Bill Emmott - International Author & Adviser


Britain will suffer if it doesn´t help the Euro
The Times - January 17th 2011

Here is a number that should be memorised by all those who sneered last week at the French prime minister, Francois Fillon, and his request to Britain to support future rescue and repair measures for the euro: $233.5 billion (£147 billion). It is the total exposure of British banks to sovereign borrowers in Ireland, Greece and Portugal. Like it or not, if those countries decide they cannot afford their debt-burdens and choose instead to default and renegotiate, Latin America-style, Britain is going to be involved.

            That figure comes from the Bank for International Settlements, by the way, the respected Switzerland-based body known as “the central bankers’ central bank”. Add in Spain and it rises to $370 billion. Now be quite modest and assume that in a debt restructuring the banks would have to write off about 30% of their exposure.

If just three countries were to renegotiate in that way, the British losses on that (admittedly simplified) basis would be about $70 billion, which is double the then record corporate loss announced by Royal Bank of Scotland for 2008. With four countries, it could be $110 billion. If Italy and Belgium join in…well, it doesn’t bear thinking about. Nor does the possible run on all European banks if this were to happen in a disorderly way, which could make the Lehman collapse look trivial by comparison.

This, incidentally, is a much better reason to gripe about bankers’ bonuses than the un-new fact that bankers are greedy. Banking regulators should be asking whether the current profits out of which they are paying their bonuses might soon prove as artificial as were the profits in 2006 or 2007.

            No banking system is an island, and even less so when London is (and wants to remain) the leading financial centre for Europe. For that reason, David Cameron may come to regret his pledge last week that Britain will not be drawn into any new bail-out mechanisms for a eurozone member, as it was for Ireland in November. This was foolish both because the November participation was perfectly sensible—Britain was simply lending Ireland money, at a decent interest rate, in just the way that the baying crowds at Westminster want banks to keep lending to businesses—and because he may have to break that pledge quite soon.

            What is happening in the eurozone is intriguing but also deeply worrying. The intriguing bit is partly that this currency-in-crisis has just recruited an eager new 17th member (Estonia), but also that it is helping Germany achieve a new Wirtschaftswunder. That country announced last Wednesday that in 2010 its economy grew by an astounding 3.6%, its fastest in two decades and roughly twice as fast as Britain. Its exports are booming, unemployment is falling, incomes are rising, business investment is climbing and household consumption is rising modestly too.

We should look on with awe but also trepidation. Apart from general Teutonic merits and the reforms of the past few years, the main explanation is the euro: having been squeezed in the currency’s early years by its rise against the dollar and fairly high interest rates, German industry is now benefiting from the weakened euro and low euro interest rates. The trepidation is that this could eventually feed through into German inflation, helped as everywhere by rising global food and oil prices. Given Germans’ historic phobia about inflation, that could be politically explosive.

If you were a member of the Greek government, or hoping to be in a new Irish coalition of the centre-left Fine Gael party and Labour after the likely spring general election, you should be looking at those German trends and pondering whether the best time for a debt renegotiation might be soon, rather than risking the German boom turning sour.

The bond markets’ fears of default are already pushing up borrowing costs, and if euro-wide inflation rises that will do so too. The euro-zone’s big debtor countries are essentially in a race between their domestic economic growth rates and the huge costs of servicing their debts. The austerity measures they have had to use to cut their borrowing are slowing their economic growth. Last year’s bail-out packages for Greece and Ireland just bought time, as would the much-speculated-on package for Portugal. They did not change the fundamental problem, that these countries are—or might soon be—insolvent.

A debt-restructuring would be a shocking and complex solution, which is why officials will carry on describing it as inconceivable until the day it is announced. As the latest issue of The Economist said, in calling for a restructuring, it is no small thing to advocate the first rich-country sovereign defaults since Germany did so in 1948. There will be at least three big difficulties: how to define which countries are in and which out, so as to avoid speculation about further defaults; how to deal with the consequent losses for banks; and how to make defaulting countries pay a sufficient price for the restructuring to deter them from simply repeating their excessive borrowing in the future.

Compared with alternatives, though, these difficulties look manageable. Waiting and hoping is the current policy, and that looks like failing. Setting up what Germans call a “transfer union”, in which stronger countries send money to support weaker ones, would cause riots to spread from Athens to Berlin. It could anyway only be feasible if the eurozone had a single federal government, as in the United States, and there is no chance of that, either. The merit of a debt restructuring is that if taxpayers’ money is needed to deal with banks’ losses, it will be German money for German banks, and British money for British banks, the politics of which would at least be simpler.

The international politics of this restructuring will not be simple at all. For eurozone members, it will involve penalties, future fiscal controls and demands for deregulation and market liberalisation. Even Otmar Issing, the German former chief economist of the European Central Bank, has written in the forthcoming bulletin of a London think-tank the Official Monetary and Financial Institutions Forum, that he is now sceptical of euro-countries’ ability to abide by any agreed rules, given their behaviour in the currency’s first 13 years.

Britain genuinely, and fortunately, does not need to be involved with that. But it has a powerful interest in ensuring that any debt restructuring is fair and well-managed, for it will unavoidably be part of it—and, indeed, in ensuring that it is done before any new Lehman-style collapse occurs. Let us hope that in private Mr Cameron and George Osborne are being rather more constructive than they were last week in public


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