Major Economic Dominos Falling: World Government Bankruptcies

Who cares what happens to the European economy? Actually, all Americans should as it directly impacts the US and portends our country's future. What we are witnessing right now is the toppling of economic domino #13- Government Bankruptcies Around the World; one of 23 dominos that have or will yet fall.

To the right is an interesting graphic that basically sums up the European economic dominos that are lining up to, essentially, topple the European Union and Euro.

After months of denials and failed fixes, the political and economic leaders of the European Union are still wrangling over what to do about Greece's debt. However, simply put, there is no way the EU authorities can stop the first domino--Greek default or equivalent write down of its impossible debt load--from toppling the over-leveraged banks which will be rendered insolvent when forced to recognize their losses.

Greek Haircut

If banks and bondholders are forced to accept a 50%-75% write down in Greek debt, then the other debtor nations will be justified in demanding the same write down for their crushing debts. This dynamic leads to estimates that more than 3 trillion euros will be needed to bail all the players out. The alternative is to deal with losses of 3 trillion euros, wiping out banks and bondholders of sovereign debt.

Germany Key, But Limited

The fact remains, the German economy is simply not big enough to fund a 3 trillion-euro bailout. Germany has 81 million people and

its GDP is $3.3 trillion; the EU GDP is roughly $16 trillion. Compare statistics with the U.S., with 315 million people and a GDP of around $14.6 trillion.

Several European nations have already been downgraded and if several nations begin defaulting on their debt, the results could be devastating.

That devastation would first drastically impact the European countries, then soon burst its way into our own nation. According to Douglas J. Elliott - fellow at the Brookings Institution - a European recession would have a domino effect and create a similarly dismal situation right here in the U.S.

Greek Tragedy Impacts US

These four crucial American sectors would be greatly (and quite negatively) affected in the aftermath of defaulting nations in the euro zone:

Business and consumer confidence: Good luck finding any business owner, employee or consumer who isn't already frightened about what's lurking ahead. If the worst-case-scenario does occur, our economy would surely experience even worst consumer spending cuts and job losses.

There's still hope, but not much. CNNMoney reported that there is a 25% chance of that worst-case scenario coming to fruition. That process would bring about a series of defaults in nations including Portugal, Greece, Ireland, Italy, and Spain.

Trade: If Europe falls into any deeper of a recession, the US $400 billion in exports would be slashed badly as well. Until Europe could afford to pay for those U.S imports, America would suffer the loss in sales and, subsequently, be forced to cut jobs in related fields.

On a international scale, other countries who rely heavily on exports to Europe would face the same situation - leaving the global trade market in shambles.

Investment: Economic data shows that American firms have more than $1 trillion of direct investment in the European Union. A major hit to Europe's economy would slash through investor profits. US investments in other countries would also be affected because of the overall domino affect in the global investing community.

Financial flows: Banks and bank subsidiaries have about $2.7 trillion in loans and commitments to corporations, and governments in Europe. An additional $2 trillion more of exposure to the United Kingdom.

The progress the United States has made in dealing with its own financial crisis thus far would not fare well if additional losses were heaped on a still-struggling economy.

The technical details of the European recapitalization will matter as well. If designed badly, the plan could even do harm by encouraging European banks to cut back on lending and to sell existing assets. A serious credit crunch would likely tip Europe into recession.

Finally, strong-arming investors into voluntarily accepting losses of 40% to 60% on their Greek government bonds will certainly add to the risks of contagion if market concerns about other troubled eurozone countries spike again in the future.

Whatever happens, the U.S. government would be wise to prepare and encourage the Europeans to take the necessary steps. Not to mention the International Monetary Fund that could continue assisting a bailout in Europe.

Here's the point: Though the mix of debt is different from one country to another, all of Europe, and indeed the developed world, is overloaded with debt: state, bank and private.

The idea that leveraging more debt can resolve this monstrous over-indebtedness is beyond fantasy.

There is a day of reckoning ahead and we believe European economic bankruptcy dominos will fall...with worldwide consequences.

Sources: Wealth Wire, Businessweek, Financial Times, IMF, CNNMoney

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