Remember the Third World debt crisis of the 1970s and 1980s? The First World debt crisis of the 2000s and 2010s may make it look like a tea party.
In the US and Britain in particular, the economic booms of the late 1990s and mid-2000s floated on a vast pool of private debt. Borrowing by firms and households grew to several times the size of the US economy and drove the growth in demand for goods and services.
Now this process has gone into reverse. Individuals and companies have reacted to the crisis by desperately trying to reduce their debts. They are spending less – and cutting demand.
This is very similar to what happened during the Great Depression of the 1930s.
The willingness of states to step in, rescue the banks, and increase spending has so far prevented a slump as severe as that one.
But this extra spending has been financed by more borrowing. This has contributed to huge increases in governments’ budget deficits – in other words, the difference between what they spend and what they receive as revenue.
So it is still debt that is keeping the world economy afloat, only now it is public rather than private debt.
In their recently published study of financial crises, This Time is Different, Carmen Reinhart and Kenneth Rogoff argue that “a build-up of government debt has been a defining characteristic of the aftermath of banking crises”, mainly because economic slumps cut state revenues.
They also document in detail how common “sovereign default” – states stopping paying their debts – is during financial crises. Before the 1980s and 1990s, the last big wave was during the 1930s and 1940s.
Even the US and Britain, by leaving the gold standard and devaluing their currencies, effectively defaulted on their debts as previously valued.
Fear of sovereign default is now stalking the euro-zone. It focuses especially on the weaker economies and, above all, Greece.
Weaker economies benefited from joining the euro-zone because it tied them to Germany, one of the world’s most powerful economies. This meant, among other things, that they could borrow at interest rates little lower than those at which the German government raises money.
But now the financial markets are focusing on those states believed to be most in danger of default. This has forced up the interest rates that countries like Greece must pay on their government debt.
The abolition of their national currencies means that they can’t use devaluation to reduce their debts and improve the competitiveness of their exports.
Some experts, for example the notorious “prophet of doom” Nouriel Roubini, believe the crisis of the smaller European economies could threaten the survival of the euro-zone itself.
To appease the markets, Greek prime minister George Papandreou is under even more pressure than Gordon Brown to cut the budget deficit.
Papandreou last week told the bosses assembled at the World Economic Forum in Davos he would “draw blood”. That’s exactly what they want.
The Financial Times newspaper last week carried a piece from a Brussels think-tank calling for a ten percent cut in consumption in Greece and Portugal.
The European Commission is demanding the Greek government force down public sector pay.
Greek workers, who have the most sustained history of struggle of any European country since the 1970s, are unlikely to meekly accept attacks on this scale.
Two days of strikes have been called next week. Hence the reports that Papandreou is manoeuvring for a bailout by the euro-zone, or even by China.
All this should put in perspective the idiotic announcements that “the recession is over”. The Great Depression went through several stages and lasted ten years.
What Reinhart and Rogoff call “the Second Great Contraction” still has a long way to run.