadian G8/G20 meetings broke sharply from that pattern. And the driving issue behind that change were sharply differing views on public spending.

In the run-up to the gatherings, summit host Prime Minister Stephen Harper sent a letter to G20 leaders calling for a wind down in stimulus spending and a focus on deficit reduction. A letter from U.S. President Barack Obama cautioned that premature "consolidation" (a new euphemism for spending reductions) could cause "renewed economic hardships and recession." European Union leaders, fresh from grappling with a credit and currency crisis that threatens the very survival of the euro zone, declared that the bigger risk is failure to control runaway deficits. Responding to Mr. Obama's call for "unity of purpose to provide the policy [spending]support necessary to keep economic growth strong," German Chancellor Angela Merkel stated, "It's not about growth at any price, it's about sustainable growth," and unleashed two of her ministers to expand on her government's position. German Finance Minister Wolfgang Schaeuble told reporters "Nobody can seriously dispute that excessive public debts, not only in Europe, are one of the main causes of the crisis," while Economy Minister Rainer Bruederle said the U.S. must join Europe in "urgently" cutting spending. EU President Herman Van Rompuy said, "Failure to correct unsustainable deficits would ultimately lead to fatal loss of credibility and confidence with lasting economic damage." British Prime Minister David Cameron noted that "for some countries, such as our own, there is a need to get on and tackle the deficit more quickly."

With a national debt topping $13-trillion (U.S.), a deficit expected to be another $1.5-trillion in the 2010-2011 fiscal year, it's hard to imagine a major economy with a greater need to "tackle the deficit more quickly" than the United States. Mr. Obama's letter referenced plans to cut the U.S. deficit by half by 2013 and "work to reduce our fiscal deficit to 3 per cent of GDP by 2015," which would mean cutting the current deficit by 70 per cent, or more than $1-trillion. To say that this seems like dreaming in Technicolor is an understatement. Mr. Obama's expensive health-care reforms, along with rising Social Security costs, are certain to increase program spending, while interest payments on the national debt will grow substantially.

(At the weekend G20 meeting in Toronto, leaders agreed on a plan for advanced countries to cut deficits in half by 2013 and stabilize debt loads by 2016.)

But even the incredible U.S. deficit doesn't tell the whole story. American states face a combined budget shortfall of some $300-billion and some are in even more financial trouble than the euro zone's so-called PIGS (Portugal, Italy, Greece and Spain). But in the U.S. case, the member of the union in the most trouble is also the biggest, and its deficit position is worse than that of Greece. The state of California faces a 30-per-cent shortfall on next year's budget of some $125-billion, or a whopping $37-billion. Obama adviser Warren Buffett has said that a federal bailout of troubled states is "inevitable" if they are to avoid default on state bonds.

A look at countries that have experienced profound economic failure shows a convergence of forces creating an unrecoverable "debt spiral." Huge fiscal deficits, ever-rising interest costs on a mushrooming national debt, and growth capital sucked from the private sector to finance public sector deficits - they all lead financial markets to conclude that a country's central bank will either default on its debt or resort to printing money, causing catastrophic currency devaluation.

Who could have predicted that this Group of 20 meeting would see the chronically profligate Europeans counselling fiscal prudence, while the world's traditional economic bedrock and issuer of the global reserve currency spends it way toward disaster? The euro zone crisis demonstrated that financial markets can lose confidence in the bonds and currency of sovereign states in a heartbeat. Remember that the combined deficits of borrowing states must be financed by private investors and countries that are running fiscal surpluses, such as China and Middle Eastern oil producers. A loss of confidence in U.S. federal and state bonds, and in the world's reserve currency itself, could trigger an economic conflagration that would making the recent global financial crisis seem like a walk in the park.

The U.S. administration is playing an extremely high-risk game that could see Mr. Obama go down as the most damaging president in history. You don't recover from alcoholism by taking another drink, and you don't recover from a debt crisis with more debt. It's past time that John Maynard Keynes's long-discredited deficit spending theories be tucked back in his grave. Even if they are, it will take decades to repair the damage already done.

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