from Edmund Conway at the Daily Telegraph:
Mervyn King, the Bank of England Governor, summed it up best: "Dealing with a banking crisis was difficult enough," he said the other week, "but at least there were public-sector balance sheets on to which the problems could be moved. Once you move into sovereign debt, there is no answer; there's no backstop."
In other words, were this a computer game, the politicians would be down to their last life. Any mistake now and it really is Game Over. Or to pick a slightly more traditional game, it is rather like a session of pass-the-parcel which is fast approaching the end of the line.
The European financial crisis may look and smell rather different to the American banking crisis of a couple of years ago, but strip away the details – the breakdown of the euro, the crumbling of the Spanish banking system to take just two – and what you are left with is the next leg of a global financial crisis. Politicians temporarily "solved" the sub-prime crisis of 2007 and 2008 by nationalising billions of pounds' worth of bank debt. While this helped reinject a little confidence into markets, the real upshot was merely to transfer that debt on to public-sector balance sheets.
This kind of card-shuffle trick has a long-established pedigree: after the dotcom bust, Alan Greenspan slashed US interest rates to (then) unprecedented lows, which helped dull the pain, but only at the cost of generating the housing bubble that fed sub-prime. It is not so different to the Ponzi scheme carried out by Bernard Madoff, except that unlike his hedge fund fraud, this one is being carried out in full public view.
The problem is that this has to stop somewhere, and that gasping noise over the past couple of weeks is the sound of millions of investors realising, all at once, that the music might have stopped. Having leapt back into the market in 2009 and fuelled the biggest stock-market leap since the recovery from the Wall Street Crash in the early 1930s, investors have suddenly deserted. London's FTSE 100 has lost 15 per cent of its value in little more than a month. The mayhem on European bourses is even worse, while on Wall Street the Dow Jones teeters on the brink of the talismanic 10,000 level.
Whatever yardstick you care to choose – share-price moves, the rates at which banks lend to each other, measures of volatility – we are now in a similar position to 2008.
Europe's problem is that the unfortunate game of pass-the-parcel came at just the wrong moment. It resulted in a hefty extra amount of debt being lumped on to its member states' balance sheets when they were least-equipped to deal with it.
Europe was always heading for a crunch. For years, the German and Dutch economies pulled in one direction (high saving, low spending) while the Club Med bloc – Greece, Portugal, Spain, Italy (and their Celtic outpost Ireland) – pulled in the other. At some point, there was always going to be a problem, given that these two economic blocs were yoked together in the same currency, controlled by the same central bank. By triggering the global recession and shovelling an unexpected load of debt on to Greece's balance sheet, the financial crisis has effectively smoked out the European folly.
The Club Med nations – and in many senses Britain – were not so different to sub-prime households: they borrowed cheap in order to raise their standards of living, ignoring the question of whether they could afford to take on so much debt. But, as King points out, sub-prime households – and the banks that lent to them – can usually be bailed out. The International Monetary Fund simply does not have enough cash to bail out a major economy like Spain, Italy or, heaven forfend, Britain. So, again, we find ourselves in unknown territory.
There are plenty of episodes in history when countries have been as indebted as they are now, but they are all associated with periods of war. History shows that when nations reach as high a level of indebtedness as Greece, and have as few prospects of growth, they will almost certainly default. Indeed, the IMF, which has pretty good experience of fiscal crises, privately recommended that Greece restructure its debt (a kind of soft default, renegotiating payment terms). It was refused point-blank by the European authorities.
To understand why, step back for a moment. It is fashionable to compare the current situation to the Lehman Brothers collapse, but that understates its severity. The sub-prime property market in the US, together with its slightly less toxic relatives, represented a $2 trillion mound of debt. The combined public and private debt of the most troubled European countries – Greece, Portugal, Spain and so on – is closer to $9 trillion.
Moreover, whereas the pain from sub-prime was spread out relatively widely, with investors hailing from both sides of the Atlantic, the owners of the suspect European debt tend almost exclusively to be, gulp, Europeans. No one is suggesting all of this debt will go bad, but the European policymakers fear that the merest hint that Greece might default would spark a chain reaction that would cause a more profound crisis than in 2008.
