Archive for Portugal

House of Cards

Posted in Finance, Politics with tags , , , on April 29, 2010 by telescoper

There’s now only a week left until polling day in the General Election, and I’ve managed to avoid blogging about it as much as possible. The main reason for this is that I feel almost entirely disconnected from the whole thing, as if it’s all a bit unreal. One of the things in the news this week sparked a memory of something I wrote a few weeks ago which, in turn, made me realise why I find it difficult to take this election seriously.

It emerged on Tuesday that the international money markets had downgraded Greece’s credit rating to “junk” status. Portugal and, more recently, Spain have since been downgraded too, but not as far as Greece. Yet. The reason for this downgrading is that analysts doubt whether these countries will be able to control their public spending sufficiently in order for them to honour huge levels of sovereign debt. The probability that Greece in particular will default in a big way has been growing steadily, according to the calculations of financial experts, and has now reached the level at which traders are adopting strategies that essentially involve betting on this actually happening.

The consequence of all this turmoil is that Greece would have to borrow money at huge levels of interest – over 15% – in order to carry on. The eurozone countries – particularly Germany – are trying to put together a package that that can be paid back at less ruinous rates, but while they continue to debate the details the panic continues.

The knock-on effect of a Greek default would be to remove money from the balance sheets of banks and financial institutions around the world. If a  bank has holdings of Greek debt, and the Greeks default, then the bonds become worthless and billions of pounds disappear off its balance sheet. Some British banks are exposed in this way, but nowhere near as much as France, Germany and Switzerland.

The baleout of Greece may work, but if it doesn’t it looks likely that Greece will be ejected from the euro and will have to take drastic measures to set its house in order. Fine, you might say. They’ve been living beyond their means for too long. That’s true. But so has Spain, which suffered even more than the UK from a housing bubble that went pop and is left with a huge budget deficit.  Spain is too large an economy to be rescued, even by Germany.  A default there, and there’s a real possibility of a chain reaction that will probably mean  curtains for the euro and possibly a real meltdown of the global financial system.  I’m just surprised that it has taken since 2007 for phase 2 of the global financial crisis to start. I think the contagion is still spreading.

 By some measures, our economy is in even worse shape than Spain’s.  However, the reason the markets haven’t downgraded us yet is that we’ve been given a stay of execution by the imminent general election. I’m sure analysts will be looking for very prompt and effective action to tackle our budget deficit if they are not going to put us through the wringer like they did with Greece. Greece, Portugal and Spain are all relatively recent democracies and it’s not obvious their governments can deliver huge public spending cuts and survive the resulting social unrest intact. They certainly haven’t managed to convince the markets they can anyway.

 What’s clear from the UK general election campaign is that none of the main political parties is willing to go public about the scale of the challenge facing whoever takes office after the election. The recent budget did a bit of trim around the edges here and there, and the party manifestos talk about the odd billion here and there in savings, but these are dwarfed by the real scale of our deficit. It seems the politicians have agreed to keep quiet about this to avoid frightening the electorate. When the votes are counted we’re going to get a rude awakening. The general election campaign is just a bizarre masquerade that’s too ridiculous to get involved in.

The scale of what could happen here is indicated by what’s happening in Ireland. Politicians here are talking about a public sector pay freeze. Ireland is actually cutting salaries in the public sector by up to 20%. I think the next UK government is going to have to do something similar or we’ll suffer the same fate as Greece. These next three years are going to be very grim for those of us working in the public sector, or at least for those who decide to stay in the UK.

We generally like to think we’re a mature democracy that’s a bit more sensible that all those mediterranean hotheads and that we’ll be able to grin and bear it for the sake of the economy. However, I’m old enough to remind the Winter of Discontent and it’s by no means obvious to me that cuts on the necessary scale will go through without sustained opposition. If – as seems likely – we end up with a coalition government with a fragile majority, this sort of thing could easily bring it down. If the markets see political instability in the UK they will certainly start downgrading our credit rating too. Public borrowing will  become more expensive, deeper spending cuts will be needed, and Britain be well and truly scuppered.