Why governments will be forced to cut back next year

2009 has seen government goodwill to all men. But as this reverses in 2010, the world – and not just in finance – could get very nasty.

This year, politicians around the planet have tried to bounce their countries out of recession. But they’ve spent much more than they’ve raked in from taxpayers. So they’re borrowing more than ever before. By the end of 2009, global sovereign debt will hit almost $50 trillion.

Yes, that’s right – 50 million million dollars. Servicing this debt alone will cost over 6% of the global tax take in 2010, up from 2007’s 4.3%. And there’s only one real answer. Governments, whatever they say now, will have to take a chainsaw to their spending.

Ireland has started cutting. It’s just lowered spending by €4bn – but that’s still less than the interest bill on the country’s national debt. Greece, which is in huge trouble, as we talked about last week, hasn’t yet.

Nor has Britain. The Chancellor’s Pre-Budget Report was based on little more than the hope that our economy will recover enough to pay his bills. As for the States and its $14bn debt in 2010 – don’t ask.

So what happens now? Global bond markets, which get called on to plug the cash gap for overspending politicians, will demand two things before they lend all this extra money.

First, a higher return on the bonds they’re buying. That’s to compensate for the extra risks they’re running. It means long-term interest rates will be forced up (as yields rise, bond prices fall) as we forecast last month. As Jeremy Warner says in The Telegraph, “a bond price crash is the surest bet in town”.

Second, huge state spending cutbacks. This will mean big public sector pay cuts, fewer welfare benefits and no more ‘stimulus’ schemes. Taxes will also be hiked. Many economies will zap back into recession. Then, says Moody’s, we could see “social unrest”. That’s rating-agency speak for riots in the streets, as public anger boils right over. But cash-strapped governments will be powerless to stop this.

In essence, we’ve lived on borrowed money for far too long. And with a real double whammy – more costly money, and much less cash government around – 2010 will be the start of payback time.

In the financial markets, that’s not only bad news for bond prices; cyclical stocks, which depend on economic growth for their profits, could get severely crunched. High-yielding defensive shares look just about the best bet for 2010.