Starting locally, debt's reach grows globally (Feature)

By Niels C Sorrells and Shabtai Gold Apr 20, 2010, 6:07 GMT

Berlin/Geneva - The ranks of countries teetering on the edge of what could be crippling debt levels seems to grow every month. The US, Britain, Greece and Dubai are only some of those whose budgets are threatened by a sea of red ink.

But while these countries will need to sort out domestically how they hope to pay off their debt while maintaining economic growth, there is reason to think that the aftershocks of their debt problems might be felt globally.

Indeed, no country - even those that have built up foreign reserves and surpluses - will be able to ignore the problems of the debtors or enjoy too much schadenfreude at their expense.

'Debt consolidation in one part of the world will be amplified,' said Sotiria Theodoropoulou, a policy analyst at the European Policy Centre. 'If recovery does not pick up, then the exports of the emerging economies will also suffer.'

Which means it is in everyone's interest for the struggling Western economies to get their houses back in order. The question, thus, becomes how.

Marc Ostwald, an analyst with Monument Securities in London, notes that today's situation is a near complete reversal of the situation 30 years ago. Then, many developing economies were heavily indebted, dependent upon loans from the West to stay financially afloat.

But, thanks to splurging in the West, debt levels there have ballooned while emerging economies - many of them sensitive to debt after a series of crises - have managed to acquire piles of cash and are now in a situation where they are loaning money to the West.

'We've transferred a lot of wealth in their direction. They've now become our bank managers,' Ostwald says. 'What we've done in the space of about 30 years is probably change the balance of the world, which is probably more logical when you look at it in terms of population.'

Nonetheless, he notes: 'We can't go on like this.'

Not only does greater debt mean Western countries - ie, the potential customers for wares exported from the now cash-rich exporter nations - are too busy digging themselves out of their debt hole to borrow more money, but that they have become greater credit risks.

'What used to be risk-free is suddenly put very much in question. The benchmark government bonds were not questioned in the big economies for a very long time, but now there is a bigger question if risk-free is indeed risk-free,' said Thomas Herrmann, an economist at Credit Suisse in Zurich.

That means bond yields - or the amount of interest countries will have to pay out to entice investors to lend them money - are likely to shift higher, he said.

Thus, not only will potential customers in the West be preoccupied with paying off their debt, they will need to set aside some of their funds to pay higher interest rates. If any country were to find itself in a position like Buenos Aires, where it has to default on its debt, those lending options could become even more stringent.

'In theory, if money becomes scarcer, then the cost of borrowing will go up, but we don't know yet exactly how this will affect trade,' notes Willy Alfaro, a senior counsellor on trade policy at the World Trade Organization.

That makes it in the interests of some of the save nations - China, for example - to start spending more money, hopefully buying products from indebted nations to help them with their economies.

Alexander Koch, an economist with Unicredit, notes that China has made some tentative steps in this direction, most notably with a programme to extend health benefits, thus freeing up pocket money for its citizens. But more could be done.

The key will be communication, says Felix Roth, a research fellow within the economic policy unit at the Centre for European Policy Studies.

'The imbalance is just causing dangers to the global economy. On a global level, one has to sit together at the G20 and discuss that.

'We should be able to communicate in this sense. That, in this world, we want to avoid economic crisis.'

But he also acknowledges that talks are not guaranteed to equal unanimity. He notes that the members of the European Union long ago agreed on the need to become more competitive. But while some nations - like Germany - have done so, others who have lagged have started to criticize Germany for doing too good a job and making their economies seem uncompetitive.

Which means, the debt situation could worsen the global economy in the short term.

'This recovery may not be sustainable,' said Alfaro. 'We are concerned in the sense that the recovery is there, but not out of the woods yet.'