Is Spain too big to fail? Or Greece? Or Portugal? It's a question that is wearily familiar when applied to the banks, but it hasn't been asked very much about sovereign nations. Until now. The "Pigs" – the nations that comprise the unflattering acronym for Portugal, Ireland, Greece and Spain – are pushing it to the top of the international agenda. Why? Because their national finances are in such a state of disarray they are putting an extreme strain on the unity of the eurozone, and helping to destabilise the global recovery.
Recently, the German Economics Minister, Rainer Brüderle, put the problem at its sharpest, saying: "This may have fatal effects on all states in the eurozone." Actually, he was too optimistic; it will affect the whole of Europe, and the rest of the world too.
So the big question looms: should the Pigs have their bacon saved by the more fiscally responsible nations – which amounts to Germany – or left to wallow in their own miserable economic pigsties? (No slurs intended; they are all highly civilised places). The answer is that they will have to be rescued, just as the banks that were, and are, too big to fail, for much the same reasons.
We now know, post-Lehman Brothers, that the damage done by allowing a large financial institution to go bust is so massive that the world's governments – ie taxpayers – have little alternative but to shore them up. So the big banks can hold the rest of us to ransom because they are indeed "too big to fail", or too interconnected or complex, and thus have to be protected by the taxpayer no matter what they get up to, for fear of worse. There is no incentive for them to limit the risks they take because they know they can never fail, unlike virtually any other free enterprise concern (although airlines, newspapers and car companies often also fall into that category).
To be fair to the Pigs, they have somewhat more of an incentive to get their public finances under control. There is still some market discipline: the threat, well and truly realised in Greece's case, is that interest rates will soar with the price of getting foreign investors to lend to them – rates are now 4 percentage points higher than the German equivalent. That in itself forces a certain amount of reform.
Secondly, the Pigs also know that if they do call the Germans' bluff and Berlin baulks at the size of the bill, or if the list of nations requiring funds becomes so large that the German economy cannot bear the strain, the real value of their euro-denominated debts will simply rise in relation to the "new drachma/ escudo/ punt/ peseta" or whatever is invented to replace the single currency. In other words, they cannot be sure they won't be allowed to fail, and that doubt is, for now, sufficient to impose some restraint. Alternatively, the International Monetary Fund would stand ready, as ever, to be lender of last resort to these busted economies, and their medicine is certainly unpalatable.
Yet the Pigs also know that the Germans and French, for politically overriding reasons, as well as economic ones, would be loath just to let the Spanish or Greeks default on their debts or threaten to leave the eurozone. The consequences would be far, far more gruesome than even the most expensive possible bailout. That, as central bankers say, is the "moral hazard" inherent in the current situation: in layman's terms, it is blackmail.
In the UK, say, or Romania or Hungary, within the EU but outside the eurozone, the state of the public finances is almost a matter of private grief, to be solved through depreciation of the national currency and the usual domestic political processes. In the eurozone, the contagion spreads instantaneously to neighbouring economies. It is an international issue, but without any process of resolution because the euro does not enjoy a single Treasury or a single European government to look after it. The Greek Prime Minister, George Papandreou, suggested a couple of weeks ago that, instead of individual nations issuing euro bonds, the EU should issue them, just as the US Treasury issues American Treasury bills. But that merely restates the problem in a different way: the problem being that the Germans will, one way or another, have to guarantee everyone else's bills.
When the Maastricht Treaty that set up the eurozone came into force in 1993, it had clear rules that limited individual national debts and deficits, but of course those rules were swept away in the financial storm. So now there is nothing, which is hardly conducive to confidence.
Finally, the current imbroglio leaves the case for the UK joining the euro as devalued as a Greek government bond. Today we would be deprived of the ability to follow the traditional British resort of devaluing our way out of trouble, so much less painful than what the Pigs will have to go through: "internal devaluation", or deflation, cutting wages for example, and social benefits. Yet it still affects us. The eurozone is easily our largest trading partner, vital to the prospects for our own recovery. If its members all deflate simultaneously through panicky "exit strategies" that are more like a rush for the exit in a burning building, then we can scarcely escape the consequences.
And if European government bonds really do seriously lose much of their value, maybe including UK gilts, we could witness a "Credit Crunch II", a sequel to the original horror. That's because such a reduction in their value would tear yet more holes in the balance sheets of banks and pensions funds that hold these bonds, and trigger another contraction of lending.
All this means, in short, is that the dreaded double-dip recession is suddenly looking a lot more likely than it did a few weeks ago. The first crunch, in 2007, came from the crisis in US sub-prime mortgages and the collapse in the value of securities based on them. This one is going to hit us from European "sub-prime" government debt being devalued.
Britain is far too enmeshed in Europe to be able to avoid the contagion now spreading through the peripheral economies. We could easily become quite porcine, and our economy roasted in the process.
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