The full scale of European debt is now becoming clear - as well as the UK's exposure to it. Default would massively damage Britain, eurobonds need to be introduced.
The true scale of the levels of indebtedness of vulnerable Eurozone countries and their capacity to bring the banking sector to its knees is made shocking clear in the latest data from the Bank of International Settlements (BIS), the international central bank for central banks.
With Italy and Spain now facing bond prices of 6% on 10-year paper and subject to jittery behaviour by the financial markets, both countries are looking increasingly vulnerable.
The reality is that the Eurozone crisis is not just a crisis for the 17 Euro area countries or indeed for the EU-27. It is a global problem for the financial sector. EU banks have exposure of $2.8 trillion in Greece, Ireland, Italy, Portugal and Spain, but the total level of financial sector exposure is a whopping $3.55 trillion.
The BIS data goes up to March 31st and shows that UK banks are, along with German banks, the most exposed to the three bailed out countries of Greece, Ireland and Portugal. The BIS figures, which include derivatives contracts, credit commitments and guarantees along with direct debt, show that UK banks are exposed to $235bn including a massive $185bn to Ireland.
The idea put forward by the likes of Boris Johnson and Tory MPs that these countries should, if necessary, be allowed to default and leave the euro, would be catastrophic for the UK. Moreover, David Cameron and George Osborne cannot afford to continue taking a back seat in the resolution of the debt crisis – along with Germany and France, the UK has the most to lose.
However, arguably the most interesting figures concern the scale of US exposure to the Eurozone crisis. At a time when internecine wrangling continues on the raising of the US debt ceiling, US banks are exposed to $710bn.
Although the recent EU summit agreed a new deal for Greece, including an estimated 21% haircut for the private sector along with new powers for the European Financial Stability Facility (EFSF), it has not calmed the markets. Although it has brought more stability for Greece, Ireland and Portugal, bond spreads for Italy and Spainhave risen back to the same levels as before the summit. The debt exposure of Italy is, at $1.3 trillion, larger than Greece, Ireland and Portugal put together.
The EU countries and the US need to work together to increase bank capital levels to increase their ability to withstand financial shocks. The results of the most recent EU bank ‘stress tests’ show that many high-street banks would be swept aside by large defaults by the vulnerable Eurozone countries.
As Left Foot Forward and many leading economists have argued, the Eurozone needs to federalise its debt to prevent the risk of contagion and to restore calm behaviour in the bond markets. The EFSF and its successor from 2013, the European Stability Mechanism (ESM), must have the funding capacity to underwrite debt, purchasing bonds on the primary and secondary markets and to issue its own bonds. Although this would mean that the likes of Germany, France (and potentially the UK) could end up paying more to service their debt, this is a small price compared to the costs of default.
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