Sunday, May 16, 2010

Bank of England Governor Expresses Fears About US & European Debts

Mervyn King, Governor of the Bank of England, says he believes that the US shares many of the same fiscal problems currently plaguing Europe.

The blunt assessment, made at a press conference this week, came as a surprise since King is generally quite guarded in his public comments.

As a rule, central bankers aren't plain-speaking or straight talking. Instead, they are careful not to rattle markets. And most are careful not to offend US policy-makers or to put them on the defensive.

That's why King's comments were so stirring.

King questioned how the US will shrink its fiscal deficit and enormous public debt over the next few years. The BOE Governor also expressed concerns about the debt problems the world over.

"It’s very important that governments — both here and elsewhere — get to grips with this problem, have a clear approach and a very clear and credible approach to reducing the size of those deficits over – in our case, the lifetime of this parliament – in order to convince markets that they should be willing to continue to finance the very large sums of money that will be needed to be raised from financial markets over the next few years at reasonable interest rates," said King.

In other words, the ability of governments to finance their debts will be predicated on their commitment to cutting both deficits and debts.

"We’ve seen the market response in the past two weeks, where major investors around the world are asking themselves questions about the interest rate at which they are prepared to finance trillions of pounds of money that will need to be raised on financial markets in the next two to three years, to finance government requirements around the world."

With that in mind, King said that it is critical for governments to take action immediately, proving to world markets that they are committed to fiscal responsibility. In King's estimation, the problems in Greece should serve as a warning to governments around the world.

"I think the important thing now is that Greece has been dealt with a major IMF and European Union package… But those measures provide only a window of opportunity. They do not affect the total amount of debt in themselves which countries around the world have to repay. The markets, which some of our European partners like to describe as speculators causing difficulty, are the very same markets where the public sector is looking to provide trillions of pounds of support to finance public debt around the major countries in the world over the next few years."

As we've already seen, reassuring world markets is critical to counties in need of continually refinancing their debts. And the thing that will most reassure markets is fiscal restraint that reduces both deficit spending and long term debts.

"Within the international community, I think there is a very clear understanding that the package of financial support which was made available at the weekend is not an underlying solution to the problem," said King. "It provides a window of opportunity which gives governments the chance to put their house in order; and it gives the international economic community a chance to talk about what I think – and have always said for some considerable time – to be one of the major issues facing us, which is the need to rebalance demand around the world economy."

King was referring to the fact that the global economy is massively unbalanced; China and other Asian countries are entirely reliant on exports to fuel and grow their economies, while the US is totally dependent on their cheap goods.

To rebalance the global economy, the one-dimensional export economies of Asia need to shift to domestic-led growth. The Chinese will need to spend more and save less, while Americans will need to do just the opposite; save more and spend less.

That would be quite a change for both nations.

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