US heading for depression, eurozone seen as a failure

The alarm bells are ringing loud and clear, signalling a global economic slowdown, but equity markets appear to be marching to the beat of their own drum.

Economies in the US and Europe are in dire straits, and it appears that growth in emerging markets, still robust but slowing down, may not compensate for the resounding crash that is imminent in the other half of the world.

Overnight, rating agency Moody's warned that the US would lose its AAA sovereign rating - a measure of its creditworthiness - if US politicians don't get their act together to address the debt burden issue. Policymakers are increasingly flirting with the idea of a "technical default" of US debt obligations, which has debt markets unnerved.

 US heading for depression, eurozone seen as a failure

The fear that the US is economy is on the verge of a 'Great, Great Depression' is now being more widely shared. Getty Images

US Treasury Secretary Timothy Geithner has warned of a "financial catastrophe" if an agreement is not reached to increase the current $14.3 trillion borrowing cap by 2 August.

Societe Generale analyst Rudy Narvas says the ratings agencies are preparing for the debt ceiling "endgame" in the US. He reads Moody's warning as a signal that if a "technical default" were to occur, it would likely downgrade the US sovereign rating. And even if the debt ceiling is raised, the US would be put on negative outlook watch if no long-term austerity measures are outlined.Narvas believes that the "increasingly partisan nature of Washington" has increased the odds that the debt ceiling may not be lifted, putting the US into technical default.

The fear that the US economy is on the verge of a "Great, Great Depression" is now being more widely shared.

And as for Europe, it is in "meltdown territory", argues economist and commentator Paul Krugman. On his blog, the Nobel Prize-winning economist notes:

"Austerity programs are not working; the prospect of a return to normal financing is receding rather than approaching."If you ask me, the water level has now dropped so far that the fuel rods are exposed. We really are in meltdown territory."

Financial Times commentator Martin Wolf puts it just as bluntly

"The eurozone, as designed, has failed. It was based on a set of principles that have proved unworkable at the first contact with a financial and fiscal crisis. It has only two options: to go forwards towards a closer union or backwards towards at least partial dissolution."

How will the endgame play out in Europe? Wolf confesses that he has no idea. But in his opinion, "the eurozone confronts a choice between two intolerable options: either default and partial dissolution or open-ended official support."

HSBC Group Chief Economist and global head of economics Stephen King outlines four likely solutions. All of them make for grim reading.

The first possibility is that the eurozone will break up. How will it happen? When either Germany, the eurozone's key creditor nation, walks away, not prepared to provide endless blank cheques to the peripheral nations. Or, instead, Greece walks away, unwilling to put up with the endless demands for austerity foisted upon the Greek people by its richer European partners." That, he says, would be a "catastrophe" for the European Union.

The second possibility is a unilateral default by a peripheral nation. But even that is fraught with dangerous consequences. Fault lines at the heart of the European project will be revealed, leaving the future of the euro incredibly uncertain. Contagion would threaten to bring the single currency to an unsavoury end.

The third option, King says, is to carry on 'muddling through', hoping that, eventually, the markets will forgive the peripheral nations and allow them to borrow on more favourable terms. But that seems unlikely because German taxpayers may not be happy to be supporting Greece for ever more without any influence over how their hard earned cash was being spent.

The fourth option is a choreographed restructuring , but even that could lead to a breakdown of trust within the financial sector sufficient to trigger a Lehman-style meltdown. In the process, the economic woes now engulfing the peripheral nations would spread all over Europe and far beyond.

In King's opinion, Eurozone countries will eventually end up opting for choreographed restructuring. But to do so, they'd have to work especially hard to avoid a "Lehman-style meltdown".

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Updated Date: Dec 20, 2014 05:02:33 IST