Britain’s economy may already have dipped back into recession, but thanks to developments in Italy over the past few days, the chances of it being pushed into something very much worse just got a whole lot bigger. As was always predictable, getting rid of Silvio Berlusconi hasn’t helped matters one jot – yields on 10-year Italian bonds soared past 7 per cent yesterday. This was the level that forced Greece, Ireland and Portugal to seek support from European and IMF bail-out funds. There is no reason to believe Italy is any more capable of weathering the storm, even if a technocratic government of national unity capable of pushing through painful structural reform is installed. Economic contraction, reinforced by repeated rounds of austerity, has put Italian sovereign debt on an unsustainable path. Italy needs growth to climb out of the hole it is in, but it is getting the very reverse. It’s taken less than a week for the Cannes summit to prove itself wholly irrelevant. Italy, the eurozone’s third largest economy, is not just “too big to fail”, but it may also be too big to bail. The crisis is again spiralling out of control Outside a few diehard zealots, it’s hard to find anyone of sound mind who now thinks that the single currency was a good idea. These days, the project is held together not by the dream of what it might one day achieve, but only by fear of the consequences if it were allowed to fail. This hardly looks a secure foundation for the future. If the euro is unsustainable in its current form, would it not be better just to get the whole thing over with and let distressed members peel off? It’s a seductive argument, but regrettably also a wrong-headed one. It’s not for nothing that the Americans and the Chinese are almost as terrified as the Europeans at the prospect of a messy end to the single currency. A eurozone implosion would amount to the biggest bankruptcy in history. There could be no benign outcome to such an event. To reapply to the eurozone what Larry Summers, the former US Treasury secretary, said about the prospect of an American debt default, it would be “like Lehman’s on steroids”. Banking systems would collapse, credit would dry up, and world trade would go into freefall. The consequences would be felt everywhere, including in the US and China. But for Britain, which is on the front line, it would be much worse. An already likely home-grown recession would be multiplied several times over. In such circumstances, it is impossible to think that sterling assets could maintain the “safe haven” status they enjoy today, with sovereign bond yields at a record low. A collapsing economy would comprehensively destroy the Government’s deficit reduction strategy, and even in the event of further austerity measures, cause the debt to GDP ratio to rise to unsustainable levels. As the risk of default rose, so too would bond yields. The UK would soon find itself in the same vicious cycle of economic decline and rising debt as Italy. According to estimates this week from Fathom, an economic consultancy, the Bank of England would need to engage in a further £1 trillion worth of quantitative easing to stand any chance of countering this effect and keeping bond yields on their present, highly accommodative footing – a scale of bond market buying which would make the Bank sole owner of the entire stock of UK sovereign debt. It is through gritted teeth that the predominantly Eurosceptic Tory leadership supports efforts to hold the eurozone together, but it really has very little option. Self-interest, not altruism – still less any Damascene conversion to the delights of the single currency – instructs their stance. It’s all about managing the immediate threat. Britain’s economy is in bad enough shape already. It needs a bomb going off in Europe like a hole in the head. Even without meltdown in the eurozone, it seems probable that we will be in some form of shallow recession over the months ahead. The V-shaped recovery that many companies were counting on, which explains why they have held on to their workforce over the past three years, is simply not happening, and given what’s going on across the Channel, is now most unlikely to. Unemployment is therefore certain to rise sharply over the year ahead. Britain requires a strong eurozone, both to support economic recovery and to move from a consumption-led to an export-led economy. But we are not going to get it, even if “Eurogeddon” is averted, given the present, destructive mix of contractionary policies in Europe. The latest trade figures demonstrate a bizarre reversal of what was meant to happen. Our trade gap is widening, not narrowing, as comparatively strong demand from Britain (all things are relative) sucks in imports from a weak eurozone, whose appetite for British goods is plummeting. It was supposed to be the other way around. The difference is explained by the fact that the UK is still supporting demand in its economy, while the eurozone is not. Europe’s prescription for dealing with unsustainable levels of debt is ever more austerity. German intransigence is preventing the sort of monetary activism we’ve seen applied in Britain and the US. The longer these policies persist, the more likely it is that the eurozone will break under the pressure. Policy designed to keep the whole thing together is paradoxically only driving it apart. What’s required is German capitulation – first, to the idea of monetary activism, allowing the European Central Bank overtly to buy sovereign bonds without limit, so as to reduce interest rates and support growth; second, to the endeavour of inflating its own economy to counter the fiscal austerity of the periphery. Is it going to happen? For many Germans, it will be over their dead bodies.If the eurozone implodes, Britain will go with it
Unless Germany acts soon, this country could find itself going
the way of Italy.
Saturday 12 November 2011
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