Are we about to enter a third, and this time fatal, leg of the financial crisis? The problems of euroland which have so unsettled markets this week – and in particular those of Portugal, Ireland, Greece and Spain (the "pigs", as they have become known in financial circles) – are worrying enough in themselves.
But they are also a proxy for much wider concern about how national governments extract themselves from the fiscal and monetary mire they have created in fighting the downturn. It's proving messy, though, and they are running the risk of provoking an even worse crisis in the process.
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Think of the three phases of the economic implosion like this. The first was a fairly conventional, if extreme, banking crisis where a cyclical overexpansion of credit and lending suddenly, and violently, corrects itself in a great outpouring of risk aversion.
In the second phase, governments and central banks attempt to counter the economic consequences of this crunch with unprecedented levels of fiscal and monetary support. Temporarily, at least, it seemed to work.
Until now, investors have been happy to finance the resulting deficits, in part because government bonds have
By Jeremy Warner Published: 7:17PM GMT 05 Feb 2010
Comments 19 | Comment on this article
Are we about to enter a third, and this time fatal, leg of the financial crisis? The problems of euroland which have so unsettled markets this week – and in particular those of Portugal, Ireland, Greece and Spain (the "pigs", as they have become known in financial circles) – are worrying enough in themselves.
But they are also a proxy for much wider concern about how national governments extract themselves from the fiscal and monetary mire they have created in fighting the downturn. It's proving messy, though, and they are running the risk of provoking an even worse crisis in the process.
Think of the three phases of the economic implosion like this. The first was a fairly conventional, if extreme, banking crisis where a cyclical overexpansion of credit and lending suddenly, and violently, corrects itself in a great outpouring of risk aversion.
In the second phase, governments and central banks attempt to counter the economic consequences of this crunch with unprecedented levels of fiscal and monetary support. Temporarily, at least, it seemed to work.
Until now, investors have been happy to finance the resulting deficits, in part because government bonds have seemed the only safe place to put your funds, but also because central banks have, in effect, been creating money to compensate for the paucity of private-sector credit. The mechanism varies from region to region, but much of this new money has found its way into deficit financing.
We are now entering the third, inevitable phase of the crisis where markets question the ability of even sovereign nations to repay their debts. Unnerved by this loss of fiscal and monetary credibility, governments and central banks are being forced, much sooner than they would have wished, to start withdrawing their support.
I say earlier than they would have wished because the recovery is not yet assured. Private demand and credit provision remain subdued. Policy-makers knew they would eventually have to abandon their fiscal and monetary support, but the timing of it may no longer be a matter of choice.
The first tremors around these so-called "exit strategies" occurred in Dubai a few months back when the emirate, fearing for its own solvency, shocked markets by announcing that it no longer stood behind the debts of its financially stretched state-owned enterprises. In this case, Dubai's fellow and richer emirate, Abu Dhabi, eventually came to the rescue.
It is much less clear that Greece, Spain, Portugal and Ireland can rely on similar support, either from richer members of the euro area or the European Central Bank.
For the "pigs", membership of the euro excludes the easy option, which is to devalue and turn on the printing presses according to local needs. Instead, monetary policy, and increasingly fiscal policy too, are dictated by Germany and France, the core euro nations.
Whether the fiscal consolidation demanded is politically feasible looks questionable. And even if these countries do succeed in making the necessary adjustments, they may face a classic deflationary debt spiral, where slashing the deficit causes the economy to shrink further which, in turn, increases the deficit.
Little surprise, then, that one of the big bets in markets right now is that these distressed members of the euro will be forced either into default, or rather like Britain with the ERM in the early 1990s, out of the single currency altogether. Serious knock-on consequences for creditor economies would follow.
Yet to true believers in the doomsday scenario, even an outcome as extreme as this would not be the end of the crisis. Fiscal ruin is not confined to the southern European nations. The hors d'oeuvre consumed, it would be on to the main course – the default of one or more of the big, triple-A rated sovereigns. Financial and economic chaos would follow quickly in its wake.
There's a world of worry out there, fed by self-interested speculators, which is proving hard to counter. Yet things rarely work out as predicted, and though nobody should be in any doubt about the scale of the economic adjustment still to be made in Western economies, more benign outcomes are still possible. Bigger, advanced economies with their own currencies are better placed to manage their exits than the "pigs".
However, right now, both Washington and London seem gripped by the sort of political paralysis that can indeed prove lethal. We should not assume that the sudden loss of market confidence that has afflicted Greece – essentially a developing market economy that should never have been in the euro in the first place – will be confined to the "pigs". The burgeoning size of public indebtedness the world over makes all economies vulnerable.
Even so, this week's tremors should be seen as more of a warning than the beginning of a fatal endgame. The austerity of tighter fiscal and monetary conditions is coming to all of us. With or without the compliance of policy-makers, the markets will impose it. But it doesn't have to be a rout.
