The heaven-bound rise of the S&P 500 during the first quarter sprang from a broader spectrum of improvement from economic indicators including car sales, better jobs growth, and increased consumer spending.
Meanwhile, Europe struck a second bailout deal with Greece, this time establishing a committee to help ensure Greece would fulfill its promises. The ECB also flooded banks with needed capital with two rounds of Long Term Repo Operation (LTRO).
The markets breathed a sigh of relief!
Then, along came Spain, Portugal, and Ireland. Let’s use Spain as the most recent poster child.
Spain is struggling to meet €11.0 billion worth of debt obligations later in April, another €12.7 billion in July and another €20.2 billion in October.
The country is trying to solve some of its problems on its own through recent bond auctions. The bond auctions went a bit better than expected, however yields on Spain’s 10-year bonds rose, making it more expensive for the country to service that debt.
Now, let’s look at the level of US debt in comparison. The Congressional Budget Office recently issued budget projections based on two scenarios: the “baseline” scenario that the tax laws expire at the end of 2012 as planned; and an “alternative fiscal scenario” with another tax law extension.
The baseline projection puts future US debt levels at $4 trillion—approximately 94% of GDP; the alternative fiscal scenario puts them at $11 trillion—almost three times that from the baseline.
What this really tells us is that the debt levels of countries matter and that our own country’s debt level could easily become a source of concern—enough to derail our still-fragile economic rebound.
The quality of debt as well as the ratio of debt to gross domestic product (GDP) is the real kicker. For example, Canada’s debt is more than double that of China. But Canada’s financial status is the strongest of any other Group of Seven nation.
As debt increases as a percentage of GDP, the amount of revenues available to service that debt becomes insufficient. Countries have to look elsewhere for sources of capital.
Europe’s problem is the seismic effect all of this is having on the Euro and ability of the European Union to remain intact.
As the level of US debt continues to rise, the possibility that it could enter the realm of Greece, Spain, and other distressed countries looms on the horizon.
As debt levels rise and funds dry up, it affects companies’ access to capital and the ability of new businesses to get the start-up funding they need. It creates a downward spiral that spills over into the capital markets.
This has been the problem in the financial markets since the credit crisis of 2008. If the US economy continues to strengthen, the growth in GDP make it easier to shake off the effects of the crisis in Europe and for investors to have confidence in our own sustainability.
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