The U.S. Is Not Alone — Europe's in Debt Too

President Obama may have left jaws hanging with his proposed $3.8 trillion budget for the fiscal year 2011 — which forecasts a stunning $1.6 trillion deficit — but he's hardly the only member of the "spend now, pay later" club. Across Europe, governments have gotten so used to embracing debt during economically tight times such as these that some experts are starting to wonder if they will get back to viable deficit levels — much less balanced budgets — anytime soon.

The U.S. is clearly in a debt league of its own. Obama's proposed deficit, representing about 11% of gross domestic product, is part of a 10-year plan aimed at reducing the U.S. budget shortfall from its current level to a still hefty annual average of 3.6% if everything goes well. The deficit amounts may be less dizzying in Europe, but they're still a major cause of concern for fiscal purists who fear that some governments may end up drowning in red ink. Twenty of the European Union's 27 members are running deficits to ease their way through the global recession, with the average pegged at 7.5% this year. Three years ago, the E.U.'s deficit average was just 0.8% of the bloc's total GDP. That figure increased to 2.3% in 2008 and then spiked to 6.9% last year.

Perhaps the worst part, however, is that deficits have risen the fastest in the euro-zone group, which requires members to limit their budget shortfalls to 3% of GDP. Many of these countries began exceeding that threshold before the financial crisis began and then went well above it after the crash. E.U. countries collectively spent $1.5 billion to save their vulnerable banking sectors and a further $200 billion in stimulus funding to revive their economies. Although the latter helped the 16-nation euro zone exit the recession in the middle of 2009, it also lifted already lofty deficit levels even higher — and brought Greece and Spain perilously close to default. Late last year, the European Commission put a handful of other nations on alert out of similar fears, including France and Ireland.

"The problem is simple in that if you're an individual, a business owner or an entire state and you build your debt level to 70%, 80%, 90% of your revenues, you soon won't be able to pay the interest on your borrowing — much less the principle — and you'll default," says economist Marc Touati, deputy director of the Paris-based financial-services group Global Equities. "We're not there yet, especially for all the nations of Europe. But there are several, including France, that simply must cut spending, deficit and debt dramatically, and soon — or things will get very ugly."

How ugly? Greece is already scrambling to lower its deficit of nearly 13% to the E.U. ceiling of 3% by the end of 2012 under a European Commission plan to be endorsed on Wednesday. Spain is similarly promising to slash its deficit of 11.4% to just 3% by 2013, although the country — which is still reeling from the recession, with unemployment of nearly 19% — has been vague about how it will do that beyond proposing $69 billion in cost-cutting measures over the next four years. Last month, French officials somehow managed to sound proud when they announced that France's 2009 deficit of 7.9% was lower than the expected 8.2% — and that they would hold it below 8.2% for the rest of this year.

Under pressure from the E.U., France also said it would seek to bring its deficit to under 3% by 2013, although that is based on optimistic economic growth levels of at least 2.5% annually. Meeting those targets gets even more challenging with the tax cuts that President Nicolas Sarkozy keeps handing out — most recently to businesses worth over $10 billion annually — coupled with his call for all E.U. countries to continue pumping their economies with stimulus spending to foster growth. Even Germany, the E.U.'s most disciplined member, will see its 2009 deficit of nearly 4% rise to almost 5% in 2010 under the government's plan to cut taxes while increasing spending.

Why all the stress about deficit spending — especially in the wake of the worst recession to hit the continent in a lifetime? Because the habit isn't new, and it is clearly harder to kick than governments pretend. Observers note that the borrowing kick has already lifted French public debt to nearly 80% of GDP — a level that Germany is within shouting distance of, and which Italy, Belgium and Greece are well beyond.

"European economies aren't as big as the U.S., so the debt involved isn't as much, but when levels get too high and financing them just isn't possible anymore, the entire thing will come falling down," says Eric Grémont, co-founder of the Paris-based Politico-Economic Observatory of Capitalistic Structures. To avoid this, he and Touati both say that states must freeze their spending at current levels to speed up a return to economic growth. But when that happens, they add, governments must also start slashing budgets, reducing expensive state services and cutting jobs — all the things that tend to weigh economies down in good times. Why? Because they say the only way big-spending nations can avoid implementing drastic debt-reduction measures is by prompting massive GDP growth — something few observers see happening anytime soon.