By Allister Heath 17 October 2014
Greece’s sudden relapse has left many equity, bond and commodity investors running for the hills
Interest rates on Greek debt have jumped. The last time this happened, in 2010, the eurozone was plunged into near-fatal crisis Photo: EPA
If Greece is the canary in the coal mine, then we are all in trouble. Interest rates on Greek debt have jumped in recent days, rocketing to around 9pc on 10-year bonds, an unsustainable financing cost for such a troubled government.
The last time this sort of thing happened, in 2010, the Eurozone was soon plunged into near-fatal crisis. Four years later, the debt crisis in the Eurozone's periphery was meant to be over, so Greece’s sudden relapse is one reason why so many equity, bond and commodity investors are running for the hills.
Unlike last time, no hidden debt has been discovered, and Greece’s budget deficit has actually fallen significantly.
While not quite a model student, Greece had at least been trying to mend its ways. The proximate trigger for the surge in bond yields is that the Athens government had been over-exuberant since the start of the year, hoping to leave the bail-out programme early, partly for the wrong, anti-austerity reasons.
None of this will now happen, and the European Central Bank has promised to help out, which may temporarily calm matters down.
The stark reality is that Greece is not out of the woods, contrary to what many had claimed – yet its crisis is containable. Its economy is too small; even under a worst-case scenario it would not be able to take down the whole of the Eurozone.
But what this latest flare-up confirms is that merely reducing budget deficits is not enough. Having an excessive national debt remains a major problem, especially now that economists are slashing their growth forecasts for the Eurozone as a whole and continent-wide deflation is looming. In such a Japanese-style scenario, the traditional debt-eroding mechanisms of inflation and growth no longer apply.
Falling prices – caused by a defective, one-size-fits-all monetary policy, and thus insufficient demand – will push up debt ratios as a share of GDP, especially when economic output is stagnating at best. As Capital Economics points out, any Eurozone country with high and rising debt ratios is vulnerable; Italy and Portugal, which both have debt to GDP ratios of about 130pc, could be next in the firing line. Once again, excess debt is the problem – though this time, burdens are rising for partly different reasons.
The euro has seen its value slide by 5pc against a trade-weighted basket of currencies since March, with Citigroup predicting that the total depreciation will hit 10pc over the next 12 months. In the past, this would have generated a 5pc boost to exports, translating to a 1pc rise in GDP over three years.
Sadly, the impact this time around is likely to be far more muted. Demand for the sorts of goods the Eurozone exports has weakened significantly. A greater share of the value of the region’s exports is in turn made up of imported components or raw materials, limiting the beneficial impact of the weaker euro, Citigroup correctly points out.
Firms will most likely make use of the weaker euro to increase their margins whenever possible, as their Japanese counterparts did recently when the yen lost some of its value.
How will all of this affect the UK? I’m still upbeat about the British economy, which has grown superbly in recent quarters and has delivered an excellent performance on jobs. But the chaos and turmoil will impact growth, as was the case during the previous Eurozone crisis.
Lower share prices are already having an impact, making it harder or more expensive to raise funds. Virgin Money, the bank 47pc owned by Sir Richard Branson, has postponed its float. Advisers report that several other stock market flotation have been suspended or pulled altogether. Millions of savers are now substantially poorer than they were, which will hit confidence and consumption.
Those forecasters who were still expecting an interest rate increase this year (in my view, entirely implausibly) are now busily changing their tune. As it happens, I don’t think any of this invalidates the case for a rapid normalisation of monetary policy but my view is now in even more of a minority.
All in all, the UK economy remains in a surprisingly good place compared with the performance of most of our neighbours.