George Osborne and David Cameron are deluded.
There’s a long list of topics to which that statement might apply, but right now, one is more important than the rest – contagion from the eurozone crisis.
Contagion normally refers to the transmission of eurozone woes to Britain via UK banks’ liabilities in the crisis areas. The greater the exposure, the worse the contagion.
This conventional view of contagion is based on direct contact between banks and infected areas. That’s how the Treasury looks at it and why the government thinks the UK is insulated. Last week George Osborne boasted that the UK was a “safe haven”. Then on Friday, William Hague declared “We’re not in the firing line”.
But what the Bullingdon boys haven’t understood is that the contagion is airborne.
A cursory look at movements in banks’ share prices shows how limited direct eurozone liabilities have translated into plunging prices.
Recent estimates of the exposure of UK banks to public and private debt in the trouble spots were £82.5bn for Ireland, £65.4bn for Spain, £40.5bn for Italy, £14.8bn for Portugal and £8.6bn for Greece.
These might seem like big figures, but for a sector as large as UK banking, worth £7000bn, they are worrying but hardly critical. The latest IMF healthcheck on the UK assessed banks’ exposure as “manageable”
In comparison, since the start of this financial year, the big banks’ share prices have plummeted – RBS has fallen 31%, Lloyds has fallen 46% and Barclays has fallen 35%. Only HSBC has been somewhat insulated, but even they have dropped 14%.
The reason for the collapse is that negative city sentiment has been turned into self-fulfilling fact by the stampede of the hedge fund herd. The link to liabilities no longer needs to be real, it just has to exist in the fevered minds of city traders.
The result of this shift in transmission mechanism for contagion is that the economy is in far greater danger than the government understand or at least is letting on.
If the trend in bank share prices established since April continues, RBS and Lloyds will return to the level where the government had to intervene back in 2008, by Christmas.
Speak to any trader or analyst about what they think will happen if there is a crisis event in the eurozone, like a default, and they are all agreed: there will be a run on the banks similar to the crash of 2008.
The only thing they view with equal certainty is that there will be a defining crisis at some point.
Estimates on the scale of the carnage vary, but in this situation a single day’s losses across the banks would likely top one third of share value.
Anything on this scale, following on from the last few months will potentially send the most vulnerable – RBS, Barclays and Lloyds -into freefall. Sentiment is already too negative and the share prices already so low that one big shock could tip them over the edge.
That would bring Hobson’s choice for the government – bailout mark two accompanied by a massive rise in the deficit and a potential UK sovereign debt crisis or the collapse of some of the UK’s biggest banks.
Take your pick. Either way, we would be in the same position as Portugal, Ireland, Greece, Spain and Italy. No credit, no confidence, no money and too much debt.
The crisis would have been fully transmitted from the eurozone to the UK.
As Osborne and Cameron phone in government from their holidays, they are content in their contagion delusion. But the reality is that the UK is no more insulated from the impact of a eurozone crisis than the French were protected by the Maginot line at the start of World War 2.
Their criticism of Gordon Brown was that he failed to fix the roof when the sun was shining. There’s some truth in that.
Now, on their watch, it’s been raining for months, the water has soaked into the timbers of the house and the eaves are bowing. But still there is no action.
If and when the roof crashes in, they and they alone will be to blame.
