Alistair Darling: Back on the brink of chaos

Why can’t we ever learn the lessons of history? In the aftermath of the First World War the Treaty of Versailles imposed on Germany a regime it could never meet. Now we are asking Greece to implement a policy of austerity that won’t work. And we know it.

We run the risk of driving moderate Greeks into the hands of those holding extreme views that in normal times they would have nothing to do with. If Greece leaves the euro the costs could be far greater than if they stay. A Greek exit could start a fire that would spread all along the Mediterranean as other countries would come under pressure. The repercussions, particularly in the banking sector, could cripple Europe for years to come.

This is uncharted and highly risky territory.

In the 1930s the orthodoxy of the day was to cut public spending and, when that didn’t work, to cut again. It didn’t work then and it is not working now. Four years after the banking crisis crippled the world economy the eurozone is in deep trouble. If it is not sorted out, it runs the risk of dragging us and the world economy down into what could be years of stagnation.

We are back on the brink. Greece is only one manifestation of what has gone wrong. The austerity plan imposed on Greece was never going to work. Very few believed it would. The Spanish government is being forced to shore up that banking system as its property market stagnates. Even in the Netherlands, standard bearers for austerity, the government has collapsed, unable to deliver a budget to comply with the strictures demanded by the eurozone leaders.

In France, where growth has stalled, at least there is an opportunity now to draw back and set a course to provide some hope. So what needs to be done? The eurozone must accept that a currency union means that there has to be increasing economic and ultimately political union. (Alex Salmond please take note.) The richer parts of the union have to support the poorer regions, as happens in the United States.

Yet this is not happening. Germany, which has benefited hugely from the euro, cannot stand aside and ignore the truth that it needs other parts of Europe to buy its goods. The last thing Germany needs is a collapse of the euro and a return to a Deutschemark that would be so highly valued that it would price German exporters out of the market.

It must be right that everything possible is done to try to rescue the situation, rather than stand by and watch a collapse that could affect the entire continent, us included.

Greece is now heading for another round of elections. It must face up to reality. Whatever happens there will be pain. This is a country where they have difficulty collecting income tax, a country which should never have joined the euro. But it needs a credible settlement. The present plans mean that even if it did all it was asked to do it would still have a debt of 120 per cent of its national income in eight years time. That is not credible.

It is all very well for economists to say ‘if only it left the euro in a few years time, all would be well’. Just think of what would happen if Greece chose, or was forced, to leave the euro. It would have to return to the drachma, which would be worth considerably less.

People would see their savings wiped out. All over the world, people would ask “which country is next?”. Money would flow out of those countries, such as Spain and Italy, seen to be at risk. Smaller countries, such as Portugal and Ireland would also be targeted.

A Greek default would feed into Europe’s banking system. It could make the collapse of Lehman Brothers, which presaged the global banking crisis, seem small beer.

That brings me to Europe’s banks. Last week, we saw Spain try to shore up its banking system. Its banks were exposed to a massive property boom, just like in Ireland. In 2008, here in the UK, our Labour government, was faced with banks just hours from collapse. As Chancellor, I had to do far more than the markets expected and much more swiftly to prevent a meltdown.

Unfortunately whilst we and the Americans in 2008 cleaned up our banking system, many European countries failed to do so. Until they do, until they face reality, suspicion will linger.

The big decision, though, is how to get growth going. At the start of this year the eurozone entered into a treaty like that of Versailles which forces countries at or near recession to cut then cut again to meet a deficit target. This is a treaty that effectively outlaws Keynsian economics.

These are dangerous times. Yes, the US economy is growing, pursuing policies that we espoused in government. But the Asian economies are slowing. Europe risks paralysis. Confidence is shot to pieces there.

The rhetoric and the practice of austerity has crippled growth. Governments can make a difference if they choose to do so. Here at home the coalition government’s prescription has thrown us back into recession. The eurozone threatens to drag us and the rest of the world even further down.

In 2008 we showed that countries acting together can make a difference. All of us – at the G20 meeting of the world’s largest economies – agreed to maintain government spending to stop our economies from sliding from recession into depression. It worked.

In 2010 our economy was growing. It was weak growth, but respectable, just like the US. Since then it first stalled and is now going backwards. The UK coalition government trashed confidence by maintaining, falsely, that we were just like Greece.

It was nonsense and they knew it. We are now paying a very heavy price. This austerity policy thrust on Europe is failing, badly. It will involve a colossal cost.

No-one argues that borrowing must not come down. But the International Monetary Fund predicts that under present policies, borrowing and debt in countries like Spain, Italy and Portugal will increase. These are arguments that were fought out 75 years ago, in the 1930s. Surely we have learned? That is why President Hollande’s election in France must prove to be a turning point.

The eurozone has to change tack. The tide is turning. It is all about a credible plan to cut borrowing and to get growth going again. Our government’s rhetoric is increasingly shrill and thin.

Europe, whether we like it or not, is run by big countries. We are not part of the eurozone nor do I think we ever will be. But as the United Kingdom we do have influence. It is for the eurozone to finance its recovery. However we have to rebuild our bridges with Europe, and France in particular. Just why David Cameron chose to slam the door on François Hollande on his visit to London February remains a mystery. The United Kingdom must be in there, arguing for an approach that gets growth going again. We need to rediscover the sense of purpose and determination that fended off catastrophe four years ago.

• Alistair Darling was Labour Chancellor of the Exchequer from June 2007 to May 2010