When George Osborne delivered his first budget, Greece made the perfect backdrop. The television news channels had split screens: on the left side, the new Chancellor making the case for austerity. On the right side: riots in Athens as a government confronted the consequences of its profligacy. Now, as then, British eyes are on Greece — but for different reasons. The prospect of a Eurozone banking crisis has now overtaken rampant inflation as the greatest single threat to the British economy.
The risk is not Greece itself, which, for all its great difficulties, remains a small and marginal economy. British holidaymakers may quietly pray for the return of the drachma and, with it, the cheap European holiday. But this is where the opportunity ends. If Greece’s collapse spreads to other countries on the Eurozone’s periphery then Portugal will be next: another profligate, corporatist economy in desperate need of radical reform. It remains to be seen whether Spain and Italy, the next two dominoes in line, will also tumble over. If they do, anything could happen.
It is often said that Osborne has made an ‘audacious gamble’ with his cuts programme — but, if anything, the reverse is true. For all the talk of austerity, the spending figures show the government to be every bit as fiscally incontinent as its predecessor. Every month, spending has been, on average, 5 per cent higher than the same month in the last year of Gordon Brown. The national debt is rising fast and will have increased by £4,700 by the time you have finished reading this sentence. Still, the UK national debt is rising at a slower rate than it would have under Brown’s plans, and the markets consider Osborne’s aim — to balance the budget by 2017 — to be credible.
It is precisely Osborne’s lack of a radical cuts agenda that gives him plausibility. He has told the markets that he aims at cutting state spending by just under 1 per cent a year. When Greece and Ireland reveal their far more ambitious plans, they tend to face more scepticism. Osborne’s cautious approach, by contrast, is seen as practical — and a Greek collapse won’t change this. We are unlikely to have to pay higher rates of interest on our debt if Greece goes pop.
The fallout will contaminate Britain, however, in no less pernicious ways. Government debt in the weaker Eurozone nations might be said to have taken the place of subprime mortgage debt in the world financial system. Like the original US variety, once it starts to go bad, the consequences will spread widely and rapidly. Continental European banks, pension funds and insurance companies are hugely exposed to Greek and Portuguese debt, not to mention Spanish debt. Why would they take on such risky assets? Because Eurozone banks and insurers are forced by law to hold vast amounts of their own government debt. They are trapped.
The disaster scenario goes as follows. In London, City analysts are openly suggesting that between half to three-quarters of Greece’s debt will have to be written off, at a cost to investors of more than €210 billion. This would wipe out most Greek financial institutions and cost European banks and funds €130 billion. If you think the numbers are scary, remember that Greece is a minnow of an economy; the fallout would be many orders of magnitude higher were Italy or Spain to succumb.
Britain is especially vulnerable because London remains at the heart of Europe’s financial networks, the nerve centre for the management and allocation of capital across the continent. A French or German financial crisis would be a disaster for the City, and hence for British jobs and tax receipts. Even if George Osborne were able to borrow as easily and as cheaply as he was before, he would need to borrow more — because the bankers would be paying less tax. It is a dirty secret in Whitehall, but we badly need the bankers to succeed. A resurgence in banking profits is the best hope for tackling the deficit.
Santander, a Spanish bank, is one of the major players on the British high street. It bought Abbey National seven years ago, then, when the banking crisis struck, it snapped up Alliance & Leicester and Bradford & Bingley and, in an act of bravado, put all banks under its name; it is also due to take over more than 300 branches of RBS and NatWest. ‘No one expects the Spanish acquisition’ ran the joke when the takeovers began. No one expected that Spain’s banking system, which once seemed so resilient, would look so vulnerable so quickly. There are several million British savers who would be very nervous if Santander hit trouble.
And then there are our exports. For three years, Britain has been congratulating itself for staying out of the euro — the plunge in the value of the pound has been our economy’s most effective stimulus. But if Greece falls, then so too will the euro. The European Central Bank could easily be rendered insolvent by a Greek collapse. The once conservative Frankfurt-based guardian of the central currency has bought vast amounts of dodgy Greek debt to bail out Athens and is now discovering that its investment is deeply toxic. All of this would guarantee a major constitutional crisis in Europe. A bust ECB could start printing itself out of trouble (as Britain has done) in defiance yet again of the European treaties and German public opinion.
Let us hope Osborne knows all of this – and is making his contingency plans. He may even have to prepare a speech explaining to British taxpayers why this indebted nation is to bail out the Eurozone. His modest spending cuts, when they eventually happen, won’t tip the British economy into recession or derail the nascent recovery in the labour market. Employment is recovering faster in Britain than almost any other economy in the world. Osborne should resist any schadenfreude when considering the plight of his neighbours. A Greek tragedy would all too soon become a British one.