As it’s prediction season, here goes… My crystal ball, for what it is worth, foretells political and economic union between France and Germany, perhaps within the next 12-24 months. Europe needs a gamechanger, one that creates an insurmountable firebreak against the speculators. Crises have historically been the motor of European integration and a full union, much like the panicky one Britain offered France in June 1940, might look tempting. It would provide for joint organs of defence, foreign, financial and economic policies, finally fulfilling the founding fathers’ dream of “ever closer union”.
Refinancing at current market interest rates is for some peripheral economies becoming unthinkable. Barring a phenomenal injection of liquidity by the ECB, they will continue to move closer to sovereign default. Unless their financing needs are removed by overwhelming intervention, the question is whether Portugal, Spain, Italy, Ireland and Greece can restructure their debts – extending maturities and adjusting interest rates to affordable levels, with the issuance of new Brady-style bonds – without causing the collapse of the euro-area financial system and the break-up of the euro itself.
I’m worried by the schadenfreude in the Westminster village at the euro turmoil. It is technically feasible for countries to restructure euro-denominated debt without exiting the euro and we should wish them the best of luck if they try. For we must be in no doubt that a bust-up of the eurozone will be bad news for the British economy. The best case scenario is the establishment of a parallel soft euro – a ‘PIIG’, as John Redwood dubs it. This may look like a plausible and tempting half-way house, which saves Europe from having to go all the way back to some kind of Exchange Rate Mechanism for a welter of hastily-restored national currencies.
But a Club Med currency shadowing a Deutschemark-zone will not come about without a financial meltdown in ‘PIIG’ banking systems. The pain will be transmitted far and wide, hitting Britain in at least three ways. First, through contagion to British banks. The UK banking sector’s total exposure to the “PIIGs” alone amounts to about £211bn – equivalent to about 4.7 per cent of UK bank assets, according to Capital Economics. UK banks can ill afford a fresh assault on their capital bases that would push up their own funding costs, lift interest rates and set back the government’s attempts to revive lending.
The second transmission channel will be reduced lending to UK consumers and businesses by eurozone periphery banks. Irish banks account for about 3 per cent of household loans in the UK and about 7 per cent of corporate loans. Spanish banks play an even more important role. Through Santander, which owns Abbey, Alliance & Leiciester and Bradford & Bingley, Spain accounts for some 14 per cent of household loans in the UK. If troubles at home force these eurozone banks to rein back their lending, especially overseas, credit conditions in the UK could clearly start to worsen again.
Finally, distress will be felt through the trade channel. At a time when domestic sources of growth are under pressure, the UK’s trade links are of pivotal importance. While Spain and Portugal may be less significant as trading partners than Ireland, the PIIGs together account for 14 per cent of UK exports, according to Capital Economics, compared to Germany’s 9 per cent share and the 16 per cent of UK exports that goes to all of Asia. A wave of defaults and devaluations from countries exiting the eurozone would not only hit demand in these countries, it would also damage UK export competitiveness.
Anyone taking pleasure in the discomfort of our European partners is in for a nasty surprise. On the contrary, the UK government has little choice but to play an engaged and constructive role in helping our European partners contain the twin financial and fiscal crises that are engulfing the various peripheral eurozone economies. The health of the UK banking system, the extent to which the UK economy is dependent on credit extended by eurozone banks and the UK’s own need to earn a living from exports make it abundantly in the UK’s national interests to do so. Chacun pour soi is not an option.
Jo Johnson is Conservative MP for Orpington