The problem is not merely that holders of Greek government debt would dump their investments, or even that they would ditch their Spanish and Portuguese bonds while they were at it. It is that government debt is the very bedrock of the financial system: should Greek government bonds collapse, the country's banking system would become insolvent overnight. In fact, banks throughout the euro area would be at risk, given that they tend to hold so much of their neighbours' government debt. That, at least, is the theory, but as was the case in the aftermath of Lehman's collapse, no one really knows how great their exposure is.
The other, more cynical, explanation for Brussels' refusal to countenance default is that it fears that this would fatally destabilise the euro project itself – which of course it would. But as the politicians are discovering, organising a European sovereign bail-out is far, far more difficult than rescuing a bank. It took barely more than a few days in September 2008 for the Government to push through the semi-nationalisation of Royal Bank of Scotland and HBOS.
Earlier this month, when the French President Nicolas Sarkozy announced that the continent would be saved by a "shock and awe" $1 trillion bail-out package, markets convinced themselves for a moment that the politicians might be able to manage it. But the challenge of having to co-ordinate an unprecedented rescue across a
16-nation region without a common language or central Treasury is proving too much for Europe's leaders. Add to this the fact that most citizens (particularly in Germany) resent the idea of bailing each other out at all, and are willing to vote out their governments to prove it, and you get the idea of the challenge at hand.
Despite his rather aloof appearance, European president Herman Van Rompuy put it pretty well this week, saying: "Today, people are discovering what a 'common destiny' in monetary matters means. They are discovering that the euro affects their pensions, savings, and jobs, their very daily life. It hurts. In my view, this growing public awareness is a major political development. It forces the governments to act."
That action, so far as Van Rompuy is concerned, means more integration and some eye-watering spending cuts across the continent. Unfortunately, both are being carried out in haphazard fashion. The bail-out package may pave the way for a central EU Treasury, but it is still being muddled through the legislative process, and could well fall foul of voters in France or Germany. Spain and Italy are, rightly, inflicting severe cuts on their budgets, but so is Germany, which ought, according to a host of economists including Mervyn King, to be spending more, not less.
In the meantime, European politicians, torn in one way by their voters, in another by Brussels, emit even more confusing signals which only destabilise markets further. Angela Merkel's ban on investors short-selling German bank shares, and the collapse of a swathe of Spanish savings banks have hardly helped, either. And all the while, the euro continues to fall as investors mull its fate. The single currency can survive – but only if its members agree to more political union, and the prospect of that would be about as palatable to the people of Europe this summer as an ouzo and retsina cocktail.
This kind of card-shuffle trick has a long-established pedigree: after the dotcom bust, Alan Greenspan slashed US interest rates to (then) unprecedented lows, which helped dull the pain, but only at the cost of generating the housing bubble that fed sub-prime. It is not so different to the Ponzi scheme carried out by Bernard Madoff, except that unlike his hedge fund fraud, this one is being carried out in full public view.
The problem is that this has to stop somewhere, and that gasping noise over the past couple of weeks is the sound of millions of investors realising, all at once, that the music might have stopped. Having leapt back into the market in 2009 and fuelled the biggest stock-market leap since the recovery from the Wall Street Crash in the early 1930s, investors have suddenly deserted. London's FTSE 100 has lost 15 per cent of its value in little more than a month. The mayhem on European bourses is even worse, while on Wall Street the Dow Jones teeters on the brink of the talismanic 10,000 level.
Whatever yardstick you care to choose – share-price moves, the rates at which banks lend to each other, measures of volatility – we are now in a similar position to 2008.
Europe's problem is that the unfortunate game of pass-the-parcel came at just the wrong moment. It resulted in a hefty extra amount of debt being lumped on to its member states' balance sheets when they were least-equipped to deal with it.
Europe was always heading for a crunch. For years, the German and Dutch economies pulled in one direction (high saving, low spending) while the Club Med bloc – Greece, Portugal, Spain, Italy (and their Celtic outpost Ireland) – pulled in the other. At some point, there was always going to be a problem, given that these two economic blocs were yoked together in the same currency, controlled by the same central bank. By triggering the global recession and shovelling an unexpected load of debt on to Greece's balance sheet, the financial crisis has effectively smoked out the European folly.
