The key source of risk in the new year is the global deleveraging that lies at the heart of our financial crisis. We will see more of its effects in 2011 and it won’t be pretty. To understand the situation better, let’s try an analogy.
Imagine you have a relative or friend who is in tremendous debt. Your feelings about helping him could be colored by how he got into dire straits. Was it because of plain bad luck — he lost his job — or because he spent his money lavishly?
Moreover, those feelings are entirely independent of your ability to help, which may be constrained no matter how much your desire to help. And obligation can trump a lack of ability in cases in which you have no financial cushion, only a couch cushion.
This scenario describes the situation in Europe today. The Germans and other EU creditor nations do not feel all that connected to the Greeks or Portuguese and resent having to bail them out. But they know the failure to do so will have devastating and disorderly consequences, such as the collapse of the European banking system (in particular German and French banks).
So they reluctantly bail out Ireland and Greece, and soon Portugal, Spain and Italy. No one is happy. The debtor nations have foreigners imposing austerity on them. They feel they have lost their independence, and indeed they have. The creditor nations are hosting unwanted new “guests,” and can’t spend their wealth for their own needs anymore.