In 2008 we all experienced, to varying degrees, how an economic crisis in a few major economies can affect many others. Canada happens to be a great example. Stalwart denizens of a unique, hybrid economy, keeping deficits relatively low, encouraging growth while having an impressive array of social programs available to its citizens, Canooks were not spared the serious market sell-off that occurred around the world, despite varying and even conflicting economic policies.

This is the new world economy, where we are not so much independent market participants, who just happen to live on the same planet, but a network of economies linked interdependently and with little (if any) control over other participants. While I understand that this fact may make some of you want to curl up in a ball and whimper, there is hope.

A fair amount of economic news lately has focused on the chances of a world-wide “double-dip” recession, due to a so-called debt crisis in Europe. I refer to that crisis with skepticism, as it is, in many ways, just a spectre, or a mirage. What we’re really dealing with is a crisis of confidence, mostly inspired by political dogma and certainly not economic sensibility. For many reasons, some valid, some not — and most of them reactions to high deficits and stubborn growth rates — investors have begun to question the fiscal state of many significant European economies. These concerns are amplified by political grandstanding across major economies, which tends to frighten citizens into embracing a certain austere dogma about spending by nations.

The problem is that when you scrutinize these supposedly troubled economies, few of them prove to be in the kind of terrible fiscal shape one would think requisite to invite the term “debt-crisis.” Greece is one notable exception to this statement — but, unless you’ve been living under a rock for the last two years, its problems are neither new nor news. Spain and Italy, with much more significant Eurozone economies, are getting lumped in with Greece, even though their debt problems are not comparable.

Spain enjoyed a significant budget surplus before 2008 and, despite the significant effects of a current housing crisis, still enjoys relatively low debt. (Exactly how low might surprise you: Spain’s debt to GDP ratio is lower than that of Canada, France, Germany, England and the U.S.A.) Italy, with its high amounts of debt but relatively low deficits, is expected to emerge from the crisis sooner than many of its economic neighbors.

So why have these countries, as well as other Euro-economies, experienced surges in borrow costs, potentially leading them to — no, make that, causing — catastrophic default? The answer is relatively simple, but a mystery to those not terribly familiar with market dynamics.

Investment markets are essentially broad surveys of market participants, with prices and yields reflecting the market’s perception of the future economic prospects of any given company or, in this case, country. Every time a nation does a bond sale to the public markets, it is asking, What percentage rate does that particular country need to pay investors to fund a loan out for, say, 10 years? Currently, investors in US debt say we will accept around 2 percent to buy that bond. This is a record low rate, despite the fact that the US is carrying a debt to GDP ratio much higher than normal, and growth has lagged throughout 2011. So, clearly, economies can carry significant debt and still not experience significantly higher borrowing costs. Why, then, is there a Euro-crisis?

The market, to my mind, is suggesting that the reason is in the differences in approach to policy that the US and the EU have taken. While the US has been willing to spend in order to encourage growth in its economy, the deficit Hawks (fiscal conservatives) in Europe have had their way, cutting spending and reducing stimulus before real growth has had a chance to take hold. If you look at the performance of any of the affected Euro economies’ markets after interest rate hikes or after a period of policy inaction due to political pressure towards austerity, you will see declines in the values of equity and debt assets and a general decline in job growth and production.

But look at how the market responds to easing programs — for example, the purchase of a country’s own debt by the central bank or other asset-purchasing programs. You will see increases in the values of equity and debt assets. Any trader, whether conservative or liberal, will tell you to listen when the markets speak.

Perhaps it’s time for politicians and economic officers to follow the professionals’ lead on this one, and pay attention to the inverse relation of asset prices and enacting austere policies. If there is going to be a double-dip recession, we should know that fear and inaction will be the only real cause.

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Image courtesy of Ingmar Zahorsky.