Obviously, if the euro zone breaks up, as many commentators including the Economist (Is this really the end?) see as reasonably likely, the global economy will suffer a massive negative shock and we may need to revisit forecasts of a decade of prosperity for the Queensland economy. Officials at the Queensland Treasury Corporation, which borrows money on the Government’s behalf, are no doubt keenly following international developments. Indeed, they are already feeling the effects of the latest financial turmoil, as reported in this weekend’s Australian Financial Review (No mood for state bonds, p. 17):

Australian state government bonds have been caught in the crossfire of the escalating sovereign debt crisis, with bond spreads blowing out relative to sovereign bonds.

The spreads of semi-government bonds issued by the Queensland Treasury Corporation have been particularly hard hit – widening to as high as 1.5 percentage points above the Australian Government bond, from an annual average of 0.9 of a percentage point.

If this continues, or worsens, I expect the Commonwealth Government will re-instate its guarantee of State Government borrowings, which it introduced in early 2009 for a temporary period until the end of 2010. In the worst case scenario, the Commonwealth Government may even have to consider borrowing on behalf of the States.

I expect (or rather hope) this would force a broad ranging debate about the nature of our federation and whether State Governments should be replaced by smaller regional Governments that would absorb current local governments.