The markets are obviously concerned about the escalating Sovereign Debt around the world as Governments are pump priming their economies to prevent a severe recession.

Is the news all bad, and will the doomsdayers eventually be right in waiting for the US to default on their debt? There is no doubt that the current flashpoints of Dubai and Greece are good causes for concern. Dubai creditors have been offered .60c in the dollar over several years. Greece has exceeded its debt limits set by the Euro Zone, and unless they can commit to a budget that lowers their debt relative to Gross Domestic Product, then the disruptions will certainly cause some market correction.

The economic framework that Bernanke and the US Federal Reserve is working under can be described as Keynsian economic theory. Private debt (70% of GDP) in the US is contracting, with the Keynsian remedy being that the Government should run a fiscal deficit to fill in the demand gap created by the contracting private sector. The deficit spending certainly has saved the world from a severe depression, which we all should be thankful for, despite the perception that Wall Street got a better deal than the man in the street. Keynsian theory also suggests that the Government should wind down its deficit spending allowing the private sector to expand. Also, interest rates should be lifted to counteract inflationary pressures.

These points are what the market is fearful of - cutbacks in stimulus spending, high debt, and rising interest rates. Economic historians point out that as the Keynsian framework was followed in the 1930's, every time the Government tried to wind back spending or lift interest rates, the economy fell back into recession.

Richard Koo, an economist working for Nomura in Japan since 1984, points out that the same thing happened to Japan in their 20 year recession from 1990 until present. Japan has been running massive deficits for 20 years, interest rates are zero, and again, every time the Government tried to reduce the deficit, the country fell further into recession. Richard Koo's point is that the Government should not be afraid of deficit spending over a long period of time, obviously against current consensus opinion. Even though the Private Sector contracted over this 20 year period, with land prices falling over 80%, consistent Government deficit spending has maintained Japanese Gross Domestic Product.

The key point Richard Koo makes in relation to Government debt is that with the deleveraging of the private sector, the savings ratio has dramatically esculated. These savings are put on deposit with the Domestic banks, which then in turn are available for the banks to invest in Government securities. In the US currently, domestic banks have $1.2 Trillion on deposit with the Federal Reserve. It is not that the banks do not want to lend, it is that the public does not want to borrow (Economist - Steven Keen's point). If Governments can borrow from the domestic savings pool to fund the deficit, then this may be the a point of equilibrium that will allow a repeat of the 20 year Japanese experience. The US strategy would then entail extending (and maybe pretending) to indefinitely roll problematic loans until the system sufficiently repairs its balance sheet to eventually to begin to expand.

The ending of the stimulus program and the lifting of interest rates is not what the US or Euro Governments wants to contemplate in the current enviroment. The Chinese Government, which is fortunate not to have an opposition party, is fairly much a closed economy. 70% of Australian exports to China remain in China. China should be able to withstand a contraction in World demand. China certainly will not allow its economy to go into recession, despite lifting bank reserves to slow down speculative demand.

A return to "the good old days" is gone. A Japanese like scenario over a long period is a likely outcome. Certainly there will be scares like Greece, Dubai, Ireland etc, but with Governments committed fiscal deficits to maintain consumption, Investors will certainly be able to position their portfolios to take advantage. Our minds will be changed should the US Government lift interest rates and contract their spending without real commensurate growth in the private sector.