Is the U.S. economy recovering, or is it being held back by its global connections?

Japan has been in the doldrums for a dozen years. Now comes a report from the London Telegraph that German banks teeter on the precipice, putting more strains on the global financial system.

Germany's weak economy and spectacular bankruptcies mean billions in loan losses for German banks already suffering from massive losses on their huge equity portfolios. Under this pressure, German banks' share prices have collapsed. Commerzbank, Germany's third largest, has experienced a 70 percent decline in value, leaving the former powerhouse with a lower market capitalization than small British specialist banks. 

German banks now labor under a shortage of capital, with just enough to support the asset base. Merrill Lynch analyst Stuart Graham says,

"We cannot remember ever having been so worried about the outlook for the industry."

Overcoming the problem will not be easy. German companies rely heavily on debt financing, but the capital crunch that German banks are experiencing means that little money is available to fund new loans.

With capital restraints on their lending ability, there is little room for the banks to become more profitable by raising their lending margins. Moreover, two of the large banks have had their creditworthiness downgraded, which raises their cost of funds.

When the economy is weak and companies are faltering, banks need to be strong enough to roll over the loans of struggling companies. When banks are weak, they cannot perform this vital function.

With no growth engine in sight and bad loans still plaguing the global financial system, the Bush administration's fixation on Iraq is difficult to understand.

True, the Democrats' class warfare demagogy and political dependence on welfare constituencies make it difficult for Republicans to deal with economic problems. This could be the reason the Bush administration has focused on terrorism and Iraq, where a "you are with us or against us" posture frustrates the usual Democratic strategy of gaining power by undermining a Republican president, thus enabling the liberal media to portray him as a failure.

The Japanese property bubble burst a decade ago, and the Germany property bubble burst in the mid-1990s. German banks are still being hit by bad debts on property deals. Japanese banks have yet to write down the decade-old bad debts on their books.

What if U.S. property values turn out to be a bubble that bursts, forcing write-offs that further weaken the global financial system?

The new global economy has not been tested by crisis. Nor has the Euro, the new money of Europe. No longer having their own currency, the Germans cannot manage their economy through the Bundesbank, its role having been taken by the European Central Bank.

In crisis, central banks, especially untested ones, fail more often than they succeed. If Germans experience a liquidity crisis and fear for their post-war economic stability, there will be a popular demand to reinstate the German Mark and the power of the Bundesbank.

The Euro would then be history, leaving uncertain the fate and value of assets and contracts denominated in Euros.

The global economy could unravel as easily as domestic economies unraveled in the 1930s.

Political fights for power and ideological campaigns, such as the one for European Union, divert attentions and energies from genuine and dangerous problems that are independent of the dreams of ideologues and lusts of the power-hungry.

The unintended consequences of human aims and goals are often more powerful than the intended ones.

Major economic institutions in the West have failed in the past. They could fail again.

The struggling global economy is worth more attention than it is getting.

Paul Craig Roberts is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions: How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice.

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