Here we are again, back to the disturbing – but entirely unsurprising – war on the ‘free market’ (or whatever is left of it after decades of government interventionism).

The pattern of governments creating a mess and promptly laying the blame at the feet of the private sector is not at all new, so EU’s and Washington’s attacks on the markets and George Papandreou’s continuing threats against ‘evil speculators’ should not have caught anyone by surprise. In much the same manner, the coming (politically motivated) clampdowns and regulations of various market activities are being designed with the sole purpose of shifting blame – for excessive borrowing, overspending, harmful interventions and defective regulation – away from the policy makers.

Of course diversion of blame and responsibility is not a behavior exclusive to governments. It has come to characterize much of today’s society, and is largely responsible for the economic, social and moral decline we’re at present witnessing all around us. (More on that in an upcoming post.)

Let’s start with Greece. Prime Minister Papandreou has stepped up his rhetoric about his country being victimized and having problems servicing its debt, not as a result of irresponsible and fraudulent behavior over many years, but because of speculators’ bets to bring it down.

“Despite the deep reforms we are making, traders and speculators have forced interest rates on Greek bonds to record highs. Many believe there have been malicious rumors, endlessly repeated and tactically amplified, that have been used to manipulate normal market terms for our bonds.” He went on to say that as a result Greece was forced to borrow at rates almost twice as high as Germany, and that such ‘prohibitive’ interest rates would swallow all gains from the planned austerity measures.

Manipulate ‘normal’ market terms? ‘Prohibitive’ rates? Someone please show Mr. Papandreou the spread between Greek and German bonds pre-Maastricht Treaty – at multiples of what it is today! See for yourself in this astonishing chart: Club Med spreads (1992-2010).

Let’s not forget that the Greeks (and other fiscally shaky Southern European states) have only enjoyed – undeservedly – low rates thanks to the EMU. And, had Greece not lied about its finances, it would never have been admitted into the monetary union in the first place (it has never complied with the required fiscal discipline, preferring to falsify data). The current rates on Greek borrowing are more than appropriate (in fact, quite benevolent) for a country that carelessly jeopardized its own future by decades-long irresponsibility.

For a decade the markets have ignored the vast differences in fiscal policies between eurozone members; risk premiums on sovereign bonds were barely discernible. After the financial crisis investors started awakening to sovereign risk and spreads became far more aligned with reality. The bond markets are once again reflecting fiscal policies, as they should. Far from ‘market manipulation’, it’s simply a return of country risk.

Indeed the financial markets are now doing the job that politicians have failed at so miserably – forcing the countries to take measures that will lead to a return to fiscal sanity (or else face the consequences). It should also be obvious that any country’s funding costs will now increasingly reflect its own fundamentals, rather than those of say Germany, as investors are unlikely to be blinded by any implicit EMU guarantees again, at least for the foreseeable future.

The Greeks, who have over decades borrowed and squandered too much money, won’t admit that their 12.7% budget deficit (that being the official figure; the true deficit is estimated at 16%), 120% debt/GDP (135% estimate for 2011), out of control government spending (at over 50% of GDP), rampant tax evasion, among other problems, are the root-cause of their troubles and consequent risk pricing by the markets. (For an analysis of the Greek situation and possible solutions see recent article here.)

Given that Greece has defaulted on its debt 108 times in the last 200 years, showing no sign that it has learned fiscal responsibility, it is rather astonishing that the Greeks should be surprised at rising interest costs. Would any responsible lender extend credit to an over-leveraged borrower on the verge of bankruptcy, at extremely low rates?

Yet the Greeks appear to believe that threats and regulation will force the capital markets to supply them with unreasonably cheap credit. During a recent Washington visit to win President Obama’s support for the war against evil speculators, Mr. Papandreou said: “Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system not to mention the human consequences of lost jobs, foreclosed homes and decimated pensions.”

