Again we face a sea of uncertainty from across the Channel. Is there any way we can avoid a nasty outcome for Britain?
Sir Mervyn King says he and other members of the Bank of England’s monetary policy committee agree there is “no meaningful way to quantify the most extreme possible outcomes” in the eurozone.
He may be right, and who I am to disagree with the Bank’s assembled brainpower and small army of economists? Sometimes, however, you have to try. It is the only question people are interested in.
That the eurozone crisis is having an impact on Britain is not in doubt, despite the daft attempt by some commentators (and some opposition political parties) to try to argue otherwise. It is not the only factor hitting growth but it is a factor.
The eurozone crisis affects business confidence and the availability and cost of funding in Britain. It also has a much more direct impact. Trade figures last week showed that in the first quarter, export volumes, excluding oil and so-called erratic items, were 0.3% up on a year earlier.
That was split, however, between a 4.4% rise in non-EU exports and a 3.3% fall in exports to the EU. The longer term picture is even more striking. Since 2007 exports to the rest of the EU are down 10%, while non-EU exports are up 30%.
We do exporters a disservice in not acknowledging the shift that is happening. I owe to Geoff Dicks of Novus Capital Markets the news that in March, for the first time in decades, non-EU exports, in cash terms, exceeded those to the rest of the EU.
As for what Dicks describes as the “hoary chestnut” that we sell more to Ireland than the Brics’ (Brazil, Russia, India, China) economies combined, that has not been true since spring 2010. Officials who put it in ministerial speeches take note.
The economy is shifting away from excessive reliance on Europe, and showing some signs of improvement. Labour market figures showed a 105,000 employment rise in the latest three months, admittedly driven by part-timers, and welcome falls in both measures of unemployment.
They also showed a 0.9% rise in total weekly hours worked in the first quarter, after a 0.4% increase in the final three months of 2011, on the face of it hard to square with an economy on the slide.
The question, as last year, is whether these signs of life will be snuffed out by what the Bank governor referred to as “the risk of a storm heading our way from the Continent”. So let me suggest a range of possible outcomes, varying in severity.
1. A ring-fenced Greek exit. This would be the best outcome for Europe, and for Greece, however much its voters appear to want to hang on to the euro while not persisting with the austerity that goes with it. It would also be the least damaging outcome for Britain. Exit, followed by a 40%- 60% devaluation as the new drachma comes into being, would not be costless. There would be taxpayer-funded losses on central bank and other official holdings of Greek debt. Though some say EU authorities would not want to see Greece doing too well outside the euro, for fear of encouraging others, its economy would have to be supported during the post-exit period. Central banks would have to pump in liquidity more generally.
More importantly, the ring-fence would have to be big enough to prevent Greece’s exit from causing a domino effect and forcing other economies out too. That ring-fence, including the European Financial Stability Facility, the International Monetary Fund and other bits and pieces, is hard to estimate with precision, with parts of it still being negotiated. But a generous estimate would be 800 billion euros (£640 billion), compared with the 2-3 trillion euros the US treasury secretary said last autumn was needed. There is work to do.
2. An extended muddling through. Neither EU leaders nor Greek politicians want to risk the leap in the dark a Greek exit would entail but neither are they prepared to confront the fundamental challenges of making Greek membership work while satisfying the demands of German taxpayers. This would suggest that the muddling through of the past two years may continue. Though this looks like the “anything for a quiet life” option, it would ensure that the crises and uncertainty of the period since May 2010 would persist, and probably make the eventual bust bigger.
3. A series of peripheral exits. A Greek exit might be manageable, but what if containment is impossible and others are forced out? Capital Economics, shortlisted for the (Lord) Wolfson prize on euro break-up, offer a menu for countries leaving the euro which comprises no advance warning, banks immediately closed. all domestic prices and contracts redenominated into the new currency (which would be worth an average of 40% less than the equivalent euro value) and government defaults equivalent to around 80% of national gross domestic product. Unsurprisingingly, the effects would be bigger than Greek exit on its own but, according to Capital, be expensive but just about manageable – with the right amount of support – for the three economies rescued so far: Greece, Ireland and Portugal.
4. A bigger break-up. The spread of contagion and exit to other countries would be another matter. A Spanish exit would be highly damaging, in both its direct and indirect effects, while according to Capital, Italy leaving would be “devastating”. “Indeed,” Capital says, “this is one reason to think that global institutions and other eurozone members would simply not allow an Italian exit and default to happen.”
What will happen? Markets have increased the probability of a Greek exit to over 50%, particularly if next month’s election continues to favour the anti-bailout parties. When it happens, it will be over a weekend and unannounced in advance, recalling all those crisis meetings of three years ago. Contained, we could live with it.
The bigger the break-up, the greater the danger. We would relive the nightmare of three years ago, only partly tempered by the hope that the authorities and the banks are better prepared than they were then.
Which will it be? The crisis of three years ago was a once in a hundred year event. Though the euro crisis is its continuation, it would be unusual to have another once a century event so soon.
The hope has to be for limited break-up, that other eurozone countries, including Ireland and Portugal, distance themselves from Greece. Maybe it will be possible to manage an orderly Greek exit. In this sea of uncertainty, it offers the best lifeboat.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is posted with permission.
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