ANALYSIS-Doom scenario far-fetched but euro gloom to deepen

* Social cohesion to be tested as debt strains take toll

* Greece under microscope; some worry over Spain

* Welfare state cushions pain but long-term cost is high

By Alan Wheatley

LONDON, Jan 7 (Reuters) - It would be fair to say that U.S.
hedge-fund manager Kyle Bass does not expect the explosion in
global debt in recent years to turn out well.

"This ends through war," Bass, the founder of Hayman Capital
Management in Dallas, said. "I don't know who's going to fight
who, but I'm fairly certain that in the next few years you will
see wars erupt, and not just small ones," he told a recent

But while many investors have, like Bass, bet heavily on
chaotic sovereign default in countries such as Greece, three
years of dogged diplomacy in Europe have so far wrong-footed the

And while some popular protests have erupted into violence,
notably in Greece, the mystery for many analysts is why
Europeans have not fought harder against escalating job losses,
social spending cuts and tax rises. Unemployment in Greece and
Spain has reached 25 percent.

Bass bases his apocalyptic view on his calculation that
credit market debt has reached 340 percent of global output,
saying the world has never lived in peacetime with such a

He says some societies will not withstand the social strain
when trillions of dollars of debt have to be restructured,
inflicting hefty losses on millions of investors.

War in the euro zone - which Bass does not expect to survive
in its present form, if at all - looks far-fetched, to put it

Europe's political elite demonstrated in 2012 its
determination to preserve the euro. Prophecies that doom has
merely been delayed could well prove yet again to be wide of the

But it is reasonable to ask how much those caught in the
cross-fire between creditors and debtors will stand for as the
euro's battle for survival drags on.

Take Portugal, now into the third year of recession, where
the president has asked the Constitutional Court to rule on the
legality of unprecedented tax increases.

Adelino Maltez, a political scientist at Lisbon Technical
University, said Portugal "got drunk on Europe" during the boom
years. "Now for the first time we have the feeling that we have
nowhere to go," he said. "For 2013 the Portuguese lack a sense
of mission. There is a recognition of collective powerlessness."

In other words, with scant prospect of a swift return to
growth, the risk in 2013 is less outright conflagration in the
single-currency area than a fraying of social and political ties
and an insidious erosion of hope.


Jean-Dominique Giuliani, who heads the Robert Schuman
Foundation, a pro-European think tank in Paris, says difficult
reforms must continue because the crisis shows no sign of going

"Changes will now be constant and will demand a great deal
of populations, overturn societies, surprise political leaders
and unsettle experts," he said in a commentary on his group's
web site.

Charles Robertson, chief economist at Renaissance Capital in
London, is among those wondering how much more voters are
prepared to sacrifice. He expects Greece to quit the euro this
year and says Spain might follow by the end of 2014.

Spain has already endured one year of unemployment above 25
percent but will probably have to manage three more in order to
meet the financial targets set by its international creditors.

"No economy (as far as we are aware) has ever sustained this
unemployment rate and maintained a peg to a fixed exchange
rate," Robertson said in a report.

Most damaging of all, he said, was the absence of hope: "For
households, wages are still likely to fall to boost
competitiveness. Households are deleveraging and defaulting, not
borrowing more to fuel consumption."

A vibrant black market and a still-generous welfare state
mean unemployment is probably sustainable at higher levels, and
for longer, than ever before, Robertson acknowledged.

Still, by 2014, Spanish voters will have had time to
conclude that the reforms introduced by Prime Minister Mariano
Rajoy, whom they elected in 2011, have failed to deliver
prosperity. "People may then take to the streets and demand
change," Robertson argued.


Even though the consensus has swung towards the euro staying
intact, many economists fret about the broader ramifications of
protracted austerity.

A possible explanation suggested by Deutsche Bank for
Europe's relative social peace to date is that the burden of
adjustment has fallen disproportionately on young people.

In Spain, for example, the employment rate for the under-25s
tumbled from 39.1 percent in mid-2007 to 18.3 percent in
mid-2012, a fall of 20.8 percentage points. For the 35-49 age
group, with a higher level of protection against layoffs, the
drop over the same period was 8.9 percentage points.

This mix of "youth sacrifice" and relative economic security
for the bulk of the population might be why street protests have
failed - except in Greece - to translate into a big shift in
votes for radical parties, according to Gilles Moec, a Deutsche

But the potential economic cost is huge. With fewer
youngsters working, Italy and Spain have suffered a loss in
productivity of about 2 percent, boding ill for future growth,
Moec estimated.

The textbook answer is to push policies that end the divide
between hard-to-fire 'insiders' and typically young 'outsiders'
on precarious short-term contracts.

The risk, however, is that these and other structural
reforms become discredited because voters associate them with
declining living standards and rising inequality, according to
Simon Tilford, chief economist at the Centre for European
Reform, a London think tank.

"The consequences are likely to be far-reaching. Not only
will governments struggle to push through the needed reforms,
but there is a risk of a broader backlash against the market
economy and the European Union," he said.

(Additional reporting by Daniel Alvarenga in Lisbon; Editing by
Ruth Pitchford)