Therefore, investors should lend to Greece at ultra low rates, ignoring any default risk, in order to allow the Greek government and population to carry on with a spending binge, delaying the day of reckoning indefinitely. (Much like banks had been coerced by the US government into lending to unworthy borrowers with no deposits and insufficient income; and we know how that ended. But more on that later.)

The Greeks’ sense of entitlement to other people’s wealth, their perceived ‘right’ to borrow at low rates, is indeed quite disturbing. Though rather than being solely a Greek issue it appears to be a sign of our times.

But why the widespread hatred of market participants, be it speculators, traders or investors?

After all, it wasn’t speculators who had run up massive debts and a 13% deficit, but the Greek politicians (and population). Investors and traders have merely exposed the truth the Greeks, as well as EU authorities, would have preferred to keep hidden. It should be obvious that Greece only has itself to blame for not being able to borrow at the same rates as fiscally prudent Germany.

The much vilified short sellers, as well as CDS (credit default swap) buyers, perform a vital function by pointing to problems and deficiencies (whether in companies, industries or countries) and backing their opinion with their money. When they believe an entity may go bust, shouldn’t they be allowed to protect themselves and/or profit accordingly? When it comes to sovereign debt, if it wasn’t for the markets, politicians would never take the necessary action to put their house in order.

Papandreou’s argument that “unprincipled speculators are making billions every day by betting on a Greek default” misses the point entirely. If Greece’s fundamentals were less disastrous, anyone betting on a default would be losing billions. No speculators can bring down a healthy company, currency or country. In any case, there are always two sides to each trade. For everyone shorting Greek debt there is also someone on the long side.

As for the fallacy of speculators destabilizing the Greek bond market via CDS use: Germany’s financial regulator (BaFin) has found no evidence that CDS were used for large scale speculation against Greek government bonds, reporting (earlier this month) that the net volume of outstanding CDS contracts has barely changed since the beginning of the year. Some of the most active CDS traders are German and French banks, who happen to hold significant amount of Greek debt. If there were no CDS (essentially, insurance against default), who would take on the risk of financing Greek debt?

Ironically, it has just been uncovered that the biggest CDS speculator, holding 15% ($1.2 billion) of the total $8 billion of Greek CDS, has been the Greek state-owned Hellenic Post Bank! (Article here.)

And yet, despite his obvious delusion, Mr. Papandreou has been finding an attentive audience in other European leaders as well as President Obama. After all, Greece’s is not the only government that views the markets as a welcome scapegoat for their own mismanagement and incompetency.

Given bureaucrats’ readiness never to waste an opportunity to further restrict economic freedom, it isn’t particularly surprising that the European Commission is discussing regulation of the sovereign CDS market, and the US Justice Department has reportedly been looking into hedge funds’ short positions against the euro, to determine whether they colluded to drive down the value of the single currency.

European politicians, who have a long tradition of anti free market beliefs, have blamed speculators for the recent decline of the euro in the wake of the Greek crisis. They, much like the Greeks, feel entitled to low borrowing costs for EMU members and a stable euro, irrespective of the fiscal and economic mess of the EU.

Germany’s finance minister, Wolfgang Schaeuble, went as far as suggesting the use of anti-terrorism methods against financial speculators in order to protect the euro. He said the government might “set up surveillance of who is getting together with whom for which kinds of speculative processes, and where.”

What’s next? Will they start arresting traders for threatening ‘economic stability’ if they happen to dislike the fundamentals of a certain country or currency and vote against it with their money?

It would seem there is no better sign that an entity is in severe trouble than authorities starting to crack down on short bets against it. The truth is, if the euro was fundamentally sound, it would not have been ‘attacked’. (Not to mention that those who believe speculators have caused the euro to drop to unfairly low levels can always back their opinion by taking action in the forex market.)

What Greece and other nations need to learn is that one cannot go on indefinitely increasing government spending and borrowing without consequences. There comes a point when markets lose confidence in the country’s ability to pay and refuse to lend the money (at acceptable rates). That moment appears to be fast approaching for a number of countries.     

