Thanks, Greece

May 22, 2013

–Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.–

The euro zone crisis has been a piece of luck for Britain. Imagine what would have happened without it.

In the immediate aftermath of Lehman, Britain’s position looked utterly hopeless. With a budget deficit of world-war proportions, and facing the cost of refinancing what had been two of the world’s biggest banks and were now two of the world’s biggest bankruptcies, the future for us at the end of 2008 looked dire.

Since then, our prospects have hardly been transformed, but we have at least been given a few years breathing space to get our affairs in order. For that blessing, we owe thanks to the Southern Europeans.

The initial reaction to the collapse of Lehman was a 20%+ fall in the value of the Pound, but that would only have been the start. As the full scale of Britain’s problems sank in, investors would have looked around for a safe bolt-hole, and they would not have had far to look. With a solid currency and sound finances, euro zone countries would have looked like attractively safe havens. Nobody would have been willing to hold UK gilts at a yield of only 3%, as they do today, when they could hold French, Italian or, better still, German debt denominated in euros, the world’s second reserve currency. In the flight to quality, investors would have flooded into the European bond market, deserting sterling and, probably, the dollar too. In order to finance our budget deficit, we would have needed to offer investors higher – probably far higher – yields.

At best, we would have faced far higher borrowing costs, inflicting unimaginable damage on the level of economic activity, while the plummeting pound pushed up the price of imported goods, resulting in a steep cut in our standard of living

At worst, we might have found ourselves trapped in a death spiral, with higher borrowing costs leading to higher deficits, requiring more borrowing and even higher yields. The only exit from this nightmare scenario would have been a re-run of 1976, with extra zeroes on the end – we would have had to sign up to a “cheap” rescue loan from the IMF and an austerity programme vastly more stringent than anything Mr Osborne has so far dared to contemplate.

Instead, the doomsday machine was derailed in Athens. Thanks to the Greeks, the euro turned into a crisis currency rather than a safe haven, and the pound came to look more and more like one of the less risky options. As Portugal and Ireland followed Greece into bailout, and Spain and Italy joined the list of problem countries, the markets realised that, if German taxpayers were going to bear the costs of bailing out ClubMed, including possibly France too, then even Bunds were no longer such a safe bet.

The result is that the UK has been given a breathing space of indeterminate length to reduce its debts to manageable size. The debt spiral is still a threat, because if the markets ever despair of our resolve to put our affairs in order, investors will flee to one of the other places on the rapidly shrinking list of safe havens, but for the moment we are able to borrow as cheaply as Germany, in spite of our incomparably worse fiscal situation.

But woe betide us if the Germans decide to walk out of the euro zone, as is quite possible, before we have restored order to our public finances. In that case, the pound could well be trampled by the stampede into a refloated deutsche mark. In short, we had better not ride our luck.

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