January 16, 2012
The European debt crisis is moving swiftly to the next phase following the downgrade of France and the collapse of the Greek negotiations with its creditors last Friday night.
It is becoming increasingly obvious that there will be no deal in Greece. This is good news because it means the end of the pass-the-parcel-ponzi-scheme, whereby the bill for more and more institutional debt was passed on to more and more innocent people who had nothing to do with the debt in the first place.
Greece will default – as it should. The bondholders will get roasted – as they should – for making bad investments. The laws of capitalism will be allowed to do their thing. Debtors and creditors will pay – as they both should – with both parties sharing the cost.
Whether this leads to Greece being pushed out of the euro remains to be seen. An opportunistic play by a desperate Greek government might be a total default, followed by the reintroduction of a new currency and then the restart button is hit. Initially, it would be an international pariah, but over time it would recover.
You might think it sounds radical, but it is straight from the IMF’s own adjustment handbook. In fact, the favoured IMF remedy to debt crises is partial/agreed default, followed by a rapid devaluation of the currency, which is then fixed at a new, much lower level.
The more aggressive approach is simply an amplified version of what is likely to happen anyway. The present policy calls for an internal devaluation plus some default. Why not an explicit external devaluation with total default, which gets you to the same place but a lot more quickly?
One of the reasons why there will be huge opposition in Europe to the Greeks going down this road is because it means the banks that lent money to Greece would get nothing or very little.
On the other hand, internal devaluation would mean that they would take a haircut and then slowly bleed Greece dry for the rest of the money. But when you think about Greece’s position, this makes no sense. Greece has a current account deficit of ten per cent of GDP. This means it must borrow an amount equal to nearly ten per cent of its GDP to pay for its current level of imports. If yet more money goes abroad to feed interest payments for foreign banks, it will have to borrow yet more just to make its current account balance. This is why getting the biggest default now must look attractive from Athens.
The realisation of this Greek position has led to the downgrading of France because the French banks are more exposed to Greece than any other foreign banks. All this news is simply the latest phase in Europe’s ongoing debt crisis. It is clear that, however it ends, the credit/banking industry will never be the same again.
We are moving from the great age of borrowing to the great age of saving. The great age of borrowing from 1990-2008 saw people, firms and countries borrow and borrow as much as they could to buy goodies today which they could only pay for tomorrow. Now the opposite is the case. We are in the great era of saving and this will mean, among other things, that the established banks in Ireland will shrink and shrink and shrink. They will sell everything and lay off staff.
In terms of job opportunities, the age of deleveraging means that the notion of safe jobs in the banking industry is over. Thinking back to only a few years ago, it was so different. When I got a job as an economist in the European economics section of the Central Bank, my mother rejoiced at the fact that the young lad had finally secured a “good” job in the bank. Second only to a “big” job in the bank, a “good” job in the bank was good because you couldn’t get fired. No one lost a job in the bank. Like the civil service, the bank had “P and P’ – permanent and pensionable – written all over it.
That age is over for good. Ulster Bank’s announcement that it is to cut jobs is only the first. Indeed, what tends to happen in these cases when there are layoffs of such magnitude, which can’t be avoided, is that the banks have been watching each other, waiting for one of them to move on redundancies first. The announcement from one is like a starter gun being fired. It gives ‘permission’ for the others to announce similar layoffs.
Up to now, bank officials have fared rather better than the people they financed in the construction sector. Relative to the building industry, the banking industry has fared reasonably well in the downturn. Layoffs in the building industry were swift and ruthless – while, in the banks, things have been much less dramatic. However, now this will change and what happened in building will happen in banking. The two industries are inextricably linked.
The Ulster Bank layoffs amount to just 0.9 per cent of the total number of people working in bank and finance. In terms of the total number of people working in Ulster Bank, the redundancies amount to close to 10 per cent of the workforce. If that were to be repeated across the industry – even exempting the growing IFSC – the impact would be devastating. We are talking about huge numbers of formerly “good” jobs gone.
The only light at the end of the tunnel would be for new banks to come in. One of the problems with the banks is that they are bust, they are carrying too much debt and they are not in a position to act as the engine for the recovery, lending to companies that are brave enough to invest.
But ultimately this recession will end. All recessions do. One of the ways to accelerate this is for new banking licences for banks with new capital to come in and start again.
Unless the state actively embraces and encourages new players – and there are some out there – the crisis will continue.
What we are seeing in Greece and France this weekend is only another phase in a banking crisis. Greece will default, taking some of the European banking industry with it.
We are witnessing the slow death of a certain form of the banking industry, but the need for banking remains. We are looking at the death of a certain type of banking – the type of banking which destroyed itself in the age of leverage. As night follows day, a new, very different banking industry will emerge. People will always want to save and others will always want to invest. The best hope for those who have lost their jobs is that the state embraces newcomers who could come in and we start again.
A Greek default would accelerate this process of creating a new banking all over Europe. Bring it on.