Which Country Will Pay the Piper First?

05/25/2010 1:30 pm EST

Focus: MARKETS

Knight Kiplinger

Editor-in-Chief, The Kiplinger Letter, Kiplinger's Personal Finance, and Kiplinger.com

Knight Kiplinger, editor-in-chief of The Kiplinger Letter, says most major developed countries have serious debt problems, but some are in worse shape than others.

European debt woes dominate the news. But excessive debt is a global phenomenon. Most developed countries overborrowed in recent decades.

In the US, federal debt soared from an amount equal to 45% of gross domestic product (GDP) in 1989 to 69% this year. Japan went from 14% to 106%, [and] the UK, from 30% to 75%.

And those figures don’t take into account other liabilities, such as state and local debt and future obligations—funds needed for pensions for citizens and civil servants or IOUs to the Social Security Trust Fund, for example. In the US, adding them would hike the ratio to 95%.

Worse, the holes continue to deepen with each year of deficit spending. The amount of debt relative to GDP will climb sharply by 2013. Few nations operate in the black—Norway, Saudi Arabia, Bahrain, and other Mideast oil producers.

And some emerging markets aren’t in as deep. South Korea, Brazil, Chile, Colombia, and Indonesia, for example, have instituted tough fiscal restraints. Canada, too, has more successfully curbed its spending. China’s debt pales compared with its reserves.

For the more profligate developed countries, the time to pay the piper is nearing. It’s fast becoming untenable to service the mountain of debt they have incurred. Economic growth will inevitably slow as spending drops on infrastructure, social welfare programs, and more.

For those, such as Britain, that rely more heavily on government programs as an engine of growth, withdrawal will be especially painful. Higher taxes [are in the cards], too. It’ll be impossible for most governments to save their way back to fiscal health. Increasing government revenues will be part of the mix.

Look for a scramble for exports, heightening trade tensions, as countries crave more growth from sales abroad to offset a dampening of domestic demand. Currency devaluations are likely as the UK, Japan, and others seek an edge for their products. The euro, already slipping in value, will likely continue to weaken. Foreign creditors will wind up taking haircuts as loans are restructured.

Even if outright defaults are mostly avoided, write-downs will hit the big global banks.

Greece probably can’t avoid default. Its bailout package is conditioned on the country shrinking its budget deficit from 14% of GDP to just 3% by 2014, a herculean task.

Spain and Ireland are in perilous shape; Portugal, only a bit better. Italy and Japan have the advantage of debt held largely domestically. Not the UK: It’s the most vulnerable of the larger economies.

For now, the US is still a safe haven. [But] all the big debtors will pay a price in the years ahead, one way or another.

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