Hamish McRae: It's not just Greece we should worry about. The problem is sovereign debt

Economic View
Click to follow
The Independent Online

I am afraid that Greece is not just back in the headlines but will remain so for many months to come.

There are a host of other vital global issues in the world of economics here, in the US, elsewhere in Europe and in the emerging world. But the consequences of Greece's difficulties are such that what happens in this one, small, interesting, troubled, but in many ways delightful country will shape what happens not just in Europe but in much of the developed world. At best, we get a patch from the EU, pushing the problem forward a few months.

The reason is concern about sovereign debt: what happens to countries that either cannot repay their debts as they fall due, or depreciate their currencies so that people are repaid in currency worth much less than the original money in which the debt was accrued?

Greece's debts cannot be repaid at face value. In that sense the protesters in the streets of Athens are right, though their opposition is not of itself coherent. So if debts cannot be repaid, and the latest projections still leave Greece with an impossibly high debt-service burden, the question is how the debts should be forgiven. Forgiven? Well, yes, because just rescheduling them to push them further into the future does not cut the eventual size of the debt. Indeed it makes it bigger.

But if a country cannot repay, then no one will willingly lend to it. So the nominal interest on existing debt has shot up, and not just for Greece. The main graph shows the rates on existing 10-year debt for Greece, Ireland, Portugal, Spain and Germany. Three years ago the rates were pretty much the same. At that time the markets believed that Greece was almost as safe a country to lend to as Germany. Even in the autumn of 2009 Greece could borrow at around 5 per cent. That judgement now looks absurd. Since the price of the debt declines as the yield rises (the two are the mathematical inverse of each other), those who bought the debt then would have lost roughly three-quarters of their money.

Unsurprisingly such lenders are none too keen to lend more, nor could the Greek government afford to pay such a rate on new debt. The effect is that the markets are closed to Greece, as well as Portugal and Ireland. The only places they can go for money is the European Union and the International Monetary Fund. Spain did manage to raise some sort-term funding last week but at around 6 per cent, and I suspect that were it to try to raise longer-term funds it too might find the rates prohibitive.

So you see the way in which the Greek problem is affecting the other weaker eurozone members. But will it affect the stronger ones?

It is difficult to make a judgement. All one can say is that some people in the markets are reluctant to lend longer term not just to Spain but to Italy, Belgium and Austria. These countries have always been able to borrow freely, but people are worrying that a few years down the line they too may find their debt burdens too high to handle.

Would-be investors look, for example, at the age structure of the Italian population and wonder whether there will be sufficient people of working age to service the debts that have been accrued. Unthinkable? Well, it was unthinkable three years ago that Greece, Ireland and Portugal would be in their present mess.

There has been a collective loss of self-confidence among the lenders. That has not happened to Germany or indeed to the UK. Germany has consistently been disciplined about its national finances while we are perceived to have a responsible government determined not to allow the debt to go on rising beyond 2015. The US is in a special position as the supplier of the world's only reserve currency, but the worries there have shown up in a steady depreciation of the dollar against most other currencies.

The wider the sovereign debt concerns spread the greater the danger that countries currently seen as completely sound may suddenly find themselves struggling to raise funds.

Pause a second and see this in perspective. Greece is an extreme case so it would be wrong to argue that a similar meltdown will inevitably happen in Ireland and Portugal. In any case the debts are smaller in absolute terms, as you can see from the right-hand graph. But the ability of any government to honour its debts depends on the ability and willingness of its taxpayers to pay the money to do so. Both Ireland and Portugal will be putting a lot of pressure on the goodwill of those taxpayers not just over the next three or four years but actually for most people's lifetimes.

The issue spreads more widely in Europe because there is freedom of movement for labour. There is nothing stopping young Spaniards or Italians, for example, from coming to the UK, having jobs here and paying UK tax rather Spanish or Italian tax. Were there to be a radical population movement from south to north, then the ability of southern Europe to service its debts would be further undermined. So what is happening now is not just about Greece. It is about Europe.

There is a further dimension: the euro. There is too much hyperbole about the immediate impact of a Greek default on the euro. It would be difficult were a eurozone country to default on its debts, with a consequent impact on European banks holding it. But since most eurozone financial transactions are with the major countries and the European Central Bank has a sound reputation as a manager of the currency – sounder than the Federal Reserve or the Bank of England – the short-term effect would not be that great.

Many people, myself included, believe Greece will leave the eurozone, but that may be some way off. But suggestions that this would lead to the end of the EU must be wrong. The union, in its various forms, survived perfectly well without a common currency and could do so again. Europe's key problem is not the euro, though having a single currency has made matters worse. It is sovereign debt – and not, I am afraid, just Greek debt.

The feelgood factor is far away as confusion still reigns over the economy

The confusion about what is happening to the British economy continues. The strong employment figures suggest steady growth while the weak retail sales show that consumers at least are having a tough time.

But in a way that is as it should be: people getting jobs in the private sector but wage growth remaining muted and consumption being held back.

Looking ahead there are two things to watch out for. One will be the progress or otherwise on public finances. It is always wrong to take one month's figures too seriously, but having come in a bit ahead of target in the last financial year, the first numbers this year have been slightly discouraging. The more interesting side of the balance is what is happening to revenue, because that tells us about the economy too. VAT will naturally be stronger as the rise to 20 per cent does not of itself seem to have had as much of an impact on activity as might have been expected – much less for example than in Germany, which did much the same some years earlier. So Ed Balls's suggestion last week that it should be cut back to 17.5 per cent seems a bit off-key. There could be a case for some tax cuts if revenues run ahead of projections, but not that. As it is, there are worries about other sources of revenue, including income tax, falling short. That would be odd, given the rise in employment.

The other thing will be the housing market. Leaving aside national divergence – very evident with rising prices in London and the South-east and falling mostly elsewhere – the overall picture is flat, maybe declining a little. Most notable is the low level of transactions. Mortgage availability remains restricted, creating a two-tier market: those already with a (probably) cheap mortgage and those who can't get one at all.

Consumption will remain muted while the housing market remains muted. We are long way from the feel-good factor reappearing.

Comments