Let me say upfront, loud and clear, that I hope my view on the way this economic crisis could go for our beloved country is wrong. Totally and utterly wrong. I fear that we could soon be staring down the financial abyss. Unless this situation is arrested here and now, we could be facing an economic crisis of Icelandic proportions. Reading through many of the opinion pieces in this weekend's press, I fear that many political commentators and players have just not comprehended how serious the situation is. And that includes the leadership of the Conservative Party.
The single most significant development of last week was the realisation that the financial markets have lost all rationality. Traders are totally gripped by fear, and have started to liquidate many assets regardless of cost. Their fears are becoming self-fulfilling. As they liquidate, prices fall more, forcing them to liquidate further and so the cycle starts again. Any argument about the fundamental value of certain assets has become irrelavant. Prior to last week, many traders were still talking about fundamental value and how things were starting to look cheap. Now, even after a fall in global equity prices of 20-25% in five consecutive business days, the same traders view the same assets as too expensive. It's not rationale, but that's the point. Britain, and the developed world, has never seen such a situation before - ever.
You may easily say that Britain is no Iceland and that I must have gone off my head, but let's look at the facts. Iceland, a tiny country, had built a huge banking system relative to its size. The total short-term liabilities (debts due in one year or under) of Iceland's banks represent 480% of government debt and 211% of GDP. Furthermore, in aggregate, its banks have a leverage ratio of 14 times, meaning that they hold ISK14 of assets for every ISK1 of shareholders equity. As a result, as Iceland's banks suffered losses on there huge asset pools, the banks had too little equity to absorb them. The Icelandic government was virtually powerless to act, as its own economic resources (measured crudely by GDP) proved too small to bailout its banks.
In comparison, although the US banking system is easily the the largest in the world, it has not outgrown its domestic economy. Taking the same ratios as above, US banks have short-term liabilities equal to 43% of government debt, just 15% of GDP, and an average leverage ratio of 12x. The US also has another weapon to combat the crisis - the US dollar which is first amongst the world's three remaining global reserve currencies (the others are the Yen and EUR). Because of its status as a global reserve currency (meaning essentially that the demand for US dollars goes far beyond its own borders), at a time like this the US Treasury can essentially print money without having to worry too much about the value of its currency diving in the financial markets. In a nutshell, the US can afford to bail out its banks.
So on a relative scale of 1 to 10, with a higher number representing greater vulnerability to the current financial crisis, Iceland would be a 10 and the US a 1.
Where are we on this scale? I would say an 8, and here's why.
The UK, like Iceland, has a banking system that is huge relative to the size of its own economy. The likes of HSBC, RBS, Barclays, Standard Chartered and Lloyds are global financial giants. Despite the UK having a £1.3 trillion GDP, her banks have hugely outgrown the domestic economy. Total banking sector short-term liabilities are 368% of government debt (the highest in the developed world after Switzerland and Iceland) and 156% of GDP (the highest in the developed world after Belgium, Switzerland and Iceland). The average leverage ratio of UK banks is 24x. Also, very importantly, Sterling is not a global reserve currency. Unlike the US, the more Sterling the UK pumps into the banking system, the greater the fall in Sterling's value on the foreign exchange markets. In a nutshell, the UK cannot afford to bail out is banking system. It's simply too big.
I say all this, admittedly without a clear idea of what the government's exact policy response should be. But I do know this:
First, its pointless and inaccurate to blame Labour for the mess that we are in. There is absolutely no reason to think that had we had uninterrupted Tory governments since 1979, that the situation would really have been very different. From a political point-scoring point of view, I would love to blame Labour for the mess we are in but it would be cheap, disingenuous and amateur. The electorate know that, and we know that. This is a global crisis that was not made in Britain (although, no question, we played a part).
Second, whilst I would not go so far as to say that the Conservatives should join some kind of national emergency government, Cameron needs to show that he recognises the enormity of the situation and the fact that we have very little time to react. He needs to put aside the usual political point scoring, bantering and party political posturing. Unless Cameron and Osborne get proactive, put their own ideas forward and give the government support when it makes sense, they will be doing the wrong thing for their country, but arguably the right thing for their party.
This is a huge test for Cameron and Osborne, one that so far they are on the way to failing. Our country is facing its most serious crisis since WW2. It's not a time for Party, but Country.
The hand of history is on Cameron's shoulder.