Hamish McRae: The real question now is what will happen to Italy and Spain
Economic Life: Unless and until Europe accepts that what is happening is not just the fault of Greece, then it too will remain in trouble
Friday 04 November 2011
It goes on, doesn't it? And the longer it goes on, the greater the danger to the European economy and maybe beyond. Anyone running a business in the eurozone has now to accept that there are huge uncertainties about the future of the euro and plan for a range of outcomes to the present crisis. For this is not just about Greece; it is, more than anything else, about Italy.
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The Greek political story changes by the hour but the fundamental economic situation has not changed for months. None of the three rescue packages that the poor Greeks have been asked to accept is viable. None of them creates a pathway that the country can march along and find itself a solvent successful economy in five years' time. The present plan, presumably reinstated now that the referendum is off, leaves the country with debts that cannot be serviced. No amount of bullying by creditors (and there has been a deal of that in the past 24 hours) can make people repay money they do not have. So there will at some stage be a further acknowledgement that this bailout has failed. I presume this will be sometime in the first half of next year, if not before.
The greater issue will be what happens to Italy, and to some extent Spain. Neither has yet had to accept a formal bailout, though each is being supported informally by purchases of its debt by the European Central Bank. Nevertheless, Italian 10-year debt is now trading at 6.3 per cent, a level the country could not sustain, given its high public debt of some 120 per cent of GDP, the short maturity of that debt, and Italy's adverse demographic projections.
So the central issue facing eurozone authorities is not so much whether Greece keeps the euro or not (my own judgement is that it is likely to keep the euro for another few years) but rather whether Italy can regain access to the markets so that it can finance itself. You can have two reactions to this. One is to say that it is intolerable and irrational that a country that has carried high national debts for a long time, and which does not have a particularly serious running deficit, should suddenly be affected in this way. Italian personal debt is low by European standards and much of its national debt is held domestically. What has happened is that there has been a change in perception that is not matched by reality.
The other reaction is that Italy, like any other country, has to live in the world as it is, not as some people would like it to be. Investors have become progressively more risk averse and many asset-holders now would prefer to accept a lower return rather than accept those risks. It is a fiduciary thing. Can anyone handling other people's savings justify the possibility that they might find those savings subjected to a 50 per cent "haircut", as is happening in the case of Greece? You cannot say bankers were stupid to buy Greek debt three years ago and then expect them to buy the Italian equivalent now. To judge by the premium over German interest rates, buying Italian debt now is perceived as more risky than buying Greek debt was seen then.
So how bad is it? In the short-term the European Central Bank can puff things up and the modest cut in interest rates yesterday is helpful. But businesses, like everyone else, have also to plan for extreme outcomes, however unlikely they think these might be. One of those outcomes is the break-up of the eurozone; another is prolonged recession in southern Europe; still another is a wider recession across continental Europe.
What we do know is that a modest but apparently secure recovery in Europe is faltering. Several of the forecasts now coming through for 2012 show some growth is still expected in the eurozone as a whole, but both Italy and Spain will show minus numbers, France will do well to show any growth and German growth will be less than 1 per cent. The OECD numbers are slightly better than this and the new ECB data may also be a bit better, but the general perception is of a mild recession – remember you can have a technical recession of two successive quarters of negative growth, while still showing a positive number for the year as a whole.
Only a mild recession? The forward-looking indicator calculated by Goldman Sachs suggests yes: things will dip below the waterline in the fourth quarter this year (see graph) but there is as yet no sign of grave distress. The world economy as a whole will continue to grow, of course, while the US continues to manage some growth. The rising tide will pull up Germany and other export-oriented European economies and that, in turn, will give stability to the continental economy. Not great; but not dreadful, at least not yet.
The question that leads on from this is what, if anything, the G20 can do about this. Here, I think, we have to accept that the G20 is a different animal from the G7 or G8. A world where leadership comes from a variety of nations at different stages of their development and with different forms of governance is a different world from one dominated by a small group of developed countries. So leaders at previous economic summits could act in a cohesive way, not that they often did. But now they can't. At the height of the post-Lehman collapse they gave the impression of cohesive leadership but, in practice, nothing was happening collectively that would not have happened on a piecemeal basis. I don't think we should dismiss the smoke-and-mirrors element of economic summits because impressions do matter. Nor should we exclude the possibility of cohesive action should the developed world plunge into another recession. But the mood at the G20 seems to be that this is a European problem, and specifically a eurozone problem, so it is up to the eurozone high command to fix it.
Our Prime Minister went into rhetorical overdrive yesterday, saying: "We face profound difficulties – unprecedented in our lifetimes – which have cast a pall over the advanced and emerging economies alike."
Well, no. I don't know who wrote that stuff for him but it is demonstrably wrong. China and India are both expected to grow at 8 per cent a year or more this year and do not face recession at all. Both countries have experienced much more serious economic problems during Mr Cameron's lifetime, youthful though he may be. Ditto Brazil; ditto Russia. Unless and until we in the developed world accept that we created these problems for ourselves it will be hard to fix them. And unless and until Europe accepts that what is happening is not just the fault of Greece, then it too will remain in trouble. As for the UK, we may well scramble through the coming months without tumbling into recession, but this "unprecedented in our lifetimes" business does not help.
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