Mohamed El-Erian

Are you tired of all the stories on Europe’s financial crisis and American politicians’ endless bickering about debt and deficits? Are you tired of weekends of hectic negotiations as policymakers rush to cobble together some agreement before markets open? If you are, you are not the only one.

Millions of people, including stressed-out policymakers on both sides of the Atlantic, wish to put these issues behind them. Unfortunately, despite many announcements, they are unable to do so decisively, and for good reason.

So we better understand why, if we want to minimize the risk of collateral damage and unintended consequences.

To do so, you need only remember one rather clumsy phrase: “safe de-levering” (also known to some as “safe de-leveraging”), or the lack thereof. Consider please each word, starting with the second one.

De-levering refers to the rehabilitation of balance sheets that have gotten over-indebted to such an extent that they are unsustainable going forward. The contributing causes are usually numerous and many years in the making.

In Europe, three peripheral countries face immediate and significant de-levering pressures. Greece and Portugal are two of them. They had too many years of irresponsible government spending, inadequate taxation, weak public administration, and insufficient economic growth. The third, Ireland, was fiscally responsible but made the big mistake of using what was a relatively healthy public balance sheet to assume the massive losses of its irresponsible banks.

These three countries now face a buyers’ strike. Lenders have been resisting the renewal of their credit lines and, needless to say, have no appetite whatsoever to provide incremental funding. No wonder interest rates have soared and financing has dried up, other than official bailouts from neighboring countries, the European Central Banks and the International Monetary Fund.

The result is not just a liquidity crisis; but also a solvency one. With government gross debt burdens ranging from 100 percent of GDP in Portugal to 156 percent in Greece, these countries are now embarked on an unpleasant, forced de-levering process.

America’s case is different. Yes, it has a high budget deficit (over 10 percent of GDP) and has experienced a dramatic increase in its debt-to-GDP ratio since the global financial crisis. Yes, the fiscal outlook gets cloudier as a result of a structurally weak budget. But unlike peripheral Europe, it is nowhere near an immediate liquidity crisis.

America’s creditors are more than willing to fund the country at historically low interest rates. Rather, it is political squabbles that have dramatically brought forward medium-term fiscal challenges, and have done so through the use and misuse of the debt ceiling, an arcane but, as we have all found out, a rather lethal legislative weapon.

We should all accept that Europe and America — the former for fundamental reasons and the latter for self-inflicted ones — are now in a de-levering cycle whose consequences will be with us for many years.

The actual process of de-levering can play out rather quickly. Indeed, too fast a de-levering can be catastrophic in terms of its impact on growth, employment and poverty. So you can be sure that policymakers will do their utmost to deliver a safe, gradual process.

The best way to do so is through high economic growth. This maintains living standards and generates incremental income to pay off debt, thus providing an orderly path to medium-term debt sustainability. Unfortunately, this option is not available today to either Europe or the US as both are stuck in what PIMCO has been describing for over two years now as the bumpy journey to a new normal.

Other than some short bursts, Europe and America are unable to sustain the sort of economic recovery that would make a meaningful dent in their debt dynamics. They will remain in this regrettable situation until policymakers become more serious about a comprehensive and coordinated set of measures to remove structural impediments to sustained economic activity — including steps to improve the functioning of the housing and labor markets, better worker retooling and retraining, enhanced education systems, even more bank lending, improved productive infrastructure, etc.

If they are unable to grow out of their debt problems, countries have four other options. Two of these are also available to us as individuals: we can default, and let restructuring lower our debt burdens, albeit in a rather disorderly fashion; or we can implement austerity, spending less in order to generate cash to pay off our debt.

Because countries control the printing presses and write regulations — things that the rest of us do not have or cannot do — they have two additional alternatives. They can try to inflate their way out of the debt, or they can reduce it through years of “financial repression,” that is, paying millions of depositors and creditors much less than they deserve in order to divert funding to debt payments.

Judging from what we have seen so far, governments are opting for different mixes.

The three peripheral European governments are imposing harsh austerity on their populations — remember the riots in Greece? — and also benefiting from the willingness of their European neighbors to financially repress their citizens in order to provide additional official funding. At least one (Greece) is having to go further by also partially restructuring its debt.