The Club Med nations – and in many senses Britain – were not so different to sub-prime households: they borrowed cheap in order to raise their standards of living, ignoring the question of whether they could afford to take on so much debt. But, as King points out, sub-prime households – and the banks that lent to them – can usually be bailed out. The International Monetary Fund simply does not have enough cash to bail out a major economy like Spain, Italy or, heaven forfend, Britain. So, again, we find ourselves in unknown territory.
There are plenty of episodes in history when countries have been as indebted as they are now, but they are all associated with periods of war. History shows that when nations reach as high a level of indebtedness as Greece, and have as few prospects of growth, they will almost certainly default. Indeed, the IMF, which has pretty good experience of fiscal crises, privately recommended that Greece restructure its debt (a kind of soft default, renegotiating payment terms). It was refused point-blank by the European authorities.
To understand why, step back for a moment. It is fashionable to compare the current situation to the Lehman Brothers collapse, but that understates its severity. The sub-prime property market in the US, together with its slightly less toxic relatives, represented a $2 trillion mound of debt. The combined public and private debt of the most troubled European countries – Greece, Portugal, Spain and so on – is closer to $9 trillion.
Moreover, whereas the pain from sub-prime was spread out relatively widely, with investors hailing from both sides of the Atlantic, the owners of the suspect European debt tend almost exclusively to be, gulp, Europeans. No one is suggesting all of this debt will go bad, but the European policymakers fear that the merest hint that Greece might default would spark a chain reaction that would cause a more profound crisis than in 2008.
The problem is not merely that holders of Greek government debt would dump their investments, or even that they would ditch their Spanish and Portuguese bonds while they were at it. It is that government debt is the very bedrock of the financial system: should Greek government bonds collapse, the country's banking system would become insolvent overnight. In fact, banks throughout the euro area would be at risk, given that they tend to hold so much of their neighbours' government debt. That, at least, is the theory, but as was the case in the aftermath of Lehman's collapse, no one really knows how great their exposure is.
The other, more cynical, explanation for Brussels' refusal to countenance default is that it fears that this would fatally destabilise the euro project itself – which of course it would. But as the politicians are discovering, organising a European sovereign bail-out is far, far more difficult than rescuing a bank. It took barely more than a few days in September 2008 for the Government to push through the semi-nationalisation of Royal Bank of Scotland and HBOS.
Earlier this month, when the French President Nicolas Sarkozy announced that the continent would be saved by a "shock and awe" $1 trillion bail-out package, markets convinced themselves for a moment that the politicians might be able to manage it. But the challenge of having to co-ordinate an unprecedented rescue across a
16-nation region without a common language or central Treasury is proving too much for Europe's leaders. Add to this the fact that most citizens (particularly in Germany) resent the idea of bailing each other out at all, and are willing to vote out their governments to prove it, and you get the idea of the challenge at hand.
Despite his rather aloof appearance, European president Herman Van Rompuy put it pretty well this week, saying: "Today, people are discovering what a 'common destiny' in monetary matters means. They are discovering that the euro affects their pensions, savings, and jobs, their very daily life. It hurts. In my view, this growing public awareness is a major political development. It forces the governments to act."
That action, so far as Van Rompuy is concerned, means more integration and some eye-watering spending cuts across the continent. Unfortunately, both are being carried out in haphazard fashion. The bail-out package may pave the way for a central EU Treasury, but it is still being muddled through the legislative process, and could well fall foul of voters in France or Germany. Spain and Italy are, rightly, inflicting severe cuts on their budgets, but so is Germany, which ought, according to a host of economists including Mervyn King, to be spending more, not less.
In the meantime, European politicians, torn in one way by their voters, in another by Brussels, emit even more confusing signals which only destabilise markets further. Angela Merkel's ban on investors short-selling German bank shares, and the collapse of a swathe of Spanish savings banks have hardly helped, either. And all the while, the euro continues to fall as investors mull its fate. The single currency can survive – but only if its members agree to more political union, and the prospect of that would be about as palatable to the people of Europe this summer as an ouzo and retsina cocktail.