Of course when it comes to short term political gain, shifting the blame onto the private sector is an entirely valid strategy. We have seen its success in the aftermath of the 2008 crisis; the people have, without much questioning, accepted the official line: the crisis was caused by insufficient state intervention and regulation of the ‘free market’. Therefore, we have been told, a massive increase in government bureaucracy and regulation was necessary.

The threats against speculators in (Greek) sovereign debt are reminiscent of the attacks on banks, hedge funds and financial markets in general, over the last two years. Of course there was much that went wrong in the financial sector, but the blame game has been indicative of the failure of governments to admit their own mistakes.

Notice that any economic boom is always a result of ‘wise government policies’. When the inevitable collapse comes, a culprit must be found, fast, before anyone starts looking at possible policy makers’ faults. And so all crises are quickly declared to be a problem of the ‘free market’.

Such denunciations look particularly misplaced given the disastrous track record of public management, including the crucial role of the Fed and US policy makers in creating the recent crisis. It was the Fed’s loose monetary policy that had encouraged speculation and inflated a massive housing bubble, aided by vote grabbing policy makers’ interventions in the housing market (incl. coercing financial institutions into lending to unqualified, low income borrowers under such monstrosities as the Community Reinvestment Act).

And of course the government sponsored Fannie Mae and Freddie Mac were by far the worst offenders, likely to end up costing the US taxpayer some $400 billion. (They remain an ‘off-balance sheet’ – or so the politically convenient fiction goes – dumping ground for the debris of the housing crisis.) But don’t hold your breath waiting for Obama et al. to acknowledge any of this; they’re too busy pounding on the banks.

Bizarrely, our political elites appear to fully ignore the fact that highly expansionary monetary policies – and resulting unprecedented indebtedness – have been largely responsible for the current mess. It’s nothing new; interventions into (what was once) the free market have always brought unintended negative consequences. And yet the link between low interest rates, excessive credit growth and asset bubbles appears to evade policy makers’ understanding.

The slashing of interest rates in 2001, and keeping them at record low levels for several years, has led to the credit and housing bubble. Spiraling debt contributed, in a large part, to the apparent prosperity of the last 15-20 years (much as it had in the 1920s, ending, equally disastrously, in the Great Depression). Greenspan and Bernanke acted as cheerleaders of debt, while policy makers were busy identifying new targets for lending, in the name of democratization of access to credit.

And let’s not forget the essential role of greedy housing market participants, millions of whom have knowingly taken on mortgages and loans they couldn’t afford to pay back, in order to satisfy their irresponsible craving for a lifestyle beyond their means. (In the past 25 years the amount owed by US families has risen more than sevenfold, from less than $2 trillion in 1984 to nearly $14 trillion, according to the Fed.) Inevitably, cheap credit has also created huge imbalances and fueled speculation in the financial sector.

And yet, shockingly, no lessons seem to have been learned. Central banks and governments – in particular in the US and UK, considering a painful period of readjustment (perhaps a short depression) to be politically unacceptable, have embarked on massive quantitative easing (in other words money printing) and huge stimuli to restore economic growth. In the process they have loaded their countries with an unprecedented mountain of debt.

Indeed, blind to the fact that easy credit and excessive debt created the crisis in the first place, the Fed and the Obama administration are happily running up higher and higher debts. In an unprecedented printing press exercise the Fed has purchased over $1.2 trillion of toxic agency (Fannie, Freddie, Ginnie Mae) mortgage backed securities (MBS), creating a floor for housing prices and so delaying necessary corrections. Hence the massive burden of toxic assets now weighs down not only the private financial markets but also the Fed itself.

Numerous other government support measures have been masking the fundamental sickness of the housing market, including tax breaks for home buyers and government-mandated loan modifications (the majority of which end up in default again within six months). The Federal Housing Administration (FHA), with its aim to make homes more affordable, has underwritten hundreds of billions of dollars of mortgages in the last two years alone. Its support for the housing market is expected to double again – growing to $1.5 trillion – over the next five years. FHA foolishly continues to require down payments as low as 3.5%, when it should be obvious that a 15-20% deposit would allow home owners to better withstand any future crisis. (Unsurprisingly, a record number of FHA-insured loans are delinquent.)

