Will Greek contagion spread to UK? The crises has been compared to Ebola. One guru said Greece is tip of iceberg. And warned the UK could follow

Whilst Gordon Brown was busy destroying his electoral hopes yesterday, turning a successful chat with a member of the public into a disaster, a real disaster was unfolding in Europe.

Not since the collapse of Lehman Brothers has the economic world suffered such a shock. Where does one begin?

Well, when you tell a story, finding the point to kick off from is always difficult. To start with the big bang, the extinction of the dinosaurs, or just with the news that unfolded last week?

Last week, Eurostat revised upwards its estimate of Greek fiscal deficit to 13.6 per cent of GDP, and warned that it may have to raise it again to 14.1 per cent. Moody’s cut Greece’s credit rating, and the yield on Greek government bonds soared.

Meanwhile, European politicians did what they are so very good at, and talked about talking, but did nothing. Barely a week has gone by over the last few months without some announcement that the EU has agreed it is willing to provide Greece with loans, but then the noise from Germany belied the hope.
But then on Tuesday, Standard and Poor’s downgraded Greek debt from BBB+ to BB+. (When I was at school I was delighted if I got a B+ for an essay – Ed.) In credit ratings terms the downgrade was a disaster, meaning Greek government debt was no longer of investment status, but junk. And the yield on bonds soared some more.

That a European rescue mission had become urgent had become obvious. And then it was agreed an emergency meeting would be held on May 8. If the story of the banking crisis and the collapse of Lehman Brothers tells us anything, it tells us that times like these require immediate action. A crisis can become contagious, and spread like an economic plague in no time.
Of course, the Germans are furious. They see Greece as a country that has grown soft on jobs for life, gives out generous pension payments, has a lying government that disguised the full extent of debt, and is rife with fraudulent tax claims by the country’s richest. They are willing to help, but at a price. But not all Greeks are freewheelers. Athens is an expensive city, and highly qualified citizens are working all the hours God sends for a salary that most Brits wouldn’t get out of bed for. That’s why they are rioting. We don’t need cuts, we need tax inspectors, they say.

Also on Tuesday, Standard and Poor’s cut the credit rating for Portugal to A-. But it wasn’t finished. Yesterday it was Spain’s turn. Its rating was downgraded from AA+ to AA.

But where will it end? Greece is suffering from the fundamental problem that it is not competitive. It desperately needs a cheaper currency against Germany and the rest of the eurozone countries. For that matter it needs a cheaper currency against sterling. Have you seen the cost of holidays in Greece versus Turkey?

But if it was ejected from the euro, and we saw a new drachma, which then fell precipitously, this would mean the value of Greek debt measured in euros would rocket.

The thing Greece needs most of all, would actually make its debt mountain unaffordable. No wonder Standard and Poor’s warned that investors may get only 30 per cent of their money back. And by the way, many fear Greece may yet face its own banking crisis, as wealthy Greeks withdraw their money and transfer it into banks overseas. Such a crisis would require even more money the government doesn’t have to bail out the banks.

But as we saw when Lehmans collapsed, a Greek default would send shockwaves that would reverberate around the global economy, once again bringing back fears of a 1930s style depression.

Angel Gurria, Secretary General of the Organisation for Economic Co-operation and Development, said: “It’s not a question of the danger of contagion – contagion has already happened. This is like Ebola. When you realise you have it you have to cut your leg off in order to survive.” Nouriel Roubini, economics professor at New York University and the man who predicted the banking crisis, said: “While today markets are worried about Greece, Greece is just the tip of the iceberg, or the canary in the coal mine for a much broader range of fiscal problems.” Ken Rogoff, co-author of This Time It Is Different, a professor at Harvard and former chief economist at the IMF, said that Portugal, Ireland and Spain are “conspicuously vulnerable”.

Alas, this is a crisis without an obvious solution. The end of the euro is a real possibility. It is hard to believe that major defaults can be avoided indefinitely. Maybe, the PIIGS will ultimately have their own currencies back, and maybe they will all default and investors will lose money. It may be that the quicker this happens, the better. But the knock on for investors will be horrendous, attitudes to government debt will change, and it is far from certain the UK could come out of such a crisis without itself defaulting.

© Investment & Business News 2013