First published in the Telegraph on 4 February 2010
It was one of those moments that can only happen in a place like Davos. There I was last week, having a coffee and minding my own business, when from a nearby table I heard a desperate voice. I assumed it belonged to a beleaguered bank executive, or a stricken hedge fund manager. “We are doing everything we can,” he said, “but the markets don’t care.”
I looked up and realised the voice belonged to the Greek prime minister. His arms crossed defensively, George Papandreou was now listening as one of the world’s top economists told him he thought his best bet was to seek an emergency bail-out from the International Monetary Fund.
Greece is indeed buried deep in the financial mire. At first gradually, and then with alarming speed, the country has lost credibility with investors to such a degree that it is now having to offer an interest rate of 7 per cent to persuade them to buy its debt, compared with 4.5 per cent a few months ago.
Some, including Papandreou, characterise this as a speculative move aimed at splitting up the euro; others see it as a statement of economic disgust at a country whose public finances, always bad, have now dipped into no-hope territory.
There is some truth to both theories, but, more important, at least for both Gordon Brown and David Cameron, there is a broader lesson: the only thing that matters more than knowing what to do about the deficit is persuading the markets that you know what you’re doing about the deficit. Because there but for the grace of God goes Britain. There is no knowing how and when investors will lose their faith in a government, but when it’s gone, there isn’t much you can do to get it back.
Greece, in other words, is the fiscal Petri dish that reveals in gory detail what could happen in the UK if this Government – or the next – fails to maintain the confidence of investors. It is not merely that those interest rates are already inflicting an awful toll on borrowers in Athens and beyond. It is that they are sending the national government towards a full-blown debt spiral, in which the cost of its annual interest bill becomes so unmanageable that it can hardly afford to supply its citizens with basic services.
I have pointed out before that countries, like individuals, occasionally reach the point where they have borrowed so much that their debt simply becomes impossible to whittle away. Greece, the markets seem to think, has now passed that point. And an IMF bail-out would only layer new debt on top of the old. In the end, the only solution is to find some way to slash spending and raise taxes without a) sparking riots or revolution and b) critically damaging the economy.
Should markets pass the same verdict on Britain as on Greece, the results would be almost identical. In its Green Budget yesterday, the Institute for Fiscal Studies, with the help of Barclays Bank, attempted to map out what would happen if the Government failed to achieve the necessary cuts in its budget in the coming years. The verdict: a “very large, and fast-acting” impact on interest rates, pushing them even higher than Greek rates today.
Still, we are not there yet. And there are four reasons to be cautiously optimistic about Britain’s chances. The first is that much of the population is already reconciled to some form of austerity. Both main parties want to cut the deficit sharply, and although the Tories talk a little tougher, in economic terms there is actually not that much clear water between their proposals and those already laid out by the Treasury.
Second, the UK started the crisis with national debt below 40 per cent of gross domestic product, compared with Greece, whose national debt was already close to the 100 per cent of GDP – near the tipping point for a debt spiral. Third, it is a little-appreciated quirk of the British market that, rather like a homeowner on a long fixed-rate mortgage, the Government has to roll over its debt far less regularly than other countries, so is significantly insulated from a Greek-style crisis.
And fourth, unlike Greece, Britain has its own currency, which affords it more leeway to adjust.
But as Greece has shown, a credibility collapse can take place even when you least expect it. Despite George Osborne’s pledge earlier this week to safeguard Britain’s credit rating, some still reckon there is an 80 per cent chance of the UK losing its coveted triple-A status – something that could trigger an investor panic.
So both main political parties should, as a matter of course, prepare detailed emergency plans saying what overnight cuts they would impose in the event of a similar crisis.
However, avoiding such a credibility collapse will not spare Britain from having to drag itself through an economic transformation with the same end: to reduce debt and to live within its means. For some countries, the financial crisis was painful because people suddenly started spending less. For Britain, it uncovered the fact that the nation had duped itself into believing it was more prosperous than it really was. We mistook a debt bubble and the proceeds of financial engineering for sustained and lasting growth. Time to get real.