What Do National Debt Problems Mean to Me?

Two fears have invaded the business world. One is the potential expansion of the European debt crisis. The other is the gridlock in Washington in regards to increasing the U.S. debt ceiling.

The Greek debt crisis festers and refuses to heal, while U.S. total public debt relative to gross domestic product (GDP) has reached its highest level since WWII.

Our outlook on Europe is fairly straightforward. The Greeks have to be bailed out. Though the Germans, French and others will complain bitterly about it, in the end they have little choice. A Greek default would seriously undermine the health of too many European banks; and, perhaps more importantly, it could cause a domino effect involving state and private financial institutions in Ireland, Portugal and Italy.

Pressure on interest rates

Assuming an agreement regarding Greece is reached in the near term, European banks may begin to build fortress balances for “next time.”  A “next time” will likely come as Greece, and perhaps other nations, fails to adhere to needed austerity measures over the next two to three years. While the accumulation of excess reserves hedges banks against a future default, it will provide less liquidity for businesses and individuals over the next few years. This lack of liquidity can be expected to exert upward pressure on interest rates. Increased interest rates and a diminished ability to borrow can be expected to create some headwinds to economic growth in Europe and in the United States.

Rising interest rates will likely come from other sources than Europe. The threat by major credit rating agencies to downgrade the U.S. Treasury’s credit rating signals a possibility of higher interest rates. We do not expect a large move in interest rates in the near term, but a noticeable shift to higher rates is expected in 2012 as the debt issues of the European Union and the United States linger.

Another clear implication of the problems in the United States and Europe is that national governments will be severely constrained in their ability to respond to sluggish economic growth with short-term fiscal stimulus. We think this is already a factor in the current slowdown, and will continue to be an issue as we move into the next recession in 2013-2014. Grand bailouts and emergency stimulus measures will be off the table the next time around.
Several key findings were observed in June:

1. Economic recovery from the disasters that befell Japan in March is taking shape. As we anticipated, the impact for the most part has been relatively short-lived and normal business cycle changes are indicated going forward.

2. There was improvement in several key leading indicators. In the case of the Purchasing Managers Index, we have a tentative May 2011 low that will likely hold, signaling that the macroeconomic trend will be one of cyclical improvement in 2012; probably more so in the second half of the year.

3. A longer-term leading indicator, corporate bond prices, turned decidedly negative this month. This change confirms our outlook that the economy will be weakening as we go through 2013.

Keep in mind that the backside of this business cycle (2011 to early 2012) looks to be a soft landing. Plan on higher volumes of activity over the next 18 months. Do you have the processing, accounting and shipping capabilities to be busier in 2012 than you are today?  The current environment is very friendly toward making capital expenditures if those expenditures eliminate a bottleneck, push you into a new market place, or have a short payback period. 

Alan Beaulieu, alan@itreconomics.com, is president of the Institute for Trends Research (ITR). His weekly radio show, “Make Your Move,” can be heard at www.voiceamerica.com every Monday at 4 p.m. (Eastern time). Podcasts are available through voiceamerica and through iTunes.

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