Alphen, Netherlands, 26
April. London in the spring sunshine
feels like an episode of the X Files. A
strange bright, warm object appears in a rare clear, blue sky of which no-one can
make sense. On Wednesday I had the
privilege of providing evidence to the House of Commons Defence Select
Committee at its first meeting to consider the 2015 British Strategic Security
and Defence Review alongside Lord Hennessy and Major-General Mungo Melvin. Those of you sad enough to wish to see
Friendly-Clinch with Battle Ensigns flying can go to http://www.parliament.tv
Perhaps the most important contribution I made was to suggest to collected
British politicians of all shades that whatever reforms are made to Britain’s
strategic security and defence structures little will change unless the
political class imposes effective oversight.
However, Britain’s
strategic future is not the purpose of this missive. Rather it is a comment made by an old
university friend over lunch in the City, London’s financial powerhouse. He suggested that the Eurozone crisis was
still in what he called the “crumple zone”, i.e. that part of the car designed
to implode on impact to protect the occupants.
In other words the crash is still happening.
This week a six-page European
Commission memorandum was leaked which revealed concerns that a Financial
Transaction Tax (FTT) would not only drive up costs of government borrowing across Europe but
damage the all-important bond markets.
As the FTT is an ever-so-thinly-veiled attempt to get the British to pay
for the failed political experiment that is the Euro it is causing both alarm and irritation
in London. Even if Britain excuses itself from this tax firms based in Britain would be badly affected by it and one of the first laws of economics is that there
is no such thing as a free tax. So why
are they doing it?
One has only to look at
the figures to see why those few Eurozone countries paying for the Eurozone
disaster want to spread the costs as widely as possible. The Eurozone faces a perfect storm that will
take at least a decade of pain to resolve.
It is a storm caused by the coming together of fragile banks in need of
bail outs and governments that cannot pay for themselves due to debt interest and
deficits and bond markets. The markets are only willing to lend because the European Central
Bank is either transferring tax income from the wealthier Eurozone states to
the poorer, or simply printing money and damn the long-term growth and inflation
consequences.
Take Greece. Total Eurozone exposure to Greek debt is
about €300 billion ($390bn) or some 3% of Eurozone GDP.
German exposure to Greece alone is approaching 5% of GDP. Six Eurozone states have now sought bailouts
with Slovenia about to follow when it is politically appropriate for their banking
crisis to be publicly declared. As each
crisis unfolds foreign investors are pulling out their money forcing the ECB to
plug the gap by impoverishing the northern, western European taxpayer.
Economic theory
suggests all six debtors should leave the Euro, devalue and thus regain
competitiveness. However, in so doing
the already immense social pain being suffered will only deepen (Spain’s
unemployment rate yesterday reached 27.16%). Moreover, even if only Cyprus, Greece,
Ireland, Portugal and Spain pulled out the costs of transitional arrangements
could be as high as €1.2 trillion ($1.6tr) or 15% of Eurozone GDP. That increases to around 20% of Eurozone GDP
when the likely additional bank bailouts are factored in.
Consequently, and
here’s the rub, Germany is likely to see its national debt increase from 81% in
2011 to around 100% in 2014-15. German
banks alone would need an injection of €500 billion ($600bn) if the Euro fails due to
their exposure to toxic debt, threatening the loss of Germany’s AAA credit
rating. However, go the other
way towards banking and fiscal union and that would cost €300-€400 billion ($390-$520tr) with
Germany bearing at least 30%. Therefore, post-German elections in September some form of debt
mutualisation is inevitable which will push German interest rate costs up by €15
billion ($19bn) per annum. Indeed, simply
holding the resources of the poorer EU states at their current levels to pay for welfare is likely
to require transfers from north to south of €250 billion ($325bn) per annum.
Which brings me back to
Britain. The Brits are also sort of broke, with the British national debt likely
to peak at around 85% 2017-2018.
However, debt is relative and British debt compares with Japan at 194% and Italy over 100%. Moreover, Britain’s national debt is only 30%
of that between 1920 and 1960. More
importantly 70% of British debt is held in the UK, whereas with the notable
exception of Italy, up to 100% of southern European debt is held by flight-risk
foreigners. In other words the British
enjoy more flexibility than any Eurozone country, unless that is they are
suckered into paying for the Euro-disaster.
The future? In the long run Germany will consolidate its
position as Europe’s strongest economic power, but the crown it wears will be hollow given the constraints imposed on it by Eurozone
debt. Britain will remain and strengthen
its position as Europe’s second biggest economy and strongest military
power. Critically, damaged by the crisis and enmeshed in ever-expanding, growth and competitive-killing Brussels regulation both will decline in relative
terms against North America and Asia-Pacific.
As for long-runs John Maynard Keynes was right; we are all dead. A crumple zone indeed. On that happy note...
Julian Lindley-French
