Welcome to the new normal. Billions of pounds were wiped off the value of shares in London on October 4. Dexia, a bank jointly owned by the French and the Belgians, teetered on the brink of collapse. One of the main barometers of Wall Street sentiment slid into bear-market territory. An emergency press conference called by Greece’s finance minister was delayed because the building was being picketed by civil servants.
The British construction sector looked as though it was heading for recession and in Spain more than one in five were out of work. The French and Belgian governments were forced to pledge that no depositor in Dexia would lose a cent, let alone a euro, as they tried to avoid a Northern Rock-style run on the bank. Traders, not surprisingly, were scrabbling for their tin hats.
The turmoil overshadowed the Conservative Party conference in Manchester, just as it did three years ago in Birmingham when the shock waves from the collapse of Lehman Brothers diverted attention from David Cameron’s attempts to portray himself as a prime minister in Âwaiting. Coalition ministers know now, as Gordon Brown and his team knew then, that the global economy is teetering on the brink of recession. Jean Claude-Trichet, in his last few days as president of the European Central Bank (ECB), said: “We are experiencing the worst crisis since World War II.”
The man in charge of the United States’ central bank, Ben Bernanke, said the Federal Reserve would do whatever it took to get the American economy moving again. His comments helped to lighten the mood on Wall Street and to limit the fall in London’s FTSE 100 to 131 points. Even so, the share index closed below 5Â 000 for the first time since July last year.
For those who believe that history repeats itself, Dexia plays the role of Bear Stearns in this unfolding tragedy. The US government found a buyer for the Bear in the spring of 2008 but failed to do the same for Lehman six months later. Dexia will be saved courtesy of French and Belgian taxpayers. Next up is Greece, and there the endgame is now inevitably going to be default.
The panic-stricken reaction of the markets over the past few days reflects a growing mood in the financial markets that the default will not be managed and orderly but messy, with knock-on effects not just for the rest of the eurozone but also for the entire world economy. Banks will go bust, credit will dry up, trade will wither, jobs will be shed. Greece, Lehman Brothers 2.0, will be the prelude to the second Great Depression, something policymakers were congratulating themselves on avoiding only a few months ago.
Dodged bullet
The fear in finance ministries, central banks and the world’s bourses is that perhaps the bullet was not dodged after all. That is still a minority view. Despite the ham-fisted way in which Europe’s policy elite has mishandled the Greek crisis — a mixture of dither and daftness — there is still a residual belief that something will be done to prevent a domino effect from a Greek default.
“I can’t believe,” said Nick Parsons, head of strategy at National Australia Bank in London, “that the German finance minister doesn’t have a file in a top drawer somewhere marked ‘plan B’, which will be activated in the event of a Greek default.”
Such a plan would involve allowing Greece to renege on 50% of its debts, already unaffordable and growing by the day. Banks across Europe would suffer losses as a result, but governments would find ways of injecting more capital into any struggling financial institution, even if that meant full-scale nationalisation. The ECB would step in to buy Italian and Spanish bonds in large quantities to prevent the contagion from spreading.
This, though, suggests that EuroÂpean policymakers are in control of events. The financial markets are far from sure that they are. David Miller, partner at Cheviot Asset Management, said on Tuesday: “Politicians are two months behind reality and their lack of clear leadership in the eurozone is spooking the markets. Investors can’t see any reason to rush into investments at the moment and they are not being soothed by patchy announcements that offer words, not actions.”
Hence the concern about the alternative, much darker scenario in which the financial market pressure on Greece becomes intolerable and triggers a default for which the politicians are not prepared. Market interest rates for the other struggling eurozone countries go through the roof. Banks in the US refuse to extend lines of credit to Europe, where the banks go down like ninepins.
Greece decides that the only long-term solution to its problems is to leave the euro, thus triggering a rapid unravelling of the monetary union. As in the 1930s, deep economic distress has profound political consequences, fostering the growth of extreme nationalist parties.
This is the doomsday option, Âand over the coming weeks and months finance ministers and central bank governors will do all in their power to prevent it from coming to pass. They will turn on the electronic printing presses, they will allow budget deficits to rise as growth slows, they will cut interest rates where it is possible to do so. Action may be taken by the Bank of England and the ECB this week, although the betting in the City is that nothing will happen until November.
Should the worst case, or anything approaching it, come to pass, recriminations will fly thick and fast. Trichet will be blamed for banging up interest rates in the eurozone when Greece, Portugal and Ireland were in recession. Chancellor Angela Merkel will get it in the neck for Germany’s hard-line approach to bailouts. European Commission president José Manuel Barroso will be accused of bowing to International Monetary Fund demands for punitive terms for financial assistance, thereby putting the whole euro project in jeopardy.
There is something in these accusations. It is now the best part of two years since the Greek debt crisis began, two years in which the problem was denied, ignored and down-played. Everything that Europe has done since George Papandreou admitted that the previous government in Athens had been cooking the fiscal books has been characterised by four words: too little, too late.
But this is not the whole story. Europe’s public debt crisis is the sequel to the private debt crisis that broke in the middle of 2007. Governments amassed huge budget deficits to shield their economies from the worst effects of the collapse of the borrowing bubble that inflated in the first half of the previous decade.
The roots of that go back still further to the increasingly dominant role of big finance in Western economies over the past quarter-century. The story has been of banks free to lend what they want and a private sector free to borrow what it wants. Mini financial crises in Mexico, Southeast Asia, Russia, Brazil and Argentina were dismissed as inconsequential until, in 2007, the bug burrowed its way to the very heart of the global financial system.
So what happens now? Some things are not in doubt. It will be a tough few months. Greece will default at some point. Policy will respond to economic weakness. But answers to the bigger questions remain unclear.
Will the euro survive? Will there be a second banking meltdown? Is the world facing a decade or two of sluggish growth to match the Great Depression of 1873-1896, as some historians believe? Nobody really knows. Which is why the new normal is not really normal at all. —