If the Greeks had a euro for every City analyst and financial reporter who has solemnly warned that the country’s debt crisis risks being ‘another Lehman moment’ for the financial markets, their economy would probably be in far better shape than it is. It has become the most over-used cliché of the last few weeks – and, like every tired cliché, simply shows that the people using it have stopped thinking clearly for themselves. In truth, the Greek crisis is nothing like the Lehman collapse. It is far worse than that.
Over the course of the last week, the Greek crisis has prompted a global sell-off in every kind of asset – and rightly so. The government of the beleaguered Greek premier George Papandreou looks on its last legs. The Germans have been wrangling with the European Central Bank over the terms of a fresh bail-out. Protestors have been marching across Greece, fighting yet more austerity. There were certainly reasons to fear that Greece might be forced into a sudden default – and that would pose huge risks for the European banking system. Greek debt is hidden on balance sheets right across the financial system. No one really knows where the losses will come out. Even so, it is nothing like Lehman Brothers.
When the Wall Street investment bank collapsed in 2008, the US Treasury and the Federal Reserve had no real idea it would pose a systemic risk to the financial system. If they had, they wouldn’t have let it go down. They would have stepped in to rescue it instead. The crisis it provoked was largely unexpected.
That isn’t true of Greece. Germany’s chancellor, Angela Merkel, and France’s president, Nicolas Sarkozy, are well aware of the threat a Greek collapse poses to the financial system. They aren’t going to let it happen until their experts have reassured them their banks can survive. After all, they aren’t stupid. They are not going to let their financial system blow up. If they have to find a few more tens of billions of euros to prop up their wayward southern neighbour for another year, they will. It’s better than the alternative. So there isn’t going to be a sudden collapse. The risks are all flagged up, and everyone will work hard to avoid them. The trouble is, Greece is just the tip of a much larger iceberg.
The Greeks have been running massive budget deficits for years. So have most of the other peripheral countries, such as Portugal, Ireland and Spain. France shows very little sign of getting its deficit under control. Neither does the US. The UK is making some progress, but lower-than-expected growth means we are unlikely to meet our targets. The sovereign debt crisis is not just a Greek issue. It is hitting most of the developed world. That is going to affect the markets in three ways.
Firstly, it is going to depress economic growth. There is only one real way to bring deficits under control, and that is to make deep and painful cuts in government spending. Nothing else works. But as governments everywhere scale back on their expenditure, growth is going to be hit. Over the medium term, a smaller state allows the private sector to grow faster. It is a mistake to fall for the simplistic Keynesian mantra that state borrowing and spending promotes growth. It doesn’t. Cuts allow the economy to grow faster – eventually. But it takes time for that to happen. And in the medium term, the economy will be more sluggish than it otherwise would be.
Next, the debt crisis is going to deter investment. Who would want to build a new factory or sales office in any of the peripheral eurozone countries right now? You have no idea what the economies will look like, or even what currencies they might be using in three or four years’ time. You are likely to face years of grinding austerity programmes as governments struggle to stay in the euro. And yet investment is the lifeblood of economic growth. If companies don’t invest, then economies are not going to be able to grow.
Finally, it is going to depress asset prices. For all the reasons outlined above, the debt crisis is going to slow global growth. That is bad for just about every class of asset, from equities, to bonds, to commodities (although probably not for gold, which is usually the one clear beneficiary of a monetary crisis). Obviously, that is going to depress the markets as well. But it also means that investors are going to be very cautious. The constant threat of defaults, the worries that it will lead to a fresh banking crisis, and the nervousness over which country is likely to be targeted next, will all make any kind of bull market very hard to sustain. And the lower asset prices are, the lower growth will be as well.
In many ways, therefore, we’d all be better off with a Lehman moment. A quick, sharp crisis that would end with Greece defaulting on its debt, re-establishing its own currency, and one or two over-exposed banks being bailed out would be better than a saga that drags on for years with no clear resolution. But it isn’t going to happen. The global economy suffered from the Lehman collapse – but was able to start recovering the following year. Unfortunately, this crisis will take far longer to resolve.