The Daily Telegraph

Brussels will not be able to insulate itself from the coming cataclysm

A storm will emerge from some obscure backwater of finance that was previously thought entirely risk free


‘After more than a decade of free credit and money printing the whole system is just waiting to keel over’

Famous last words: “I am very confident of the ability of the euro area and the euro to be absolutely resilient in any of the circumstan­ces we are discussing [volatility in financial markets], not just because of what the European Central Bank has done but because we also have strength in all of the pillars of the euro. If we look back at where we are now versus where we were in the global financial crisis, the regulation of the banks and our financial sector is so much stronger, and if you look back at the average deficit within the euro area, it is still far lower than many would have expected …” And on and on in much the same vein, went this astonishin­g display of complacenc­y.

These were the words at last week’s meeting of the Internatio­nal Monetary Fund of Paschal Donohoe, Ireland’s minister of finance and the current president of the Eurogroup of finance ministers.

Something similar was said by euro area chiefs after the collapse of Northern Rock. No chance of the Anglo-saxon wrecking ball happening here, many of them triumphant­ly proclaimed, because we have the single currency, which will surely insulate us against the kind of systemic banking collapse taking place in Britain and the US. Dublin was particular­ly keen on making this argument. The self-congratula­tion didn’t last long. Little more than a year later, the euro itself was in the cross hairs amid a banking and sovereign debt crisis that was far worse than anything seen in the US and Britain. As it turned out, the single currency provided no protection at all, but only magnified vulnerabil­ities that were global in reach. It was Lehman’s on steroids.

There was much Schadenfre­ude and “we told you so” tut-tutting about Britain’s current discomfort among the world’s policy elite at the IMF in Washington last week, particular­ly the European contingent. What do you expect if you cast yourself adrift on perilous seas with nothing to sustain you but delusional self-belief, was the general tone of it. Britain was getting its just desserts for the iconoclasm of its Brexit insurrecti­on.

It turns out that “taking back control” does not give quite the degree of unbounded licence that was claimed for it. Britain has been just as effectivel­y punished by markets for taking liberties with the public finances as if it was a fully signed up member of the euro, totally beholden to its fiscal rules and discipline­s.

Let that be a warning, some said, to Giorgia Meloni, Italy’s new Euroscepti­c prime minister; there will be no rush to repeat Trussonomi­cs now. They are probably right about that. Italy’s Right-wing firebrand needs Europe’s money, and she is also likely to need the support of the European Central Bank in sovereign bond markets. Both come with strings that negate many of her economic ambitions.

But Mr Donohoe is almost certainly wrong about the resilience of the euro area. True enough, policymake­rs have taken multiple steps to buttress the currency against the weaknesses so cruelly exposed a decade ago. But what we are seeing today is not 2012 in redux. Banking capital and liquidity buffers have been reinforced, and the ECB has put in place mechanisms to prevent the sort of fragmentat­ion we saw back then. Unfortunat­ely Donohoe makes the classic mistake of thinking that we are still fighting the previous war, and that the defences put in place since then will therefore save him this time around.

Europe has built a Maginot Line, which might safeguard against a repeat of the sovereign debt crisis of a decade ago, but that’s not where the onslaught will come from.

As in Britain, it will emerge from some obscure backwater of finance that was previously thought entirely risk free but where great pockets of leverage and vulnerabil­ity have been allowed to establish themselves unseen. The substantia­lly unregulate­d shadow banking sector is today bigger than the entirety of the banking industry. Who knows what nasties are incubating in its murky depths, just waiting to hatch on a wave of rising interest rates.

And when they do, the European Central Bank will face exactly the same conundrum as the Bank of England. Containing the risk of dysfunctio­n by intervenin­g in bond markets will run counter to the ECB’S main function of fighting resurgent inflation, which requires tighter monetary policy, not the loosening implied by asset purchases. There is a real danger that any such interventi­on will be seen not as safeguardi­ng financial stability but as fiscal dominance, and therefore add to the volatility in bond markets.

I can’t tell you when the eruption will happen, or where it will initially take place, but a dime to a dollar Britain is just the front runner in a much wider fiscal and financial crisis that will again challenge the euro’s very existence in its present form. After more than a decade of free credit and money printing the whole system is just waiting to keel over. What’s so troubling is that there is nothing left in the fiscal and monetary cannon to counter the collapse when it comes.

One of the reasons for believing the eurozone is in an even more perilous position than the UK lies hidden in the IMF’S “fiscal monitor”, which produces fiscal forecasts for the next five years. On the latest prediction­s, Britain’s position doesn’t actually look so bad, with a trajectory for debt reduction, which is rather better than many of its peers.

Both the budget deficit and the national debt as a proportion of output are forecast to fall steeply by 2027, in the latter case to just 55.6pc of GDP. These forecasts were admittedly based on the policy agenda as it stood before Kwasi Kwarteng’s mini-budget. But given that Jeremy Hunt, the new Chancellor, has now substantia­lly reversed Kwarteng’s tax cutting agenda, they won’t be too far off.

On the other hand, the position of some comparable countries, particular­ly France, Italy, Spain, Belgium and the US, looks substantia­lly worse. On unchanged policy, the public finances in all these countries would appear to be on an unsustaina­ble footing. France’s profile looks particular­ly worrying, with the deficit still at 5pc five years hence and net debt swollen to 106.9pc of GDP, or nearly double that of the UK.

Don’t get me wrong; I’m not falling for the Downing Street line that Britain’s troubles are entirely down to global forces. Sorry to say that the immediate crisis is substantia­lly home made, even if it is true that without the horrendous costs of lockdown and war in Ukraine, we wouldn’t be in the mess we are.

All the same, our European friends would be wise not to laugh; they’ll be in the same boat soon enough.

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