When the credit crisis stung the developed world, governments from Washington to Dublin assumed the private debt of their banks and extended assistance to millions of newly unemployed workers -- and they did this with fewer tax dollars. The immediate result was predictable: higher deficits.
The long term impact is less predictable. Debt as a share of rich countries' economies has doubled since 2007, the Economist reports, and United States and Europe will still have to borrow about $7 trillion to meet our needs in 2011. What happens when it looks like rich countries can't afford to pay back their creditors? Yields rise, for sure. Rich stable countries like Germany suddenly find themselves on the hook for smaller, less stable economies. But what then?
The stage is set for a wave of sovereign debt crises in the developed world:
Amid all this uncertainty, only one thing is clear: sovereign yields are likely to rise, and even the strongest governments cannot afford to be sanguine about a bond-market bust. America may be the issuer of the world's reserve currency, but its debt markets are not immune to a sudden upward lurch, which in turn could threaten the fragile recovery.
Governments could, and should, minimise this volatility. America needs to complement its short-term tax cuts with an agreement on medium-term deficit reduction. Japan should kick-start growth and overhaul the tax code. But the most urgent task is in Europe, where leaders need to blend inconsistencies between today's rescues and tomorrow's reform proposals into a coherent plan for managing the euro.
Read the full story at The Economist.