What has been happening to the euro over the past few days is a stark warning to governments all over the world. No, the Eurozone will not break up in the coming months, though it may well do so at some later date. The problems that the Eurozone's weaker members – especially Greece but also Portugal, Spain, Ireland and Italy – have exposed is that governments of countries with weak finances are being put on notice. They must fix their finances swiftly or face the consequences of a sudden loss of confidence. Greece is the canary down the coal mine.
Those consequences include a sharp rise in the interest rate at which the government borrows, which in turn would lead to higher borrowing costs for everyone, companies and individuals alike. What Greece has taught us is that we have reached a situation where many governments, not just these weaker Eurozone members, are in a position where they cannot increase their budget deficits and actually have to start cutting them fast. The harsh truth is that if there is another dip in the world economy there is nothing governments can do about it. The financial markets won't let them.
To many people this will seem monstrous. Governments around the world have rescued the world's financial markets from their own folly. Now those very same markets are biting the hand that fed them. So in the past few days we have had strong words not just from the Greek, Portuguese and Spanish authorities defending their own policies but also attacking the morality of the markets. This is a theme familiar to Britons with any memory of the 1960s and 1970s. Harold Wilson used to attack the currency speculators, coining the famous expression "the gnomes of Zurich" to exemplify all that was evil about international finance.
The trouble is that there is a shortage of savings in the world, or at least in the Western world, and governments with heavy borrowing need to compete for those savings along with the rest of us. Borrowers want to know whether they will be repaid. Governments that are perceived to have been less than frank about their countries' finances go to the bottom of the queue. Greece is unfortunately in that category.
Over the past few days there has been a progressive loss of confidence in the willingness, and maybe even the ability, of the weaker Eurozone economies to service their National Debt. Greece, along with other Eurozone governments, has debt coming up for repayment in the next few months. To sell that debt – to persuade investors to lend the country money – it may have to offer much higher interest rates. Conceivably it might not be possible to sell the debt at all.
In either of those instances the country would have to be rescued either by the European Union or by the International Monetary Fund. It would have to be rescued because the idea of a member of the Eurozone simply being unable to repay its debts would have unthinkable consequences for the rest of the region. Greece has to be rescued not so much to protect Greece, but to protect Portugal, Spain, Italy, etc, from all having to pay higher rates for their debt.
You could almost say that if Greece is the national equivalent of Northern Rock at the head of the list of weak institutions, Portugal is the equivalent of Bradford & Bingley, Spain of Alliance & Leicester and Italy of the Royal Bank of Scotland.
There is a further reason for concern. A lot of Greek government debt is held by banks elsewhere in Europe, including the UK. So were Greece to default, it would weaken the entire European banking system.
So Greece will be rescued. But the terms on which this happens matters because they have to be credible. A botched rescue might be worse than a formal default. Suppose other Eurozone countries agree some form of emergency loan but failed to impose fiscal discipline. Then it would be assumed that Europe as a whole did not have the will to correct its deficits and that some way down the line there would be an even bigger collapse. Why lend to Eurozone countries at all when there are other countries around the world with better growth prospects and a less adverse demographic outlook? We have seen a bit of that fear in the past few days. Expect more.
All this has implications for the rest of us. The immediate reaction of the markets has been to mark down the euro and sterling against the dollar. There is a similar distrust of British financial policy as there is to that of many Eurozone countries, though we are not bracketed in the same league as Greece. Were the next British government unable or unwilling to correct the budget deficit, which relative to GDP is roughly the same as Greece's, then we too might find ourselves unable to sell government stock, except at much higher interest rates. We are not yet on trial because everyone knows that this cannot be fixed until after the election. What our politicians say means nothing. Everyone is waiting to see what they will do.
The even bigger issue will be what the US does. For the moment it has been the beneficiary of uncertainty elsewhere. When savers are troubled their first instinct is to go for investments that look safe. The US remains about 30 per cent of the world economy and for all its problems that sheer size makes US investments attractive. But even the US does not get a free run. It is easy to see a set of circumstances where there is distrust of the government debt of many countries and people instead choose to hold their savings in commodities or in the debt of the few countries, such as Germany, which still inspire trust.
We are starting to catch a glimpse of the post-recession world. It will obviously be one where there will be great pressure on governments to get their deficits down. That will be a drag on growth, so the recovery will be a dull and listless one here and elsewhere. Within Europe, the ability of governments to get deficits down will determine whether the euro has a long-term future. (My own view, for what it is worth, is that it will be through this crisis but not the next one, the one that comes along in another 10 years' time.) And beyond Europe, the pressure will be on other governments, including the US. Growth is better than recession, but it won't be great growth.
h.mcrae@independent.co.uk
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