Speaking of loose monetary policy… rates have been fixed at near zero. The resulting boost to the price of securities held by banks, as well as what are, in effect, zero interest loans from depositors, have translated into strong revenues for the sector, allowing banks to ignore the bad loans still on their books. It is clear that the irrational monetary policy with artificially low interest rates, plus monetization of debt, will continue for quite some time. A certain recipe for the next bubble and crisis.

And of course the government has also embarked on an unprecedented fiscal stimulus, a consequence of which is a massive increase in public sector debt. (The US national debt now stands at over $12 trillion. But add the ‘off-balance sheet’ unfunded liabilities and the total public debt comes to an estimated $60 trillion – an amount that can clearly never be paid off. We’ve discussed the impact of extreme debt levels in a recent post here.)

Despite the shocking debt and deficit we’re unlikely to see any serious attempt at spending cuts any time soon; quite the opposite, there seems to be a new US spending bill proposed almost every week. Crucially, at a time when existing entitlement programs are bankrupt, the Obama administration saw it fit to create a monstrous new $2 trillion health care entitlement.

In spite of the alleged temporary nature of the public spending boom, the expansion of government will likely be permanent. The price to pay is obvious – high deficit, high taxes, slower economic growth and less wealth. Unless, that is, you agree with Mr. Obama and the ‘leading’ economists that government spending creates wealth.

The belief we can cure a debt crisis with even more debt would also be rather comical, if the situation, and consequences, weren’t so tragic.

So what then is the solution?

Instead of the government attempting to micromanage the financial markets (and any other private industries) via further interventions, regulation, punitive taxation, bans and growing bureaucracy, we should simply allow the free market to work. The finance industry as well as borrowers should be let to suffer the consequences of their actions (be it bad lending or irresponsible borrowing). They also need to be allowed to make commercial decisions without coercion or interference from policy makers. In the absence of government intervention – that only creates distortions and moral hazard – the markets would curb bad behavior via defaults and bankruptcies, resulting in suitable risk adjustment by other participants.

US home owners should also be liable for any outstanding mortgage balances (as is common in virtually every other country), instead of simply being allowed to walk away from underwater mortgages. Naturally such policies would mean fewer home buyers taking on mortgages they can’t afford to repay, and that goes against the government’s idea of home ownership being a near universal ‘right’ – a notion which, bizarrely, still appears to be alive and well in Washington. But until people return to a suitably affordable lifestyle (whether that be renting instead of home ownership, or a more modest home) we are only kicking the problems down the road for a little longer.

It is natural that in a crisis, recession or period of high unemployment people are angry; they need to externalize the enemy. The markets, speculators, or Wall Street are a highly convenient (and sometimes justified) target when it comes to diverting blame away from policy makers, central banks and general population. They also provide a welcome opportunity for governments to expand and to regulate more, tax more and interfere more in private sector activities.

However, if any lessons are to be learned at all, we must acknowledge that it was the culture of living on (cheap) credit and spending beyond our means – spurred by disastrous monetary policies and interventions - that led to record indebtedness, housing bubble and collapse, and resulting financial and economic hardship. Only then will we be able to recognize that the current policies are simply setting the stage for a much larger crisis a few years from now.

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The Dubai and Greek crises have forced investors to pay attention to something long ignored – rising sovereign risk. According to this week’s reports, Dubai is trying to settle debts for 60 cents on the dollar. Meanwhile, there has been no real progress in the unfolding Greek debt crisis.

Given the scale of fiscal deterioration in much of the developed world, the trouble is unlikely to end with Greece. For now, however, this looks like a mainly EU-specific problem.

