Las Vegas, Nevada

Mohamed El-Erian, PIMCO's co-CEO and probably one of the best credit gurus in the United States, believes the global economy will struggle because of the ongoing deterioration in public finances. Though the next credit shock might be a few years away following the dark days of 2007-2009, governments will face the Piper again amid a flood of issuance to finance out-of-control deficits and rising long-term interest rates.

"The importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood," El-Erian wrote in a PIMCO commentary. The potential damage from increased government borrowings is "at present being viewed primarily --and excessively -- through the narrow prism of Greece," he wrote.

Thus far global markets have discounted sovereign credit dislocations in Dubai and Greece. Both economies are a small percentage of global GDP. But over the next several months or years bigger fish among the growing debt pool will face major hurdles as a combination of rising public pressure to reduce spending and grow employment result in some sort of currency or sovereign debt crisis.

According to Grant's Interest Rate Observer and the Bank for International Settlements, German banks are in the firing line among those creditors in the euro-zone with significant loans outstanding to Greece, Ireland, Spain, Portugal and Italy.

Combined, these weaker European Monetary Union (EMU) members have borrowed $732 billion dollars from Germany with Spain, the single largest debtor, at $240 billion dollars. German banks, however, only have $625 billion dollars of capital.

French banks are also vulnerable. French banks have lent out a cumulative $858 billion dollars to Greece, Ireland, Spain, Portugal and Italy. The French have a whopping $489 billion on their books tied to Italian credit.

Governments may have to raise taxes and slash spending to cope with swelling deficits after nations, including the U.S., borrowed unprecedented amounts to stave off the global financial crisis, said El-Erian. "A failure to carry out fiscal measures in time would raise the possibility of governments seeking to eliminate excessive debt through inflation or default," he said.

James Grant, poignantly reminds us that this avalanche of debt runs the likelihood of causing inflation down the road. "The burden might eventually have to fall on central banks, which – unlike gold miners – can create money on a computer keyboard."

The next 12 months will be critical. Just how central banks plan on removing fiscal stimulus at the same time an economic recovery is taking root will be most difficult. Removing the punchbowl early is something the Europeans are contemplating since the Germans remain Weimar-wary and will seek to avoid any inflation above ECB targets. But the Federal Reserve is not an inflation-fighting institution and instead will overshoot credit targets and print more money as the United States prefers to suffer the inflationary consequences than a repeat of the 2008 crisis when deflation purged the financial system.

The odds that we won't suffer some sort of major policy blunder and consequential crisis is highly unlikely. Too much government debt is chasing too few buyers. At some point, the bubble now accelerating in public finances must pop.