Why Britain Won't Be the Next Greece
In some ways, for Britain to become the new Greece all that is necessary is for Greece to remain the old Greece. This is, of course, because of the malign magic of "contagion." We may or may not have a worse fiscal position than the Greeks – I'll return to that – but we don't need to be profligate borrowers to catch the Greek disease. The Germans, Swedes and Norwegians – with the strongest public finances in Europe – also will catch it. And it will be very nasty indeed. Angel Gurria, the secretary general of the Organisation for Economic Co-operation and Development (OECD), said the other day that "this is like Ebola." If anything, he is downplaying the threat.
How will we catch something so virulent from as far away as Greece? In the same way as we caught our last economic illness, through an intensely integrated international financial system. British banks have lent money to Greece, both to her government and to private companies and individuals, but not that much in the big scheme of things – perhaps $15.4bn (£10.4bn), according to the Bank for International Settlements.
But the European banks own much more. To give one example, the German Hypo Real Estate bank holds some €8bn of Greek government bonds, now virtually unmarketable and, on a mark-to-market basis presumably worthless. This is doubly ironic because, you might recall, it was Hypo Real Estate that was one of the earliest victims of the credit crunch because it had bought so many mortgage-backed securities from the US. To buy one lot of toxic debt may be regarded as a misfortune; to buy two looks like carelessness...
Hypo is nationalised now, so it leaves the German taxpayer with the exquisite dilemma of either losing money on its lending to Greece or, if it walks away from that, seeing its banks pay an even heavier price in the inevitable meltdown when their "investments" are devalued by, well, anything from 20 per cent to 80 per cent, according to the latest estimates.
Hypo is not alone among continental institutions. The French bank Société Générale (SCGLY) has €3bn in Greek exposure, Fortis (BNPQY) and Dexia (DXBGF) €3.8bn and €3bn respectively, while Credit Agricole (CRARY) has gone the full monty and owns a Greek bank of its very own, Emporiki, which naturally makes a loss on its €28.4bn balance sheet.
Altogether the German banks own about $45bn in Greek sovereign debt, against $78.8bn for the French groups. Given that the problems facing Greece may easily soon present themselves in Portugal, Spain, Italy, and Ireland, it's worth mentioning that in the case of the largest of these potential problem economies, Spain, the UK banks have £75bn of exposure, including to its overextended property market. Barclays (BCS) and RBS (RBS) are in there, though no one is clear about how deep.
So what? Well the last thing we need is another banking crisis, and yet this is what is now brewing. The mechanism is very simple. Ironically, national regulators require their banks to hold large quantities of government securities as part of their capital base. It never occurred to them that their own national debt would be given junk bond status. When that happens, as it has to Greece and may yet to others, there are two immediate and enormously damaging consequences. The banks, just as we saw in the credit crunch in 2007, will contract their lending to business and consumers still further, with predictable and grim consequences. As in 2008, the banks will require rescues, bailouts, emergency liquidity, and recapitalisation all over again. Yet a second banking crisis would be much more difficult to resolve, because the way we have funded bank bailouts is by issuing more government debt, precisely the source of the present problem.
Behind all this is a three-year process whereby market losses were transferred to banks which were then transferred to taxpayers and then to taxpayers in economies with stronger public finances, such as Germany. When the Germans run out of cash, the Americans run out of credibility, and the Chinese run out of patience, there will be nowhere left for the trillions of dollars in losses built up during the financial crisis to go. The International Monetary Fund (IMF) may soon be left with an extremely long queue of orphan economies looking for assistance, and it may not be able to help all of them.
And when banks have toxic debts on their books but no one knows how much is stashed where, and because the banks refuse to be transparent about their losses, then confidence in the inter-bank market evaporates and the money markets freeze up. As in 2007 and 2008, that means that the banks' usual sources of funding are closed to them and that again puts a restriction on their ability to go about their normal business and lend. They will be further weakened, and the world central banks will be required to pump yet more liquidity into them.
Fortunately, the apocalyptic portrait of the future I have just painted – one that is rapidly becoming reality – has been recognised by the authorities in the EU. The echoes of the terrible autumn of 2008 are starting to be heard.
Olli Rehn, the EU's economic and monetary affairs commissioner, who has been popping up more and more, and who is the nearest thing the EU has to a finance minister, said the other day: "Little did authorities of the US know in September 2008 what the bankruptcy of investment bank Lehman Brothers would lead to. The consequence was that the world's financial system was paralysed in a way that led to the biggest global recession since the 1930s. Consequences from Greece's insolvency would be similar if not worse."
Which leaves me with the question of whether Britain is incubating a Greek-style virus of her own. There's a lot of talk about the relatively long maturity of UK gilts, and our historic record and the fact that our national debt is lower than Greece (though we may flatter ourselves on any or all of those). Yet by far the most important factor is that we have our own currency.
We can, in extremis, monetise the debt – that is, print money to be rid of it. Indeed, there is strong case for saying that the main reason why Britain has the longest record of honouring its debts in the world (England has not defaulted since 1672, and the UK never has) is because the nation also has a pretty poor track record of inflating it away to nothing. Somehow, though, no one seems to mention that. Perhaps they have forgotten inflation was the British disease. A relapse seems entirely likely.
from London, for Independent minds