Germany is, for the moment, unwilling to talk about bailouts, and demands austerity measures from the Greek government. EU finance ministers stated Athens must comply with austerity demands within 30 days or risk losing control over its own tax and spend policies. But the truth is, the EU has no real enforcement mechanism, and Greece knows it.

The Greek government promised to reduce its fiscal deficit to 2.8% of GDP by 2012, and to under 9% by the end of this year. However, the EU authorities are fooling themselves into believing this to be possible – current Greek deficit is 12.7% (and that is only the official figure; Greece has forged data before). Due to both political and economic reasons chances of Greece meeting such targets are near zero. The Greek population is largely against austerity (and keen to express it via crippling strikes and riots), making it highly unlikely that the socialist Papandreou government will be able to enforce any meaningful measures.

Some 95% of Greek debt is held by a number of large European banks, so a Greek default would most likely spark a massive bank crisis in Europe. The contagion would inevitably spread to Portugal, Spain, Italy, Ireland and possibly other countries. But even if Greece is bailed out, it will unlikely meet the conditions that will come attached to a bailout, hence just kicking the problem down the road for another while.

And of course the problem is much larger than just Greece. Fundamentals are very poor across much of the eurozone, meaning that a number of countries could easily follow Greece down.

The root of the problem is the one-size-fits-all monetary policy of the euro. The monetary policy set for the centre (Germany, France) was always going to be inappropriate for the economies of the periphery. Instead of adopting stricter fiscal discipline (since monetary and exchange rate policy was no longer in their control), Greece, Spain, Portugal etc used the extremely low interest rates and high credit rating they gained access to thanks to the EMU to go on a long, wild spending spree. The cheap credit fueled housing bubbles as well as ever growing public sectors and generous welfare systems. It was inevitable that the day of reckoning would come.

Southern Europe’s competitiveness has also declined sharply as these countries joined the eurozone with an exchange rate that overvalued their currencies, raising the cost of labour.

The fiscally precarious states benefited from low rates because, in the eyes of investors, their bonds enjoyed an implicit guarantee of the stronger eurozone members. Once investors finally started paying attention to their fiscal situation, and to the risk of Greece being let to fail, the spreads between German Bunds and Greek bonds have widened considerably, increasing the country’s debt servicing costs.

In a staggering display of self-delusion the Greek prime minister said yesterday that Greece wants to be able to borrow on the same terms as other eurozone countries. I suppose we shouldn’t be surprised at such misguided sense of entitlement; entitlement, after all, is the theme of our times. Papandreou also stated “it is a fallacy to say the Greeks are reckless”. Yes, Greeks indeed are the model of prudence and their current fiscal mess and the fact they have been in default for 105 years out of the last 200 should just be ignored by the markets (or ‘socially useless’ speculators in modern day political speech).

Although distrusting Greece’s willingness and ability to reduce deficit, the markets, for the moment, continue to believe in an eventual bailout. Should it start looking like there will be no such thing after all, the spreads on Greek debt would dramatically expand and most likely push Greece into default.

Yet the fiscally responsible Germans have little appetite for bailing out Greece. A bailout, in their view, would destroy EU’s monetary (and any remaining fiscal) discipline and undermine the credibility of the euro. Not to mention that it would not solve the structural problems facing the eurozone. Since German taxpayers are hardly going to be willing to open their wallets to the profligate states every time there is a crisis, a bailout of Greece may only bring closer an eventual break-up of the EMU.

Having said that, German banks have massive exposure to Spanish, Irish, Italian and, to a lesser extent, Greek and Portuguese debt – to the tune of some 523 billion euros. Germany will undoubtedly take that into consideration when deciding on bailing Greece out or letting it fail.

So what are the options for Greece? The traditional remedy would be currency devaluation, but eurozone members don’t have such luxury. Control over their monetary policy is in the hands of the European Central Bank (ECB).

The most prudent thing for Greece would be to undertake the severe budget cuts necessary to get its fiscal deficit down to 3% of GDP over the next few years. Such extraordinary fiscal tightening would result in a few years of declining GDP and high unemployment. There is not much indication that Greek voters are even remotely considering taking a few years of pain (austerity & recession) for a future gain.