Comments: 19
@ Charles Lee on February 06, 2010 at 09:30 AM "One thing we can be sure of. The Germans, for all their stern talk, will blink and bail out their sloppy Southern partners. This important exercise in hegemony over Europe is too important to fail. Do not bet on default by the PIGS." Precisely what I've been banging on about for I don't know how long! The euro was expressly designed to enmesh its members inextricably into the Franco-German Axis. The FGA will see Europe reduced to a state of utter beggary before they will tolerate any threat to the centuries long dream of empire. Which of course is where it become really interesting ; how long will their subjects -- especially the Germans -- tolerate the lash of austerity for the sake of a mad dream? On past history a very, very long time! And the longer internal and intra-national enmities are suppressed the greater the final explosion when it occurs. In sufficiently extreme circumstances men do not think individually ; they think as a mob. My guess is that, failing the implosion of the so called EU ( the FGA ) from either its own internal defects, or an attack from without, then there will be no significant violent dissent from the march of empire. For you in Britain, it will only be the sight of armed, uniformed Romanian and Bulgarian European Gendarmerie Force me clubbing, tasering and shooting strikers and rioters on British streets that will awaken you from you trance of apathy and compacency. And just ask yourself : in times of widespread violence, who will have the guns? When I write 'you' I do not of course include you, my fellow scribblers on our DT Democracy Wall. But we are lone voices crying in a wilderness of hordes of people in power who like things just as they are. And will resort to ANY methods to maintain their rich status quo.
The trouble is that if a government continues to print vast amounts of money which is not related to goods produced or services rendered in the market place, eventually the whole sorry edifice will collapse. Which is exactly what the gang of Communist/Fascist/Industrial Monopolists who are setting the stage for the New World Order of State Feudalism have been busy planning and organising for years now. If it is not too late throw away the works of John Maynard Keynes and start reading those of Friedrich Von Hayek. Or accept slavery and starvation.
The man who saved the world, and promises huge sums of UK money (money we need here at home!)to various foreign causes, valid or not, will surely sell off our gold for Euros and hand it over to the EU so that PIIGS can continue to do as they please. Problem solved. Well it would for PIIGS, but not us. Brown would be feted in Club Med, and like his pal, Tony, hated at home. But, Hey, he saved the "bacon"!!!
Excuse my ignorance on these matters. If Third World debt can be cancelled, why can't the debt in Greece be treated the same?
Why is it never seemingly ok in mia nstream media apart from Ambrose to actually call a PIG a PIG and let everyone know th truth. As Marc Faber says we are all Doomed. Why does evert=ything have to sound positive. Why is it not ok to be negative? Being nagative is being truthful. This is akin to someoen with terminal cancer and then the doctor telling veryone its all going to be ok. Jereamy starts off well but then concludes that its all ok the patient may recover This is balderdash The worlds economy has been run on claptrap Keynesian "economics" for decades and all the deficits that everyone said do not matter and all the debt that has fuelled this growth have got to breaking point. This is the end game and lime dominoes all debt soaked nations, individuals and companies will collapse. This is the result of not clearing debt out before with recessions but we merley kicked the keynesian can down the road. Keynes was a fool and even now people still think hsi policies work. It didn't work in Japan and it won't work now. Austrain economics is the truth. debt needs to be cleared otherwise the whole system WILL collapse
Jeremy, the second phase which you mentioned in your article is what is commonly referred to as kicking the can down the road. You breathe a sigh of relief when you do it, but the problem is that when you walk up to the can to kick it again you never know if someone has in the meantime put lead in it or whether you are going to kick the jagged edge. That is the scenario now facing the UK and US governments and all other deficit bloated countries. To single out the PIGS is like the Bank of England accusing the Zimbabwean Central Bank of fiscal irresponsibility.
One thing we can be sure of. The Germans, for all their stern talk, will blink and bail out their sloppy Southern partners. This important exercise in hegemony over Europe is too important to fail. Do not bet on default by the PIGS.
The bottom line is that for a long time we overspent. We borrowed and borrowed and borrowed. We borrowed prosperity from the future. Now we must pay back that prosperity, and for years to come. There's nothing the Chancellor of the Exchequer can do to ease the pain. The pixiedust of Quantitative Easing, zero interest rates, VAT reduction etc is the equivalent of taking a couple of paracetamols to ease a rotten tooth. We're due at least two very hard years - 2010 and 2011 - with anaemic economic growth to follow for the rest of the decade. All that any of us can do is hunker down, pay off debt, postpone major purchases and steer clear of the stock market.
Those wishing to bet against the sovereigns should bear a little matter in mind. It is no more than a push of a button to initiate the bet but where are you going to collect if the U.S. and U.K. go down? You think some shmuck of a counterparty is going to pay up when the US or UK is forced to default? Wakey, wakey!
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