In January, when I was covering the World Economic Forum in Davos, Switzerland, the alarm bells were sounding about sovereign debt. When discussing the next global crisis, Ken Rogoff, a professor of economics at Harvard, gave an impassioned warning. “Government money brought us back,” he acknowledged, “but it morphed into a long-term debt crisis—an illusion of normalcy. The crisis is over because governments guaranteed everything and spent like drunken sailors.” Rogoff gave the bailout its due, noting that it was a good thing that we didn’t have a second Great Depression. “The problem is,” he added, “if one looks at history, banking crises are too often followed by a wave of sovereign debt crises a few years later. No surprise, [today] debt is exploding. In countries like the U.S., we may see painful political consequences—belt tightening, higher taxes, slower growth. In emerging Europe, we could see worse, including outright default. We may tell ourselves we’re better; we’ve figured things out; we won’t have the political problems other countries have faced; we’re different. But I submit to you, we’re not.”
Not everyone agreed with Rogoff’s position, but almost like clockwork, when I arrived back in New York from Davos, the focus turned to Europe and a staggeringly slow recovery. CEOs from Hewlett-Packard to Coach told me Europe was stuck in the mud, unable to break out of the grips of recession. And now the new focus was government debt, particularly in Greece and its impact on the rest of Europe.
Since Greece was part of the eurozone, consisting of sixteen states that use the euro as their sole currency, there was deep concern over the possibility that the entire region could be on the hook to bail them out. Once again, we were dealing with “too big to fail,” only this time it was on a national level. How many American companies would be exposed, and how deep would the contagion run? These worries gripped the markets.
When the euro was formed back in 1992, there were several critics who argued that it was folly. They asked, how could you combine a large group of nations with very different economic landscapes and financial sensibilities under one umbrella, one currency, and one central bank? For example, as the strongest player, should Germany’s central bank be governed the same way as a weak player like Greece? Now it seemed that the worst fears were coming to pass. With Greece’s sinking fortunes tied to Europe’s financial stability, the stronger nations were facing popular unrest. I saw that people in Germany were angry the way many Americans were angry in the face of bailouts a year earlier. They were asking, “Why should Germans, who have practiced fiscal responsibility, have to bail out the people of Greece for their bad spending habits?” The situation was reminiscent of the weekend on Wall Street when Hank Paulson and Tim Geithner tried to persuade big firms like Goldman Sachs, Citigroup, Morgan Stanley, JPMorgan, and others to create a fund to help Lehman or face the risk of going down themselves. A year and a half later, European leaders were trying to convince Germany, Italy, Ireland, and, to a lesser degree, Portugal and Spain to do the same for Greece. When the European Union and the International Monetary Fund came up with a bailout of $1 trillion, it was stunning. This was an extraordinary amount of money, and yet in the days following the announcement, the global markets plummeted. Investors were not convinced it would work.
It wasn’t only European fortunes that were tied to Greece’s crisis. There were implications for America as well. According to Moody’s, Greece’s debt was an untenable 115 percent of the country’s economic output. No one I talked to saw U.S. debt escalating to levels as high as Greece’s, but one investor I spoke with off the record—a leading investor in China—shared with me important information about one possible consequence that could have a major impact on the economy here. This investor was very concerned about U.S. debt because he said that 50 percent of China’s wealth was invested in our debt. If our situation did not improve, he told me that China would scale back its buying of debt. The outcome: we’d probably have to raise interest rates to make the debt more attractive to investors, and that would likely have ripple effects on interest rates domestically, affecting everything from bonds to the housing market.
Again, it was a sobering picture of the consequences of too much debt. As we watched riots break out in Athens over the prospect of skyrocketing taxes and the brutal sacrifices being imposed on a nation on the brink of failure, I couldn’t help thinking that we should be taking a lesson from the crisis abroad. Imagine a scenario where the U.S. government would announce simultaneously a huge tax hike, a wage freeze, a spike in the price of oil, delayed retirement, higher interest rates, higher unemployment, and a generally depressed standard of living across the board. While such a scenario was not likely, it was not the stuff of science fiction, either. The sovereign debt crisis could place the American dream at risk.
In May 2010 I spoke to former president Clinton, and he cautioned against the mentality that we could spend our way into prosperity. “The American people have to take responsibility,” he said. “You just can’t keep saying you want more government than you want to pay for. And borrowing money from overseas, it’s just not right. It’s bad for our kids and grandkids, and it puts us in a very vulnerable position going forward.