Another option is default, which would reduce the debt burden but also result in a severe and long recession/depression. Government spending would be cut drastically and immediately since Greece wouldn’t be able to borrow for quite some time. Finally, Greece could also decide to leave the eurozone, go back to drachma and, in effect, devalue its debt. It would make the country more competitive. Of course their borrowing costs would also soar. However, this appears to be the least likely path for Greece to take.

Essentially, Greece and the Greek voters should be given two choices: take the pain and make the necessary cuts or leave the EU. This would leave the decision in the hands of the Greek people, avoiding further cries of them being stripped of their sovereignty, and it would ultimately be better for EU’s monetary and fiscal discipline than a bailout and the moral hazards that come with it.

After all, Greece is not eurozone’s only problem. Budget deficits have reached unprecedented proportions in many EU countries. Concerns about the weak fundamentals and the state of public finances in Portugal, Spain, Italy, Ireland, the UK are evident in the financial markets, with rising sovereign bond yields and sliding euro.

Portugal’s and Spain’s external debt position is worse than that of Greece; their household debt is also considerably higher. Spain, apart from a nearly 10% deficit, has unemployment close to 20% and a banking system weighted down by a massive amount of overvalued real estate. Oh, and the socialist Zapatero government is not any more likely to be able and willing to cut spending than the Greeks. Italy’s and Ireland’s external debt obligations as well as GDP and unemployment rates are also worse than those of Greece. So while the markets’ focus is primarily on Greece, contagion is a very real threat. And not even Germany has the finances to bail out the likes of Spain. Given its size, a full blown fiscal crisis (or default) in Spain would most likely be the death of the euro.

The eurozone governments have to borrow approx 2.2 trillion euros from the capital markets this year to finance their budget deficits (Greece needs some 60 billion just to make it through the year); it won’t be an easy task. A wider fiscal crisis in Europe appears increasingly likely.

Yet ballooning national debts, out of control deficits and rising sovereign risks are not just a European issue. Most advanced economies have huge fiscal problems. The IMF projects the G20 government debt/GDP ratio to reach 118% by 2014. This will severely constrain economic growth.

A recent study by Carmen Reinhart and Kenneth Rogoff (‘Growth in a Time of Debt’) found that “the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.”

The following chart shows the public debt to GDP ratios across the world.

(And let’s not forget the true public debt/GDP levels are several times higher then the explicit figures that exclude massive unfunded liabilities for public pensions, healthcare, social security.)

Consider also the high government spending as a percentage of GDP in many advanced economies today, which causes a further drag on growth, and you get a future of slow economic growth and high unemployment. (In Greece, as well as the US, UK and other countries government spending now makes for approx 50% of GDP.)

The fiscal deterioration will become worse still due to the massive demographic challenges in the developed world. The IMF estimates that increased health spending and other costs related to aging population will drive debt to GDP levels of advanced economies up by a further 50% over the next 20 years.

We will therefore see a significantly higher economic growth in low debt, and most likely sluggish growth in high debt economies such as the UK, US, much of the eurozone and Japan. (A strong rise in government bond yields of much of the developed world is also inevitable.)

But it’s not just government debt. There’s too much debt everywhere, including in the private sector (although the private sector has started deleveraging, while the public sector increased leverage). Total debt is highest in Japan at 459% of GDP and the UK at 469% of GDP (or 380% if adjusted to reflect UK’s position as a financial hub). Spain follows in the third place at 342% (in Greece total private-public debt stands at around 225% of GDP).  

Over the next decade sovereign debt crises and defaults seem inevitable. Those countries that can resort to the printing presses will take the path of a massive monetization of debt, hence reducing their debts through severe inflation. That is the most likely outcome in the US and UK. (Clearly, paying our debts back in devalued currency is simply default by another name.)

