This morning’s financial headlines made grim reading

Thursday’s losses across the world’s financial markets have been a long time coming.  Even if the private sector has largely repaired its balance sheets since the financial crisis, government certainly hasn’t.

In fact, a working majority of the causes of the crisis are still in place.  The west continues to be a large-scale importer of credit, debt as a percentage of GDP continues to grow, and back in the private sector the scale of the off-exchange derivatives market has grown rather than shrunk.

This latest crisis has its immediate roots in American politics.  The fact that President Obama and Congress came so close to allowing a default has implications above America’s own debt costs, although the US’s AAA credit rating may well be past repair – watch the hawkish S&P’s ratings closely.

To give a sense of how a downgrade could affect the American economic position, a downgrade here in the UK would cost us an additional £10 billion in interest repayments every year.  The US would be far higher.  If Ireland is any guide, the result of this sort of increase is to set in train a series of downgrades as the higher costs make repayments less and less affordable.

More significantly, US debt had always been assumed to be so safe as to be in effect zero risk.  Back when Bear Stearns were chasing Northern Rock down the drain, the common view of the markets was that a US default of any scale was unthinkable.  That is no longer quite as certain, even the probability remains remote.

When the markets are down, investors take a ‘flight to safety’ to the bond markets, sacrificing returns for security.  But if investors lose confidence in the safety of bonds issued by the world’s most powerful nation, where can that security be found? The impact on financial markets is fundamental.

Here in Europe we have our own version of the same problem.  The eurozone is simply not equipped to meet sovereign bond difficulties on this scale.  Northern European nations are fundamentally different in output, per capita wealth, demographics and export characteristics to their southern neighbours.

When a country experiences a recession, they have traditionally been able to allow their currency to devalue, which should through simple economics improve the ability of that country to rebuild through export growth.  But in the eurozone, Greece and its fellow PIGS are currently trying to scratch a living exporting at prices more appropriate for the seemingly impervious German economic miracle.  The growth they need to have any chance of meeting their debt is simply not going to arrive.

Grafting northern European monetary policy onto southern European fiscal policy is an inherent contradiction that is simply unsustainable without buoyant growth.

Even in Italy, where the budget is tightly managed and the government’s principal creditors are internal, the likelihood is for debt to rise from an already eye watering 128 per cent to 150 per cent in the next six or seven years.  Default is inevitable.  For that matter, bond traders are opening up price differences between French and German debt as well, as the crisis laps closer to the UK’s shores.

I wrote this article on my BlackBerry on the way to the office while reading fairly grim headline data – the FTSE closed 11.3 per cent below its May high, and the Dow fell harder than it has since October 2008.

The markets had their say on all of this yesterday, and they will carry on today.

But if you are looking for a glimmer of hope? The markets are almost always wrong.  They overstate, then they correct.  It may not be as bad as it appears – for one thing, I simply cannot imagine that the United States of America could possibly bring itself not to pay its credit card bill.

Let’s hope that hunch is correct.

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Allen Simpson works in the City. This article represents his personal opinion.

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Photo: Mike Brzozowski