Bracing for Stormy Economic Weather - UPDATE

Update at bottom.

The leader in the most recent issue of the Economist questions Europe's collective will to defend the euro.  The result of failure would be catastrophic, in that august publication's opinion.  I am not so sure, but it would be bad in the short term.  They recommend a number of steps in the unsigned editorial, most notably, printing more euros, although that's not how it is phrased of course.

That is because much looser monetary policy is necessary to stave off recession and deflation in the euro zone. If the ECB is to fulfil its mandate of price stability, it must prevent prices falling. That means cutting short-term rates and embarking on “quantitative easing” (buying government bonds) on a large scale. And since conditions are tightest in the peripheral economies, the ECB will have to buy their bonds disproportionately.

It is an open question whether the euro will survive in its present form, but regardless of the outcome, we can expect turbulence ahead.  Even if the euro is saved by the aforementioned actions, it will set in motion long term inflationary pressures as the euro loses value against the dollar.  This will have a negative impact on U.S. exports, putting more pressure on our tepid recovery.  However, if the euro zone can't be saved, and widespread defaults on government bonds outside of Greece get started, then a real liquidity crisis could trigger a second global recession.  America would not be immune to this outcome either.

Either way, we are going to see real pressure on our own government's deficit situation, as economic headwinds deprive governments at all levels of revenue.  At the same time another recession increases outlays due to unemployment payments and increased use of food stamps, medicaid and other parts of the social safety net. 

The silver lining is that Obama is unlikely to be re-elected in such a climate.  But many Americans and people all over the world are going to suffer.  The root cause of our troubles is clear; all over the western world, politicians have made promises that were going to be impossible to fulfill.  This is the central appeal of Chris Christie; he is the politician who has best articulated this truth.  The end result is that those dependent on the government, whether retired employees, social security recipients, or others, will not have the standard of living they thought.  Governments will not keep their promises, either through bankruptcy, inflation or abrogation, because the collective promises can't be met. This will lead to lowered consumption as the reality of reduced lifetime income sets in and long term re-adjustment in the economy.  We are not going to have a full recovery for a decade, in my humble opinion.  But the tea party movement is correct in focusing on getting the spending under control now, because the sooner we come to grips with the spending problem, the sooner the economy will recover.

UPDATE

Over at Zero Hedge, Phoenix Capital Research has this to say:

Indeed, with Europe’s entire banking system insolvent (even German banks need to be recapitalized to the tune of over $171 billion) the outcome for Europe is only one of two options:

1) Massive debt restructuring.

2) Monetization of everything/ hyperinflation These are the realities facing Europe today (and eventually Japan and the US).

Either way we are talking about the destruction of tens of trillions of Euros in wealth. The issue is which poison the European powers that be choose.

Personally, I believe we are going to see a combination of the two with deflation hitting all EU countries first and then serious inflation or hyperinflation hitting peripheral players and the PIIGS.