Stephen King: Euro meltdown would pave the way for another Great Depression

Outlook: Imagine that Europe is unable to agree on a convincing solution. What sort of system would we be left with?

The euro's future is all our futures. Whether or not you like the single currency, the world economy's health depends on its survival. Should the euro collapse, we will find ourselves heading into another Great Depression.

Its establishment removed the currency risk which had inhibited investment across the eurozone. Suddenly, a single European capital market became a reality. Germans could invest in Italy, Spaniards could invest in France and Belgians could invest in Portugal. National borders which had so limited economic opportunity simply dissolved.

Its arrival led, within Europe, to a turbocharged version of globalisation. But it was an unstable version: the abolition of multiple currencies also led to the emergence of massive imbalances.

German exports went through the roof. Partly this was luck: Germany happened to make a lot of capital goods, precisely the kinds of things in demand in China and elsewhere. German exports also did well because its companies maintained strict control over their labour costs even though they no longer had to face the tyranny of Deutsche Mark appreciation.

The rise in exports could have persuaded Germans to live the good life. They might have spent the benefits of their new-found competitiveness on consumer goods, sucking in more imports and keeping their balance of payments position in check. They decided, instead, to save the income and their trade surplus soared.

For Germans, a big trade surplus is a sign of success, so much so that many in Berlin think others should follow their example. While it's a familiar lament, it is also economically illiterate. For every German trade surplus, there has to be an offsetting deficit elsewhere in the world. Everyone cannot follow the German model. Indeed, the bigger the German surplus, the more other countries will have to head in the opposite direction.

Although we tend to think about trade surpluses and deficits in terms of competitiveness, this is mostly the wrong approach. A country that manages to sell more exports may be more competitive than it was previously, but that in no way implies that it should refuse to buy more imports. Indeed, it may be that two countries both become more competitive simultaneously, allowing them to export more to each other with no impact on their balance of payments position.

In truth, surpluses and deficits are much more about the balance between domestic savings and investment. If Germans want to save more than they invest, they may end up with a balance of payments current account surplus regardless of their competitiveness. The surplus savings may leak abroad and end up funding someone else's current account deficit.

Over time, Germany has lent more while countries like Italy have borrowed more. But to know what's caused what, we need to look at the capital markets. If lenders chose to increase lending and had to persuade borrowers to borrow more, interest rates would have to fall. If, instead, borrowers chose to increase their borrowing and had to persuade lenders to lend more, interest rates would have to go up.

For much of the euro's life, the story has been much more about the generosity of lenders than the desperation of borrowers. Until the 2008 crisis, interest rates on peripheral debt fell lower and lower. In effect, Germany's export success was generating higher surplus savings which had to find a home. With the end of currency risk, these savings went south, forcing interest rates in Italy, Spain and elsewhere downwards. As rates fell, so southern European nations borrowed more.

Unfortunately, the crisis then intervened. Incomes ended up lower than expected and the ability of southern debtors to repay their northern creditors was seriously impaired. The creditors chose to blame those in the south for having borrowed too much. Yet, it was at least as much a story about the creditors having lent too much. Demanding austerity from the south was all very well but it was hardly the fairest way of sharing the burden.

Moreover, it hasn't worked. Many investors now believe that, in the absence of common cause between north and south, the euro will be torn apart. And they're making their own contribution to the process. They sell Italian bonds while buying their German counterparts, figuring that, in a post-euro world, a new Italian currency would fall against a new German currency. And they sell the institutions that own Italian bonds. In the absence of political unity, we end up with financial mayhem.

Imagine that Europe is unable to agree on a convincing solution. Imagine that the anti-euro bets increase and that the single currency crumbles. What sort of financial system would we be left with?

With the reintroduction of currency risk, financial institutions would have to unwind a huge chunk of their cross-border holdings. There would be no point investing French pensions in Italian lira assets if a newly-introduced lira were to find itself constantly falling against the currencies of northern Europe. It would leave French pensioners seriously short of French franc savings. There would also be massive legal uncertainty. If the euro disappeared, how would an Italian bond issued in euros and owned by a French institution be valued?

The rush to unwind would create massive doubts over the health of individual institutions, leading to a drying-up of credit. Lending would collapse, bankruptcies would soar and co-ordination among European policymakers would be nigh-on impossible to achieve. We would face financial anarchy on a scale big enough to throw Europe – and much of the rest of the world – into another Great Depression.

