The Euro dominoes are lining up nicely

Over the last week the biggest story amongst the chattering classes was about Rupert Murdoch, his organisation, the people in it and sundry other actors in the unfolding drama. Meanwhile the real big story, the matter that most galvanised the most members of the UK population was that energy prices are to rocket, this at a time when most real household incomes are falling and when many are already having trouble meeting their energy bills.

But the story that will possibly have the biggest impact on our lives is that the Euro zone contagion has spread to Italy, as predicted in this blog. In reality it is quite amazing that it took so long for the financial world to cotton on, it is not as if the figures are secret.

We now know that Greece is definitely going to default on its government debt. Firstly because the task of servicing and paying back their loans is financially impossible. Secondly because the Greek people don’t see why they should pay back the money they have borrowed and spent when the rich Germans can pay it off for them. The Greeks don’t like to pay taxes and they expect to retire on a big government paid pension when they are 50, why should they be expected to give up the good life that the rest of Europe has paid for since 1981?

When the default happens the debt will be written down by, say, 50%. In which case the Greeks would eventually be expected to pay back half what they have borrowed and the lenders will take the loss on the other half. If the write down isn’t big enough the Greeks still won’t pay the loans back, so the write down needs to be significant. The losses will hit every bank in Europe and many elsewhere in the world. It will also hit lots of governments really hard. So there will be a big fallout and big costs for everyone including you and me.

Then of course the Portuguese and the Irish will say that if the Greeks receive this write down then they deserve the same. So, inevitably all the banks and governments will take a further hit. So now we are talking about a far bigger upset than the sub-prime contagion that started in 2007 and which took out Lehman Brothers. Which brings us to the dominoes.

The initial domino will be Greece, this is just a matter of when, not if. Portugal and Ireland will inevitably follow. The resulting financial fire-storm looks very able to then take out countries that are currently right on the brink of disaster, to push them over the edge, to default. These countries are Italy, Spain and Belgium. Next in line would be the UK, thanks to the huge financial hole that Gordon Brown dropped us into with his out of control profligate spending.  Here are some GDP figures (expressed in billions of US$ PA) so you can compare these seismic events:

Greece  305
Ireland 204
Portugal 229
Italy 2,055
Spain 1,410
Belgium 466
UK 2,247

What is not good is that the financial markets are already writing this domino effect into their activities, which makes it even more likely to happen.

So how will the world handle defaults on this scale? The simplest way is for the governments involved to print a lot of new money. It is called quantitative easing and it was used to help pay for the consequences of the sub-prime disaster so it is a well trodden path. So very many hundreds of new Dollars, Pounds and Euros will pay off debt, but in doing so they will devalue all the money that is already out there by way of inflation. The commercial banks will be in big trouble because the losses from the write downs on their lending will erode their capital bases. The way out of this is for governments to invest in the banks in the form of new equity, once again a well trodden path.

Once you realise what is going to happen you can see why gold, which provides no income, is rocketing in value. Events will be so seismic that they will put many economies into recession and will reduce the quality of life for hundreds of millions of people. Thank you Greece. One good side effect will be that reduced energy demand will bring down electricity and gas prices for overburdened British households.

Meanwhile our politicians are being indecisive and are refusing to get a grip on things. Ostriches with their heads in the sand. German politicians know that their voters will be making the biggest pay outs and they know that it will be exceedingly unpopular. But it is what will happen no matter what way events unfold. It would be far better if politicians could accept the facts and then take control of events because the way things are going just now we could descend into the same sort of chaos that attended the sub-prime crisis.

One player on the world stage that could cushion the blow for everyone is China. They did it during the sub-prime crisis by sharply increasing their domestic consumer demand and they easily have the money to do it again. In fact so interconnected is the global economy these days that the Chinese economy will take an enormous hit if they don’t act as fairy godmothers. Being generous will be the cheapest route for them.

And so what of the Euro, the fatally flawed mechanics of which allowed the Greeks to instigate this whole mess? It looks like the politicians think that it will only work going forward with fiscal union. So ironically events that should lead to less federalism will lead to more federalism. As to who will be allowed to be in the Euro, that is a different matter. There is talk now of a Super-Euro for the financially responsible “northern” countries with the dissolute “southern” countries forced back to their Drachmas, Pesetas, Liras, Escudos and Punts.

All in all this is far, far more important and will impact on us far more than tabloid journalists behaving like tabloid journalists and corrupt policemen behaving like corrupt policemen.


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