Sometimes the eurozone feels like a Horizon holiday brochure from the 1970s: last week Spain, this week Greece. Horizon went bust, and the question is whether one or more eurozone members will suffer a similar fate.
I shall come to Greece in a moment. First, let me offer my take on Thursday’s Mansion House announcements by George Osborne and Sir Mervyn King.
Having been banging on for longer than I can recall about the need to boost bank lending, including last Sunday, I welcome these initiatives. The £80 billion “funding for lending” scheme, the additional liquidity of at least £5 billion a month under the extended collateral term repo scheme and giving the Bank’s new financial policy committee an additional growth mandate add up to a reasonable package.
I do not believe this initiative will lead to a rush of risky lending. We can also dismiss the tired old “pushing on a piece of string” cliche: weak credit is holding back demand.
The dangers are on the other side, that the banks have locked them into a mindset in which they genuinely believe there are few creditworthy borrowers out there.
Many banks, indeed, appear to have adopted the approach of the old shop sign: “Please do not ask for credit, as refusal often offends. The ultimate sanction against them, if they refuse to play ball, is direct lending by the government, perhaps via state-owned Royal Bank of Scotland.
The truth is that Thursday’s scheme has been much too long in coming. The economy has been starved of credit for nearly five years.
The governor defended quantitative easing (QE) at the Mansion House, as he was obliged to, but something like the new scheme – or the purchase by the Bank of a wider range of private sector assets (rejected by King again) – should have been in place alongside QE when it was first launched in March 2009.
One thing is clear. This was not the response to fears of “Panicos”: renewed eurozone turmoil. It will take more than this to insulate Britain from what Europe could throw at us. If the eurozone goes badly wrong, other emergency banking and liquidity measures will be needed.
It is clear eurozone shocks are far from over, with bond markets unconvinced by the 100 billion euro Spanish banking bailout, its bond yield hitting 7%. Today’s second Greek election in as many months risks fresh turmoil.
Irrespective of party support, most Greeks want to stay in the euro, perhaps preferring the slow grind of years of austerity to the sudden and shocking collapse in living standards suffered by Argentina when it defaulted and devalued a decade ago. But is it in Greek hands?
Many Greek scenarios that have come my way. Aviva Investors sees a 40% chance of no exit/muddling through; 40% of a managed exit; and 20% of a disorderly departure, after which European equities drop a third. One of our biggest fund managers, in other words, sees only a 40% chance of Greece staying in the euro.
Berenberg, the German bank, has a set of scenarios linked to today’s election. If pro-bailout parties win, led by New Democracy’s Antonis Samaras, the “troika” of EU, European Central Bank and IMF could agree a modest relaxation of austerity and there would be a 75% probability of Greece being in the euro by the end of the year.
If, instead, there is a victory for Alexis Tsipras’s Syriza party and allies, he could renege on pledges and fall into line, or forced to negotiate an exit — Greece leaves chaotically. Under Syriza Berenberg sees only a 30% chance of Greece staying in.
Maybe we should expect, as on May 6, an inconclusive election, leaving the country and its euro membership in limbo, albeit with the EU keen for clarity before the June 28-29 summit of EU summit leaders.
The world can only wait so long for Greek voters. To paraphrase Lady Bracknell, one messy election is a misfortune, two looks like carelessness. Greece would begin to look ungovernable. Holger Schmieding, Berenberg’s chief economist, sees the probability of Greece staying in the euro in these circumstances as 50% or less.
You can see where this is going. There are circumstances in which Greece can stay in the euro but plenty in which it will not. The chancellor gave voice recently to a view expressed here, which is that a Greek exit may be the only way to break the log jam and persuade Germany to support remaining members of the eurozone.
The assumption is that a Greek exit is manageable, not just in the technical sense of replacing euros with a new drachma but also in ring-fencing other eurozone economies, halting the contagion that, left unchecked, would run from Athens to Lisbon, Dublin, Nicosia, Madrid, Rome and even Paris.
Given the EU’s record so far, however, and its apparent inability to organise a drink-up in a Belgian brewery, a managed “Grexit” may be hoping for too much.
How bad could the alternative be? On the Baseline Scenario website (baselinescenario.com), Peter Boone and former IMF chief economist Simon Johnson and Peter Boone sketched it out. Their piece, The End of the Euro: A Survivor’s Guide, makes for scary reading.
“Some form of new currency will soon flood the streets of Athens,” they write. “It is already nearly impossible to save Greek euro membership: depositors flee banks, taxpayers delay tax payments, and companies postpone paying suppliers — either because they can’t or because they expect soon to be able to pay in cheap drachma.”
Then, say Johnson and Boone, trouble really starts. “Europe’s electorate will be rudely awakened to the large financial risks foisted upon them in failed attempts to keep the single currency alive. If Greece quits the euro this year, its government will default on approximately 300 billion euros of external public debt …
“More importantly and currently less obvious to German taxpayers, Greece will likely default on 155 billion euros directly owed to the euro system (the ECB and the 17 national central banks in the eurozone).”
Capital flight from other peripheral euro members increases in intensity, the euro plunges, inflation soars, financial turmoil increases and the single currency is pulled apart by forces it cannot resist.
“A disorderly break-up of the euro area will be far more damaging to global financial markets than the crisis of 2008,” they write. “Europe’s rich capital markets and banking system, including the market for $185 trillion in euro-denominated derivative contracts, will be in turmoil.
“It is almost certain that large numbers of pensioners and households will find their savings are wiped out directly or inflation erodes what they saved all their lives. The potential for political turmoil and human hardship is staggering.”
Will it happen? One would hope not. Europe’s political establishment used to talk about the eurozone as a haven of stability. In the coming months they will have their work cut out to stop it becoming a source of massive instability.
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.