Is the plight of Greece a one-off worry or a canary in the mine, warning of toxic fumes about to engulf other governments in Europe and elsewhere?
Business leaders in Davos this week were asked about their greatest worries and number one was the danger of government defaults. That is a natural response to the rising indebtedness of governments throughout the developed world, and in some regards the position of Greece is no worse than that of several other countries. But countries that have control of their own currency can avoid default, at least on debts denominated in that currency, by printing more of the stuff. The money with which the debts are repaid may be worth less, but on paper the debts have been serviced.
This is why Greece has become a test case. It is a member of the eurozone and so does not have the option, as for example the UK does, of printing the money. (We will come to the impact of the UK's "quantitative easing" programme in a moment.) Greece might indeed default, as the markets now recognise, for they are charging an additional 3 per cent a year or thereabouts to insure against it.
The markets were further unnerved by stories that China might buy Greek debt, the suggestion being that the big European countries, including Germany and France, were not prepared to help, so in desperation Greece was turning to China.
That particular story has been denied, and I don't think it is helpful to chase the twists and turns of market rumours – or indeed the country's public accounts, the accuracy of which is not totally assured. What one can say is that the government deficit is running at around 12-13 per cent of GDP, roughly the same as the UK and US, but that the absolute level of debt is around 120 per cent of GDP, which is top end. It is in the same bracket as Italy. But the main developed countries are racing upwards too, and while they may not breach the 100 per cent of GDP level, they are getting close.
For Greece, the central issue is whether the government has the political will to get the deficit back under control. Its official forecast is that it will be back under the 3 per cent of GDP Maastricht limit by 2012, but not many people think this is achievable. On the other hand, its tax levels are quite low relative to other nations, so in theory at least it has headroom to correct its deficit by increasing taxation, an option that Italy does not have. In any case, Greece accounts for only a tiny proportion of EU output and debt, around 4 per cent. So in financial terms it is a small task: Germany could pay off all Greece's debts, if it chose to do so, adding only a few percentage points to its own debt. But of course it won't do so, for having to bail out irresponsible member states was not part of the deal to which the other euro countries signed up.
So what will happen? My own guess is that Greece will manage to assemble some sort of austerity package, that is, a more credible package than the one it has at the moment. In return for doing that it will get emergency support from the EU. I cannot quite see what form that support will take, but the prospect of a European government defaulting – and the rest of the EU authorities standing by – would be so damaging that it will not be allowed to happen.
It would be damaging in two ways. First, there would be the domino effect on other shaky member states. If Greece, why not Ireland and Spain? If Spain, why not Italy? The danger would be a progressive loss of confidence in all EU governments. In that sense Greece is the canary in the mine, warning of trouble for all.
Second, there is the threat to the euro itself. The common currency weakened sharply following the concerns about Greece, which in the short-term may not be at all a bad thing. But if it pushes up borrowing costs for all it becomes most damaging, and if it were to lead to a country exiting from the eurozone altogether that would be a huge blow to the euro's long-term survival prospects.
So there is to be a deal, albeit a messy one. Greece will be humiliated; other EU countries considering joining the eurozone will note that membership brings obligations as well as advantages; and other present members in trouble will also get central support. The political will to preserve the eurozone is so huge that the currency will survive this cycle. However, the cracks exposed now will not easily be papered over, and the inevitable question will be whether the currency will survive the next downturn, the one that will occur some-time between 2017 and 2020.
To try to predict the timing of the next global downturn is a bit ridiculous, of course. But we can be pretty sure that the economic cycle is so embedded that, just as there is now some sort of upturn, so in a few years' time that upturn will come to an end. My greatest worry is not that the world will fail to escape the present recession, but rather that it will fail to get global finances into decent shape in time for the next one.
By global finances, I mean, in the first instance, the public debt of the major developed countries. So far most governments have been able to finance their deficits without too much difficulty, but this has been a strange time. In the case of the UK, for example, some £200bn of public debt in the past nine months has been bought by the Bank of England. That is larger than the public deficit. So presumably other holders of our debt must have been selling: has, as Simon Ward of Henderson asks, the "smart money" been getting out?
To be clear: I am not saying that the UK faces a catastrophic loss of confidence akin to that which seems to be happening to Greece. What I am saying is that over the next couple of years questions will be asked about the sustainability of the finances of all governments. Just as it was unthinkable three years ago that a major bank might go bust, so it appears unthinkable now that a major government might do so. But even if countries that have their own currencies can avoid technical default, they may find that they face a serious run on their currency, and in practice a weak currency drives up long-term interest rates.
So the answer to the question posed at the beginning of this column is that Greece, while not quite a one-off situation as Ireland and Spain may be in broadly similar trouble, is at least at the outer end of the global scale. But in the coming years markets will become more and more sensitive to danger of default, and accordingly Greece is a warning to the rest of us.
It can be fixed. Canada coped with its huge debt burden, built up during the late 1980s and early 1990s. That will be the model for the rest of us.Reuse content