The Greek fiscal crisis, which is rocking Europe and spilling over the rest of the world, should not be a crisis at all.

Greece is a small country, and its economy represents barely 2% of the GDP of the Euro-zone. For Greece to cause such a disturbance there must be something else involved, something much more fundamental than the Greek government’s dubious accounting and the resulting financial difficulties.

At bottom, the crisis really hangs on a simple fact: a government’s ability to borrow is not infinite. In reality the limits are much tighter than has generally been assumed.

This hard reality has been ignored for a couple of generations, for two main reasons. First, the paradigm of continuous economic growth, fueled by abundant energy, assumes that tomorrow’s economy will always be bigger than today’s. Thus future tax revenue will catch up with, and surpass, current borrowing.

Second, financial globalization has created a much larger pool of money for states to dip in. The sale of government bonds is no longer limited to the domestic market, but can be done halfway across the globe, creating the illusion of an unlimited supply of readily available credit.

A loan, however, is still a loan. The creditor wants to be repaid, and if there is a risk of default, the interest rate will rise accordingly, potentially pricing the borrower out of the market.

The global recession has vastly increased government deficits. States have spent enormous sums to keep the global financial system from collapse. At the same time vast amounts of “stimulus” spending have been injected into domestic economies even while tax revenue was dropping. As a result government debt has surged to levels never seen before, outside of wartime.

Greece happens to present a particularly acute case. But in fact many governments are in the same situation, having borrowed more money than they might ever be able to repay. Hence the threat of “contagion”: that the “Greek illness” will spread to other states, such as California, Portugal or even the mighty U.S., creating a growing black hole within world finance. Once such a sinkhole begins to spread, who knows what it will swallow?

States of course have defaulted before, but these were individual cases, each with its own particular reasons: mismanagement, folly, oversized ambitions, war. But today governments are colliding with a mathematical truth: borrowing is limited even for the most powerful. The United States is no exception. Despite the size of its economy and the status of the dollar, the limits of its borrowing are probably much closer than the authorities choose to believe.

An analogy may be drawn from the oil industry. If oil is drawn out of a reservoir slowly, the field will produce for a long time. But if the rate of extraction rises too high, the reservoir can be irretrievably damaged, and it will dry up, with the reserve now locked in the ground.

It is the same with credit. Right now, governments are building up debt much faster than the world can supply it. Greece has been the trigger, but not the cause of the crisis. The problem is that there is not enough money out there to satisfy the current needs for sovereign borrowing.

Since the United States government borrows a large part of its budget from abroad, we are faced with a choice. Either we continue on the present course until the interest rate rises to a level we cannot afford, or we curtail our spending so as to extend our credit horizon. To go back to the oil analogy, we either keep pumping until the reservoir collapses and goes dry, or we reduce the rate of extraction to what the field can support.

Some will say that we cannot cut government spending without causing some kind of economic collapse. This is a handy excuse for inaction, but the prediction is not necessarily true. Cutting spending will cause some hardship, but far less than a catastrophic funding collapse would entail.

We therefore must, finally, get serious about cutting government spending. The next few planks of the platform will deal with this paramount issue.

This entry was posted on Thursday, May 13th, 2010 at 10:39 pm and is filed under The National Interest Platform. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.