I fear that the acute financial woes in Greece are but a side-show to a much more serious sovereign debt crisis that threatens to engulf the Eurozone in the months ahead.
The lesson of this week’s global stock market jitters is that the UK, whilst proudly standing outside the Eurozone, will not be immune to its political and economic impact.
The coalition government’s Budget set out a determined programme of decisive action to deal with the domestic deficit. Inconveniently this long-overdue transfer from stimulus to austerity is being faithfully emulated by many other EU nations, led by a German government constrained by a constitutional requirement to move to a balanced budget. This battening down of the hatches in key EU nations augurs ill for prolonged evidence of consistent renewed economic growth in mainland Europe. The twin worries of an unrequited policy of ‘export-led’ growth and monetary protectionism which I wrote about here after Labour’s last gasp budget in late March, now look very real indeed.
The main concern for the near term is of contagion – to Portugal, Spain (an economy four times the size of Greece) and even to Italy (two times the size again). Leading City figures working in European banks tell me that they are increasingly alarmed at the prospect of sovereign default by the turn of the year, especially as much of the debt of many of the struggling Eurozone countries – unlike the UK – will need to be refinanced over the next two or three years.
The more optimistic view is that some of the weakest economies can be persuaded ‘voluntarily’ to leave the Euro. These nations would take with them huge write-offs and guarantees on existing debt obligations, although it is difficult to see how such countries would ever again be able to finance their debt by selling bonds in the global capital markets. The lack of a mechanism to expel recalcitrant nations from the Euro may persuade the worst offenders simply to soak up support from the emergency fund for the European currency. Alternatively a two-tier Euro may enable Germany, France and others to draw away from the worst excesses of the currency crisis.
But make no mistake, the UK will be caught up as this drama unfolds even though we smugly sit outside the Eurozone. Some 55% of our external trade is with the countries that make up Eurozone and our exports are already becoming considerably less competitive as the Euro depreciates against sterling.
Moreover, the fiscal and economic squeeze now underway in Europe designed to correct the sovereign debt crisis runs the real risk of promoting a renewed banking crisis. The truth is that in this low-to-zero interest rate environment (a deceptively benign state which provides a strong disincentive to foreclosure) many banks, both domestically and in mainland Europe, still have huge unquantifiable toxic ‘assets’ on their balance sheets. The interconnectedness of the global finance industry means that whilst British banks are not directly exposed to Greek debt, their German and French counterparts are. If Spain, Portugal or Italy falter then the exposure of our banks is more immediate still.
If this were to precipitate a renewed credit crunch, it is difficult to see how the British SME sector can play its crucial part in the export-led, private sector recovery on which all our hopes for economic growth are pinned.
Business expansion requires the smooth operation of a banking sector, willing and able to loan money freely.
It also requires confidence.
Sovereign default in the Eurozone in the next twelve months – if it happens – will have as profound an effect psychologically as it does economically. In truth the outcome many now regard as inevitable may prove every bit as seminal an event on global affairs as the collapse of Lehman Brothers in September 2008.