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Debt and Opportunity

April 21, 2012

The financial meltdown of 2008 and 2009 struck far and wide, leaving few places in the world unscathed. While the collapse of Lehman Brothers in New York can be pointed to as the seismic disturbance at the epicenter of the calamity, the European debt crisis was the resulting tsunami whose effects were much more far-reaching and destabilizing.

With the words “European Debt Crisis” smeared across news tickers, computer screens and magazines around the globe, it is easy to come to the already suspected conclusion that the entire continent is awash in unsustainable debt loads and has passed its prime, lacking economic agility. Considering the stagnant or negative population growth and rigid labour laws that keep youth unemployment high one could even say the continents fate is sealed.

The situation in Germany however, along with several of its northern European neighbours, is actually much different and stands as an example of how to eventually liberate the nations at Europe’s periphery from burdensome debt scenarios. While Germany has assumed massive new liabilities over the last two years to shore up several of the EU’s less frugal member states, it also enacted the continents most aggressive austerity measures in 2009 and 2010, a time when most of its neighbors where busy trying to spend their way out of the recession.

The federal government pushed back several large-scale infrastructure investments and trimmed spending that was deemed nonessential. Coupled with declining unemployment and contracting interest rates on its existing debt, the situation has improved greatly over the last several years, leaving Germany with an increasingly manageable debt load and a robustly growing economy.

In 2009 the Bundestag in Berlin enacted a constitutional amendment called the Schuldenbremse, or debt-brake. The law calls for an end to new Federal debt after 2016 (restricted to a.35 of GDP ceiling) and for no state debt whatsoever after 2020. Several other EU member states have already introduced such debt brakes, and as agreed in the end of 2011, nearly all the rest will over the coming year or two. Codifying strict limitations on new debt is the only way the continent can avoid ending up in this dire situation again, be it in 25 or 50 years.

When one considers the demographic realities of Europe in 2012, this long term and enforced change is essential. If debt loads are crushing now, they will only become more so as the working age population in nearly every EU member state shrinks and the ranks of the state supported elderly expand. Germany was early to tackle this issue as well, raising the retirement age to a current 67 years and leaving the possibility for increasing it to 69 or 70 in the future.

Getting existing debt under control as quickly as possibly is one of the most effective ways for Germany and its peers to grow their economies and also be left with fiscal and policy tools to use in the event of future crisis. While current austerity budgets are causing great pain across the continent, there are few if any alternatives. Huge debts, double-digit deficits and high unemployment have all tied the hands of governments, forcing them to get their houses in order. Prudent budgeting and debt maintenance now can make a future financial crisis much more manageable.

In principle, the last decade betrayed a logical model of fiscal planning. Running deficits and expanding debt during times of prosperity is a recipe for disaster that Europe would be best not to repeat. Germany appears to have foreseen these larger problems, as it now is foreseeing others, and is aggressively trying to influence the rest of the continent to follow its footsteps.

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