So we need a solution. And it's a solution that must accept collective responsibility. The north may want to blame the south but that is the wrong strategy. In the event of a euro meltdown, the northern creditors would suffer as much as anyone else. Berlin and Paris will now have to take political risks to come up with a solution. But it's better to take political risks – including a sharing of the burden between creditors and debtors – than to face monumental economic failure.

Stephen King is the global chief economist at HSBC

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45,000: SThree: SThree Group have been well e...

Ashdown Group: IT Manager / Development Manager - NW London - £58k + 15% bonus

£50000 - £667000 per annum + excellent benefits : Ashdown Group: IT Manager / ...

Recruitment Genius: Sales Consultant / Telemarketer - OTE £20,000

£13000 - £20000 per annum: Recruitment Genius: Scotland's leading life insuran...

Ashdown Group: Training Programme Manager - City, London

£40000 - £45000 per annum + benefits : Ashdown Group: Training Programme Manag...

Day In a Page

NHS struggling to monitor the safety and efficacy of its services outsourced to private providers

Who's monitoring the outsourced NHS services?

A report finds that private firms are not being properly assessed for their quality of care
Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

The Tory MP said he did not want to stand again unless his party's manifesto ruled out a third runway. But he's doing so. Watch this space
How do Greek voters feel about Syriza's backtracking on its anti-austerity pledge?

How do Greeks feel about Syriza?

Five voters from different backgrounds tell us what they expect from Syriza's charismatic leader Alexis Tsipras
From Iraq to Libya and Syria: The wars that come back to haunt us

The wars that come back to haunt us

David Cameron should not escape blame for his role in conflicts that are still raging, argues Patrick Cockburn
Sam Baker and Lauren Laverne: Too busy to surf? Head to The Pool

Too busy to surf? Head to The Pool

A new website is trying to declutter the internet to help busy women. Holly Williams meets the founders
Heston Blumenthal to cook up a spice odyssey for British astronaut manning the International Space Station

UK's Major Tum to blast off on a spice odyssey

Nothing but the best for British astronaut as chef Heston Blumenthal cooks up his rations
John Harrison's 'longitude' clock sets new record - 300 years on

‘Longitude’ clock sets new record - 300 years on

Greenwich horologists celebrate as it keeps to within a second of real time over a 100-day test
Fears in the US of being outgunned in the vital propaganda wars by Russia, China - and even Isis - have prompted a rethink on overseas broadcasters

Let the propaganda wars begin - again

'Accurate, objective, comprehensive': that was Voice of America's creed, but now its masters want it to promote US policy, reports Rupert Cornwell
Why Japan's incredible long-distance runners will never win the London Marathon

Japan's incredible long-distance runners

Every year, Japanese long-distance runners post some of the world's fastest times – yet, come next weekend, not a single elite competitor from the country will be at the London Marathon
Why does Tom Drury remain the greatest writer you've never heard of?

Tom Drury: The quiet American

His debut was considered one of the finest novels of the past 50 years, and he is every bit the equal of his contemporaries, Jonathan Franzen, Dave Eggers and David Foster Wallace
You should judge a person by how they peel a potato

You should judge a person by how they peel a potato

Dave Hax's domestic tips are reminiscent of George Orwell's tea routine. The world might need revolution, but we like to sweat the small stuff, says DJ Taylor
Beige is back: The drab car colours of the 1970s are proving popular again

Beige to the future

Flares and flounce are back on catwalks but a revival in ’70s car paintjobs was a stack-heeled step too far – until now
Bill Granger recipes: Our chef's dishes highlight the delicate essence of fresh cheeses

Bill Granger cooks with fresh cheeses

More delicate on the palate, milder, fresh cheeses can also be kinder to the waistline
Aston Villa vs Liverpool: 'This FA Cup run has been wonderful,' says veteran Shay Given

Shay Given: 'This FA Cup run has been wonderful'

The Villa keeper has been overlooked for a long time and has unhappy memories of the national stadium – but he is savouring his chance to play at Wembley
Timeless drama of Championship race in league of its own - Michael Calvin

Michael Calvin's Last Word

Timeless drama of Championship race in league of its own