Of course the most desirable way to address the budget problems would be by radical spending cuts. The scale of fiscal tightening necessary to return to healthier debt levels would cause a medium-term drag on growth. But not reducing debt will ultimately have much greater consequences.

However, chances we will witness drastic spending cuts in the UK, US and across the eurozone in the next few years are rather slim. The culture of entitlement has made it near impossible to talk about the hard facts. Our political elites will continue to ignore the fact that the bloated welfare states have become unsustainable and we can no longer afford them. The reason is simple – it’s not what the voters want to hear. Instead of acknowledging painful reality and the need to make sacrifices, we prefer to keep kicking the problems into the future. Until the inevitable day of reckoning comes.

Indeed the developments in the US and UK are not at all encouraging.

The Obama administration is determined not to waste a good crisis and continues to focus on a massive expansion of government. Instead of letting the free markets work and acknowledging that it’s the private sector that creates wealth and will be the engine of growth, the political leaders on both sides of the Atlantic show an enormous zeal to meddle in the free markets and reinvent and fix what wasn’t broken.

Redistribution of wealth via tax hikes (as well as introduction of entirely new taxes), a ruinous healthcare reform, expensive energy and climate change legislation, pro-union policies, excessive and ill thought-out regulation… Obama has shown a deep lack of understanding (and indeed contempt) of private business and a determination to socialize the US economy.

And while the productive part of the economy is being hammered, the public sector has been enjoying an unprecedented boom. In 1902 total US government spending was approx 7% of GDP. In 1928 it came to just over 10%; two thirds of that was state and local and just 3% was federal spending (about the same as 150 years earlier, excluding increases during war periods). Government spending has since exploded, making for more than 40% of GDP – two thirds of that being federal expenditure. Public spending increases in 2009 alone came to well over $1 trillion, a rise of more than 20% from 2008.

The UK has fared even worse, with government spending increasing from about 36% of GDP to almost 55%, putting increasing pressure on the dwindling productive segment of the economy.

The following chart from the Wall Street Journal shows the shocking and unsustainable spending explosion. US government spending has grown seven times as much in real terms as median household income over the last 40 years!

And, just as in the UK, employment and compensation in the public sector have continued to increase while the private sector has taken the pain. (Public workers not only enjoy far higher wages than their private sector counterparts but also benefit from extremely generous pensions. These largely unfunded public sector pension liabilities will naturally just serve as further drag on economic growth for many decades to come.)

As the following chart from the Business Insider shows, the US has gone from producing jobs in wealth creating private industries to jobs in the wealth destroying government sector. By the end of 2007 the total number of government jobs exceeded the total number of goods producing jobs.

Indeed, whether we look at the public sector gorging itself at the expense of the private sector, or the widespread culture of entitlement and welfare state (at the expense of the dwindling numbers of hard working taxpayers), this is what has come to characterize our time: enabling the unproductive and lazy to steal from the productive and enterprising. Otherwise called socialism.

So what is being done? Do we see any plans for serious fiscal tightening and debt reduction? Quite the opposite, our leaders seem to be enjoying a rather long vacation from reality.

Obama (and Gordon Brown) have apparently not been listening to Reinhart and Rogoff, or they wouldn’t be attempting to solve our problems by issuing yet more debt.

Perhaps we shouldn’t be too surprised that debt reduction doesn’t seem to be our policy makers’ priority. Indeed, one might think our extreme indebtedness is nothing more than a minor nuisance. Neither our political elites nor the central bankers and leading economists appear to grasp the obvious: that years of cheap, excessive credit and high debt were precisely what got us into trouble. And yet we’re still happily continuing on the same path.

In only three years the Obama administration will have increased the national debt by some $4.35 trillion. (And that excludes the huge deficits of off-budget programs like Medicare, Medicaid, social security.) The budget freeze proposed by the administration for 2011 is projected to save some $15 billion (or about 0.4% of the total budget, a drop in the ocean). Note that it’s merely a budget freeze, not a cut in nominal terms. Worse still, the the vast majority of federal programs (incl. Medicare, Medicaid, social security, military, homeland security etc) are to be exempt from the freeze.

