Why The Center Cannot Hold……John Mauldin’s “Outside The Box”

Posted By on May 7, 2010

Risks associated with the fiscal deficits. And by the way, we should note that 25 of 27 European countries are running deficits in excess of 3% of GDP. Ireland has a deficit of 14.3%. Portugal is at almost 10%. Greece is almost 14%.

Here is a table from Variant Perception in London, from data from The Economist. Notice that France is over 8%. Germany is almost 6%. Wow. We’ll look at the implications of this later.


The first risk…. is of course, higher interest rates brought about by what they term increased risk premia. In essence, investors want to get paid more for their increased risk. Interest on Greek debt for 5-year bonds is now 15%. There is no way for them to grow their way out of the problem if interest rates are at 15%, up almost fourfold in less than a year. Rates are rising for other European peripheral countries as well.

The second risk “… associated with high levels of public debt comes from potentially lower long-term growth. A higher level of public debt implies that a larger share of society’s resources is permanently being spent servicing the debt. This means that a government intent on maintaining a given level of public services and transfers must raise taxes as debt increases. Taxes distort resource allocation, and can lead to lower levels of growth. Given the level of taxes in some countries, one has to wonder if further increases will actually raise revenue.

“The distortionary impact of taxes is normally further compounded by the crowding-out of productive private capital. In a closed economy, a higher level of public debt will eventually absorb a larger share of national wealth, pushing up real interest rates and causing an offsetting fall in the stock of private capital.

This not only lowers the level of output but, since new capital is invariably more productive than old capital, a reduced rate of capital accumulation can also lead to a persistent slowdown in the rate of economic growth. In an open economy, international financial markets can moderate these effects so long as investors remain confident in a country’s ability to repay. But, even when private capital is not crowded out, larger borrowing from abroad means that domestic income is reduced by interest paid to foreigners, increasing the gap between GDP and GNP.”


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