Related articles

---

• No Related Post

---

Whoa, that was quite a fall.  Markets across the world fell sharply last week. Since the beginning of the year, stock indices from China to the UK, from Japan to the US have fallen by between 7 and 9 per cent. And that’s a nasty drop by anyone’s standards.

Mind you, there was a bit of inevitability about this. Much of the media and analysts, with this column no exception, had been scratching their heads over the rises seen during the last few months. It was obvious to just about everyone there were serious dangers ahead. Why was it, then, that in times of such uncertainty markets boomed? Markets totally failed to call the seriousness of the credit crunch, with the Dow for example hitting an all time high in October 2007, after the fall of Northern Rock and after a time when an increasing number of commentators said things were looking bleak. It seems they haven’t learnt their lesson.

Maybe, the great sovereign debt crisis that we had been warned to expect months ago, is at last beginning to make itself felt.

What is quite interesting, however, is that when you scratch beneath the surface, the picture of doom becomes a tad murky. It maybe that the real crisis we are about to embark on is not so much for the economy overall, as a crisis for the euro? 

First off, there are no prizes for guessing why Greece is in such a mess. This year government net debt is expected to reach 120 per cent of GDP. At the same time, her current account deficit is expected to be around 8.9 per cent of GDP. So it’s something of a deadly duo of ills inflicting the economy from beneath the Acropolis.

In Portugal, net debt is expected to reach around 83 per cent of GDP, according to NIESR. That’s bad, but not awful. However, her current account deficit is expected to hit a whopping 9.7 per cent of GDP.

Italy is grappling with debts which are similar to those seen in Greece, but at least its trade deficit isn’t quite so bad.   This is expected to be about 2.5 per cent of GDP.

Then there’s Ireland, her net debt is expected to be about 90 per cent of GDP, and while her current account is expected to be positive this year, next year it is expected to hit around minus 5.6 per cent of GDP.

As for Spain, net debt is actually quite modest, by current standards. It is on course for 61.8 per cent of GDP this year. But, alas, her current account deficit is expected to vary between 4 and 6 per cent of GDP over the next half a decade.

And that’s the PIIGS – Portugal, Italy, Ireland, Greece and Spain. It’s not just government debt that is their problem, it’s the combination of government debt and trade deficits. 

For some of the countries there’s bad luck too. Much of Spain’s debt is funded by bonds that mature this year, so an awful lot of re-financing will be required.

This contrasts with the UK, by the way, where much of government debt is funded by bonds that are years away from maturing.

Pink Floyd once sung about pigs on the wing. You may recall the image of a massive pig shaped balloon floating over the Battersea power station.  It cut a lonely figure, one flying pig. Alas, however, in today’s economy the PIIGS are not alone. The Baltic economies too are suffering from enormous trade deficits, while Romania is expected to see its trade deficit top 10 per cent of GDP this year.

But it’s not just about government debt and trade deficits. There’s consumer debt too. This is the big problem in Spain and Ireland, where the housing bubbles have added to their woe.

In the UK, of course, our consumer debt is dreadful too, but we do have one advantage over the PIIGS.

We are not in the euro.

The UK’s best hope comes from the cheap pound, meaning an export led recovery could yet grunt its way into leading the UK out of trouble.

Greece et al are haunted by the euro. They desperately need a cheaper currency?

Some say Germany will eventually rescue its indebted neighbours. But, politically,  that would be hugely controversial in Germany where the citizens, who have gone through a period of austerity and cut backs, will feel reluctant to bail out countries that have not been willing to make the same sacrifices they have made.

The IMF may step in, of course.

Others speculate this could be the end of the euro. Some say the PIIGS will be left with no choice but to adopt the kind of polices followed by the UK in 1931 when she pulled out of the gold standard, and depreciated the currency.

 Others speculate that it will be Germany that gives up on the Euro.

The alternative solution for the PIIGS would be to see sharp falls in the single currency. Well that has already started.  But this would do nothing to fix Europe’s imbalance. Germany’s trade balance is expected to be 4.4 per cent of GDP this year.  A falling euro is likely to push the German surplus up even further.

We will leave you with two thoughts. One is looking back, the other looking forward.

Firstly, there can be no doubt that had the UK joined the Euro when it was formed, then right now problems in this country would be a whole lot worse.  Until a year or ago, euro interest rates had been consistently lower than UK rates.  Lower interest rates would have pushed up UK house prices even further, and UK consumer debt would have gone through the roof. There is reason to worry, however, that the crisis with the PIIGS will lead to a crash in the euro, eroding the recent terms of trade benefits that many hope will charge the UK recovery.  

Secondly, demographics may be the long run key. This may surprise you, but the UK is just about unique among the world’s developed economies in that it is likely to see the dependency ratio fall over the next few years. Immigration and the government’s move to increased the retirement age of women, and beyond that to increase all our retirement ages, means that the ratio of working to retired population is not likely to get worse for several years.   Japan, of course faces a hugely serious problem. But then so too do much of Eastern Europe, Scandinavia, the Baltics, and France.

The demographic crisis in the making is not quite so serious in Spain, marginally less serious in Italy, a good deal less serious in Greece and not really that serious at all in Portugal.

The markets are not taking this into account. They dismiss Japanese debt as not being a problem because Japanese saving is so high. They celebrate the modest levels of Scandinavian debt. But as these populations age, the equation will change.

The real long-run problem lies with the ageing of the population. And if we can avoid a really big crisis as this problem manifests itself, pigs really will have learnt how to fly.