It should be obvious that the US won’t get its debt under control unless it sharply reduces government spending, including on health and pensions that have simply become unaffordable. The US is not much behind Britain and the eurozone when it comes to the horrific shape of public finances. The only advantage, for now, is the dollar’s status as the world’s reserve currency (and of course the country’s control over its own monetary policy).

But that doesn’t change the basic fact – you cannot spend your way out of a fiscal crisis. The current path is unsustainable. The Obama prescription of more debt, more spending and more taxes is a triple ticket to ruin, plain and simple.

But, it would be unfair to focus solely on the US, for here in Britain we are in an even greater mess.

The UK has not only the world’s highest total debt/GDP (along with Japan) but also one of the worst budget deficits at 12.6% of GDP. (According to OECD, only Iceland and Greece have higher deficits, at 15.7% and 12.7%, respectively. The UK is expected to post a 12.8-13% deficit this year, overtaking Greece.)

The speed of the debt run-up has been nothing short of alarming. Unsurprisingly, Britain is already paying higher interest rates to borrow than Spain or Italy. While the yields on gilts have recently risen significantly, they are heading far higher – as soon as the markets start taking a look at other basket-case economies aside of Greece. The pound has fallen by some 25% vs the dollar, and has much further to go unless the markets start seeing some credible solutions from Britain.

Yet there is no political will to face the excessive debt, no meaningful plans for deficit reduction. Gordon Brown’s government has rejected any idea of implementing spending cuts in 2010/2011. And the opposition? David Cameron said spending cuts during the early part of a Conservative government wouldn’t be ‘particularly extensive’.

Government spending has exploded over the 13 years of Labour governments and is now completely out of control. But one would look in vain for austerity measures and severe fiscal tightening, not just from Labour, but also from the (so-called) Conservatives.

The micro-cuts that both the government and the Tories are proposing will not even make a dent in the monstrous amount of public spending. The pledges to ring-fence all main areas of spending, including the wasteful, bureaucratic and inefficient NHS, instantly expose any deficit reduction plans as lacking of credibility.

What remains are tax raises. As if Gordon Brown’s hike of higher earner income tax from 40% to 50% (or 62% once national insurance contributions are added on) wasn’t bad enough, further tax increases are likely on the way. All that (along with the insanity of the additional 50% bonus tax) will only achieve one thing – further damage to the dwindling private sector already suffocated by a gargantuan web of high taxes, red tape, hostile regulation and uncertain political environment.

From Labour’s point of view, there is no harm in further undermining the only economically productive part of the economy. Expansion of government and redistribution of wealth are the objectives. What Brown and Obama have in common is their disdain for and antagonism toward anyone earning (or striving to earn) a decent income, and the desire to redistribute from the hard working and productive to the idle and unproductive.

It matters little which party wins the upcoming general elections; all three of the country’s main political parties have fully embraced ‘progressive’ (read socialist) ideas. A Tory victory may be slightly less disastrous than another Labour term, but nothing that the party is offering will set Britain onto the right path.

And the people have only themselves to blame. Thanks to the vast expansion of government too many millions are now enjoying an idle life of welfare-dependency. Add the millions more in public sector jobs with their high wages and appallingly generous pensions, and it is little wonder that politicians are unwilling to do anything that would anger the majority of the voters.

We have become a society with an overwhelming sense of entitlement – at the expense of those who still believe in self-reliance and hard work, only to see their wealth stolen by the parasites. This unsustainable situation will inevitably blow up, and deservedly so. Only then will a new cycle be able to start. And perhaps, just perhaps, we will even witness a return to common sense one day – as in smaller government, less interference in the free markets and the productive sector, less dependency and more self-reliance.

But in the meantime, as public debt is becoming a crushing burden on most developed economies, the only thing that appears certain is a widespread sovereign debt crisis (and defaults) a few years from now.

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