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The Globe and Mail

Lenders are the scapegoat in euro zone debt crisis

Neither a borrower nor a lender be/For loan oft loses both itself and friend/ And borrowing dulls the edge of husbandry.

– Hamlet

This advice from Polonius to his son in Act I of Shakespeare's play seemed especially prescient during German Chancellor Angela Merkel's recent visit to riot-torn Athens. Greece plummeted over "the edge of husbandry" after decades of runaway deficits, business-crippling bureaucracy and endemic corruption.

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Now the only thing keeping that country from descending into Third World status is a €240-billion ($309-billion) euro zone bailout funded predominantly by German taxpayers. Yet, far from being considered a friend, Ms. Merkel's visit ignited violent riots that included the burning of swastika-adorned German flags.

Blaming others for their self-inflicted woes is a trait Greeks share with citizens of other countries that are sinking under the weight of too much debt.

But these same citizens were perfectly happy to benefit from extravagant government programs that drove public debt to astronomical levels, igniting the euro zone debt crisis and bringing the U.S. to the brink of the so-called fiscal cliff.

Why now do voters suddenly revile those who lent their governments the money? The answer to that question reveals the reason for the Greek riots and for the increasingly volatile unrest among the multitudes of unemployed youth in Spain, Portugal and Italy. It's summed up in one word: Austerity.

For the first time in recent history the sovereign debt of several Western developed nations has fallen below investment grade, triggering a cycle of escalating bond-yield risk premiums that makes it even more difficult to service these debts. The end point of this self-reinforcing downward spiral occurs when the proverbial debt wall is hit,

either because lenders simply stop buying new bonds or the country defaults on servicing its debt.

Arresting that downward spiral requires highly unpopular austerity measures. And when debt-crippled governments are forced to cut public service jobs and social program spending, those long ignored lenders suddenly become the scapegoat. But voters should blame the people they elected. The cruellest thing a government can do is make people dependent on programs that can't be sustained.

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A heavily indebted country is similar to a family whose mortgage and car payments consume much of its income. Rather than cutting back, they obtain multiple credit cards that are progressively maxed out, incurring very high interest costs. Finally, the family defaults on their loans, destroying their credit rating and triggering the loss of their home and car. But, instead of recognizing that they are the architects of their own demise, they blame the mortgage, car loan and credit card companies.

Hitting the debt wall is a more attenuated process for countries than for families. Sovereign debt lenders tend to hang on longer because the prospect of losses on large sovereign loans is so daunting. And unlike ailing euro zone countries, families can't look to the International Monetary Fund for rescue. But even the IMF isn't capable of stopping the downward debt spiral of member countries without severe cuts in public spending. As growing numbers of angry unemployed youths take to the streets, the political fights over stimulus spending versus austerity policies will continue. But as in the case of that over-extended family, the debate about whether to cut spending or continue borrowing is no longer relevant when lenders stop lending. Many of those jobless youths will wish their parents had the wisdom of Polonius.

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