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The second global banking crash

The EU sovereign debt crisis is not primarily about the 17 countries that constitute the Eurozone, it’s about the intertwined European banks’ exposure to a mountain of speculative lending in high-risk countries that could never have survived German competitiveness within a single currency. The UK is equally at fault here even though not itself a member of the Eurozone. UK banks’ exposure to weaker countries in the Eurozone has been estimated at some £268bn, equal to one-sixth of UK GDP. Though UK direct exposure to sovereign debts is low (perhaps some £22bn), UK banks’ lending to households and businesses in Greece, Portugal, Ireland and Spain has been much higher. As a result, if there were to be a sovereign default, which now seems increasingly inevitable, UK banks would be liable for huge losses.

That is why this crisis is not pre-eminently about saving Greece. It’s about saving the banks of leading Western countries, indeed for the second time in 3 years. Cameron’s moralistic stance about it being ‘right’ to inject a further UK £40bn into the IMF has got nothing to do with high-mindedness, and everything to do with low pragmatism in trying to drum up international support for a rescue package of which British banks would be prime beneficiaries.

There is the further problem that since the City is Europe’s biggest market for the derivatives called credit default swaps (basicially insurance policies in the event of unpaid bills), London’s losses on CDSs could be enormous and could start a snowball effect by triggering other related losses. Then there is the very real risk of contagion, with Italy now replacing Greece as the markets’ main target. That could set off a credit crunch even more severe than in 2007-8. In the worst scenario a default by Portugal, Ireland and Spain in addition to Greece could cut Eurozone output by 6% and because of UK banks’ being so closely (and unwisely) intertwined in these fragile economies, Britain itself could be dragged down by some 3-4% on top of the collapse in investment, the fall in real incomes and the rise in unemployment.

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