European Central Bank executive board member Lorenzo Bini Smaghi warned of a looming debt crunch in several developed countries that could cripple economies if left unchecked.
Although deficits are expected to start narrowing gradually next year, some major economies face a bleak picture, with the United States for example looking at debt to gross domestic product of 110% by 2015, Bini Smaghi said.
"The issue of the sustainability of the debt in several industrial countries is looming," he said in a speech given at a conference on Thursday and posted on the ECB's Web site on Friday.
"Owing to the role of advanced economies as lenders of last resort to their own financial system, as has been confirmed by this crisis, a debt problem at the level of the state would cripple the economy as a whole," he added.
Bini Smaghi was speaking amid renewed concern over banks and growth that has prompted spreads on the debt of some weaker euro zone countries to widen back out towards record levels — and in Ireland's case surpass them.
The Italian also said there could be broad ramifications if investors began to take the view that long-trusted government debt was no longer a 'risk-free' purchase.
"What scenarios open up if advanced economies' sovereign debt assets are no longer perceived as risk-free assets? How would this affect the functioning of financial markets?" Bini Smaghi asked.
"The disappearance of 'good' collateral would reduce credit supply and thus impair economic activity," while "in the case of reserve currencies, higher solvency risk would potentially hamper the stability of the international financial system," he said.
ATHENS WOE
Bini Smaghi, one of the ECB's six-strong Executive Board, said Greece would default on its debts if it abandoned the euro and even an 'orderly' debt restructuring could cripple an economy.
He said the idea of Greece leaving the euro was absurd, arguing that its debt problems gave it even more reason to stick with the single currency.
"If Greece were to exit the euro, a hypothesis … I consider absurd, its debt burden would de facto worsen given that it is denominated in euro, and partial default or restructuring would in that case be unavoidable," he said.
"What many analysts — or I should say doomsayers — have not understood is that the debt problem is the biggest incentive for Greece to remain in the euro area."
Greece, whose debt problems ignited the euro zone debt crisis, admitted on Friday that its deficit cuts fell short of target in the first eight months of the year due to heavy debt payments and worse-than-expected revenues.
Debt problems also continue to blight the region's other highly indebted perimeter countries.
Ireland on Thursday said it would announce the cost of winding down troubled lender Anglo Irish Bank within weeks, aiming to draw a line under an issue that has raised fears of a full-blown Irish debt crisis.
Bini Smaghi said uncertainty over how financial markets will react to debt levels made it difficult for governments to set budgets.
He also hit back at recent criticism from select policymakers, including French Economy Minister Christine Lagarde, that Germany's strong trade surplus was hurting the rest of the euro zone.
"Surplus countries are in surplus in the first place either because they are fiscally more conservative, at least compared with the more profligate countries – and rightly so I should add – or are facing a situation in which private savings are very high and might even increase if public dis-savings were to rise," he said.
