Debt and Deficit: When Graphics Speak Louder Than Words

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By EconMatters

cartoon bush tax breaks Concern about the European sovereign debt crisis has moved from Greece, to Portugal when Moody’s downgraded the country to junk status last week. Now Italy has become the new victim as worries of a debt crisis contagion, as Italy, euro zone’s third largest economy, is the next weak link in the region (See Chart).

The Wall Street Journal reported that default insurance costs for Italy, Portugal, Ireland and Greece have all hit record highs Monday, July 11.  The crisis only got worse Tue. July 12, when Ireland also got axed to junk by Moody’s.

debt to gdp for the piigs in europe
Source: New York Times

According to NYT, the interest on Italy’s 10-year bond spiked to a record 5.67%. While that is still far below what Greece is paying nowadays, analysts say Italy will have serious problems if its borrowing costs exceed 6%.

If markets were worried about banks’ exposure to Greece, check out these numbers cited by NYT:

“European banks have total claims and potential exposures of 998.7 billion euros to Italy, more than six times the 162.4 billion euro exposure they have to Greece, according to Barclays Capital. European banks have 774 billion euros of exposure to Spain and 534 billion euros of exposure to Ireland. 

In the United States, banks are also more exposed to Italy than to any other euro zone country, to the tune of 269 billion euros, according to Barclays. American banks’ next biggest exposure is to Spain, with total claims estimated at 179 billion euros.”

In addition to a debt load of 120% of its GDP–the second highest in Europe–Italy’s predicament could also be partly attributed to the political power struggle between Prime Minister Silvio Berlusconi and his finance minister, Giulio Tremonti, as the political dispute is threatening the country’s austerity and debt management efforts.

If the Italian sings a good political opera, the United States gets an Emmy for its political soap.

Deadline is fastly approaching for the United States.  If the Congress fails to reach a deal in 10 days in order to meet the Aug. 2 deadline to lift the nation’s debt ceiling, the U.S. could face probably its biggest calamity in history–a sovereign default.

Congressional Republicans, who insist that any deal could include no tax hikes, have rejected President Obama’s $4 trillion deal.  At the same time, Democrats also oppose Obama’s plans to cut government aid to seniors and low-income Americans.

This chart below from Bloomberg illustrates the great divide between the nation’s spending and income.

historical chart of federal revenue from taxes

The dotted line shows federal spending as a percentage of GDP since World War II. The solid line shows income taxes as a percentage of GDP are at 14.9%, the lowest since 1950. The average in the last 60 years has been closer to 18%, based on data compiled by Bloomberg.

What does this chart tell you? It makes logical sense that in order to narrow the spending and income gap, both lines would need to move towards the middle. That means raising taxes AND cut spending; otherwise, it will be just twice as difficult to put the government budget on the right track.

One analyst remarked that “Italy is too big to fail,” while the other noted “If Italy goes, it’s no longer a domino.  It’s a brick!”  If the descriptions of “Too Big To Fail” and “Brick” applies to Italy, think of the U.S. as “Too Big To Bail out” (since “Too Big To Fail” did get  bailout) and “an asteroid the size of Texas” (as in the 1998 movieArmageddon), which would be probably end up to be an understatement for the world.

Further Reading:
Gold and Dollar Pop on Euro Debt Crisis
Cracks Beneath: China, Greece, US and Derivatives 

EconMatters, July 12, 2011

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