America is talking about austerity, including this past weekend’s compromise fiscal framework, but using financial repression. So far, this has taken the form of the Federal Reserve maintaining interest rates at extremely low levels for an exceptionally long period of time — so much so that savers and creditors are paid interest rates that are below inflation, and in some cases, well below inflation.

This will not suffice. Look for America to intensify financial repression through regulations that forces banks and other regulated entities to hold low yielding government securities. Also, it will attempt to generate unanticipated inflation. Ultimately, it will be forced into more painful austerity involving both spending and tax measures.

The de-levering pressures will be with us for years, and governments will mix and match from the menu of options. Accordingly, periodic debt dramas and crises will not go away any time soon. Debt is simply too high and there isn’t enough economic growth to painlessly de-lever.  Each response that governments decide to adopt has different implications for us, as savers, investors, debtors, home owners, and business people (the topic of a future piece).

Unfortunately, none of us have the ability to fully insulate ourselves from the collateral damage and unintended consequences. The best we can do is to understand the process, including what governments will do. In this way, we can try to minimize, though never eliminate, the adverse impact of de-levering.

By Mohamed A. El-Erian
The opinions expressed are his own.

Friday’s stunning and very public quarrel between the president and the Speaker of the House of Representatives was the catalyst for a weekend of frantic negotiations on how to increase America’s debt ceiling, maintain the country’s sacred AAA rating, and avoid a near-term default. Meanwhile, administration officials and members of Congress took to the airwaves on Sunday trying, but largely failing, to strike the balance between statesmanship and another round of the Washington blame game.

It was hoped that all this would serve as a prelude to a political compromise announced just before the opening of Asian markets. This did not materialize. But while another self-imposed deadline has been missed, it is likely that the nation’s leadership will stumble into a short-term compromise over the next few days — one that raises the debt ceiling and avoids a debt default but, importantly, leaves the AAA rating extremely vulnerable and does little to lift the damaging clouds hanging over the US economy.

It will come down to the wire; and when the stopgap compromise is reached, many in Washington will declare victory and, in the process, claim credit for averting a national disaster. Yet the resolution will likely be temporary, and the damage will be real and long-lasting — both of which render an already worrisome situation even more difficult going forward. Indeed, by illustrating so vividly to the whole world what is ailing America, the weekend’s political theatrics should make us all worry even more about the world’s largest economy.

First, consider the context. America’s already-fragile economic psyche and its global standing have taken a material hit. Forget about “animal spirits” for now. Instead, worry even more about an economy that is already having tremendous difficulty sustaining an acceptable growth momentum, and that already suffers from an unemployment crisis that is increasingly protracted in nature. Analysts will now scramble to again revise down their projections for growth, and up those for unemployment.

Second, remember the content. The debt and deficit issues that are at the root of the debt ceiling drama are, unfortunately, a small part of a much larger set of structural impediments to employment, investment and wealth creation. The housing sector is still languishing, credit intermediation is uneven, infrastructure investment is lagging, job skill mismatches are increasing, and income and wealth inequalities are worsening.

Third, lament the process. Virtually all Americans worry about these problems and too many feel them acutely on a daily basis. Astonishingly, however, our elected representatives and their appointees are just bickering and, distressingly, failing miserably to communicate a vision that provides for even the smallest amount of medium-term optimism. The endless political squabbles compel all to question whether politicians are aware of Main Street’s realities, let alone up to the task of making things better.

Finally, don’t forget the international angle. Anyone who travels will tell you that America’s friends and allies are bewildered at what is going on here (and its enemies rejoicing). This comes at a time when the country can ill-afford to lose the confidence of large foreign holders of US Treasury bonds, overseas manufacturers with factories here, those that use the dollar as the reserve currency, and the many who have outsourced to here the intermediation of their hard-earned savings and pensions.

Yes, after taking it to the edge, it is still highly probable that Washington will manage to step back from defaulting on the national debt. But no one will, or should, feel good about how this happens.

It is highly likely that the solution will be a band aid that has to be replaced in the coming months. In the meantime, America’s structural injuries will deepen and, to an extent that was unthinkable, America’s economic future will become even cloudier.

This country’s turnaround is less of an economic engineering predicament and more of a political fix. But if Washington continues to squabble and if acrimony intensifies further, it will quickly become both.

This piece originally appeared on the Huffington Post.