Funny how the market is just waking up to the Euro debt problem. Many have argued that debt levels are unsustainable, yet the IMF has adopted the neo-Keynesian line that governments can spend with impunity so long as unemployment is high. If there are unemployed workers in the economy, then conventional wage-push inflation — i.e. workers negotiating higher wages, which in turn drives up consumer prices — can’t happen. Or so the argument goes.

But this ignores bond market realities. The PIIGS on Europe’s periphery — Portugal, Ireland, Italy, Greece and Spain — have huge budget deficits as a percent of GDP, but don’t have the power to print money to pay it back. So bond markets are bidding up the cost to insure their debt:

Correlation among asset classes has returned with a vengeance recently as stocks and commodities have moved in sync 80% of the time since January 11^th of this year vs. 11% of the time between April and August of 2009.

The pundits would like to pin the tail of this donkey on the PIIGS but I would ask you to consider whether a country whose entire population is 11,238,162 means as much to the global economy as the 14,800,000 people officially unemployed in the U.S.A, which doesn’t count the additional 11,200,000 that are “underemployed”, bringing the total of those not contributing to the recovery to 26,000,000. Mike O’Rouke used a different yardstick in this week's Barron’s, highlighting the similarity of the GDP of Greece with that of either Michigan or Ohio in the lower 48.

A European country is struggling to rein in its swelling budget deficit. It chooses to sell additional treasury bonds to fund its spending needs/desires.

The European Commission doesn’t like the direction its member country is heading with that rising deficit. So the group publicly pressures the member country to act more responsibly.