Alf Young: Summit to think about, it’s serious

AS the G8 leaders tackle the economic crisis, the UK government must change direction, and quickly, to survive, writes Alf Young

CONSIDER the chemistry among the seven men and one woman, gathered overnight around a dinner table at Camp David, wrestling, as leaders of the G8 nations, with what to do about this latest phase of a global financial crisis that started in 2007. Yes, next month will see the fifth anniversary of the day the US investment bank, Bear Stearns, first revealed its mind-boggling exposure to dodgy investments based on aggregates of subprime mortgages that individual holders across America could no longer afford to service.

To minimise the potential fallout, Bear Stearns was thrown into the maw of one of the real heavyweights of American banking, JP Morgan Chase. Last week, it was revealed Morgan had lost some $3 billion in trades in credit derivatives made by one London-based trader. Heads have rolled. A judicial investigation is under way. Now there are reports that the same unit that took that egregious hit has built up as much as $100bn of exposure to risky bonds structured around European mortgages, the same kind of esoteric and potentially toxic financial instruments that lay at the heart of the original crisis.

Plus ça change, then, in financial markets. But governments right across Europe, caught up in the fiscal firestorm that followed the crash, have fallen like nine-pins. Their replacements preached austerity and deficit reduction. But the agony has gone on and on. Growth has evaporated. And now the very architecture of post-war European integration – the eurozone – is creaking at its seams.

Greece stands on the brink of leaving the single currency altogether. Spain, where the property boom boomed loudest, is on the rack, 16 of its banks hit by more credit downgrades, half of its young people without jobs. Ireland, another property boomer, votes on the eurozone’s austerity pact on 31 May. Its voters, as they have done twice before, could yet say no. So back to that G8 octet, gathered at President Obama’s Maryland retreat. Their host faces a tense re-election battle in November. He fears a partial eurozone collapse could backfire on America’s faltering recovery at the crucial moment. He wants EU leaders to focus more on growth and jobs. But the four European leaders around the table with him are a motley crew.

The German chancellor Angela Merkel seems determined to uphold the current eurozone austerity pact against all-comers. She faces re-election next year and, in recent weeks, her party, the CDU, has lost ground in regional elections, in both Schleswig-Holstein and in North-Rhine Westphalia. In both polls the upstart Pirate Party, fast becoming an electoral phenomenon across Europe, took around 8 per cent of the vote. Pirates stand for open access to the internet, civil rights and free education.

The new French president, François Hollande, is now an ever-present reminder to Merkel of what could happen next. He unseated Sarkozy on a platform of restimulating the flagging French economy. If he can’t get her to budge on moderating the existing austerity pact, he wants additional action on growth, through the use of Eurobonds or new lending from the European Investment Bank. The fiscal conservatives around Merkel haven’t yet blinked.

Beside Hollande is Mario Monti, a former EU commissioner, who, until next year at least, will lead Italy’s unelected cabinet of technocrats in a unity government. But even Monti, with no voters to worry about, is having doubts about where austerity is taking us.

Then there’s David Cameron.

He will be meeting Hollande for the very first time, having foolishly failed to do so earlier this year when he came to London. Our Prime Minister has also been ratcheting up the rhetoric about the eurozone’s mounting woes. Taking his cue, perhaps, from the governor of the Bank of England, who suggested the eurozone was “tearing itself apart without any obvious solution”, Cameron declared it was time for Merkel, Hollande, Monti, et al “to make up or break up”.

How they must have loved that in Berlin, Paris and Rome. Perhaps, before reaching for another ill-considered sound-bite, the prime minister should have taken his diplomatic cue from the newly-elected Russian president, Vladimir Putin. He isn’t even going to Camp David. He’s sent the man he replaced, Dmitry Medvedev, instead. The G8 party is completed by Canadian premier Stephen Harper and by prime minister Yoshihiko Noda from Japan, the sixth holder of that post in the past five years.

A quiet chat with Mr Noda might help David Cameron sort out some of the things that are said to be troubling our PM about where the UK economy is heading in all this global turmoil. His coalition’s orthodoxy from the start has been: we must sort out our deficit and reassure the bond markets first. Otherwise they’ll punish us with punitive interest rates. If we hold our nerve, growth will follow.

But growth hasn’t followed. Currently it’s nowhere to be seen. Stagnation looms.

Japan went through two difficult decades after its big property and banking bubble burst in 1990. Successive governments resorted to a series of massive fiscal stimulus packages. As a result, its budget deficit is still above 8 per cent of GDP and its public debt is around 200 per cent of GDP. Yet the bond vigilantes are nowhere to be seen. Japanese government bonds are still in great demand. As a result, the yield on ten-year bonds has dropped as low as 0.85 per cent, the lowest in the developed world. Even out to 30 years, bond yields are below 2 per cent.

If it had the political will, the UK government could borrow in the bond markets right now at real rates (taking inflation into account) that are virtually zero. Instead of slashing investment programmes, as it has been doing in recent budgets, it could finance a substantial stimulus package at negligible cost. It shows no signs of taking that advice, although the PM is apparently urging the Treasury to boost some of the existing credit easing schemes, provided none of it shows up on the government’s own books.

Meanwhile, as Sir Mervyn King warned this week, the UK’s struggle to even recover the output lost in the post-crash recession, let alone generate any additional growth, now looks like stretching out all the way to 2014.

And if the eurozone does start imploding, we could be looking at an even longer wait than that. A Japan-style lost decade or even two. But without seizing the opportunity to try something more than serial austerity.

Before David Cameron flew off to Washington he promised he would fight at Camp David to keep Britain “safe” from the euro storm. But unless he thinks again and concedes his coalition’s medicine isn’t working, we’ll face more than a storm.

A decade or more in the deep freeze, seems more like it.