AS if a sovereign debt crisis were not enough, along comes North Korea, the roguest of rogue states, and suddenly it seems as if South East Asia could be on the brink of war. North Korea is the single most evil regime in the world, a despotic, idiotic and inhumane communist totalitarian state which has reduced its people to a state of almost complete misery. Nobody can predict Pyongyang next move, which is why there is now such nervousness; a weakened President Obama is unlikely to be able to do much so the ball is in China’s court. Whether or not this dispute is resolved in a sensible way – and the maniacs in North Korea suitably slapped down – will tell us a lot about Beijing’s maturity as an emerging superpower.
Markets always underestimate geopolitical risk; economists, analysts and traders always seem to believe that rationality will prevail. If only. So yesterday’s events sent shivers down everybody’s spine, especially given that nobody believes Europe’s sovereign debt crisis to be over. The assumption instead is that it has just started and that the euro’s survival is now at risk. Ireland’s government is teetering; it remains unclear whether the deal that has been agreed – an €85bn bailout, with a plan of action to be unveiled today – will ever even see the light of day. At least Brian Cowen survived a motion of no confidence last night. The Irish public and opposition politicians may yet decide that they would rather play hardball with the country’s creditors – after all, their position is not as weak as some may think given that the EU is desperate to halt contagion to other nations.
When the possibility of war in the Korean peninsula is added to this horrid mix – an event which, apart from its horrific impact on human lives, could dramatically derail the Asian growth engine – one understands immediately why everybody is suddenly so jittery. Geopolitics had already started rearing its ugly head recently, with various failed attempts at terror attacks and several high alerts in Germany and France.
So far, none of this has hit the real economy – yesterday’s purchasing managers index from the Eurozone was strong – but with bond yields constantly rising in several European countries there is bound to be some sort of impact. Spain’s risk premia hit their most elevated levels since the creation of the euro yesterday; this won’t be good for growth.
Arturo De Frias of Evolution Securities has crunched the numbers. Under his worst case scenario in Ireland, with unprecedented write-offs, RBS could lose up to £7bn; Santander and BBVA would suffer lesser hits from Portugal (just €4.5bn in the case of Santander under the Armageddon scenario). This wouldn’t be that bad. So the behaviour of banks across the continent – share prices have slumped – confirms that investors are pricing in a much wider disaster, with contagion to Spain. Bailing out Greece, Ireland and Portugal would cost €300bn; doing the same with Spain would add €350bn to the bill. While in theory the EU’s economy is big enough to shoulder such a sum, there is no way it would be palatable to German voters.
We are living in an increasingly strange dual world: on the one hand, the global economy is continuing to recover, with growth in the US accelerating and Asia booming; on the other, there are huge sovereign and geopolitical dangers. Let us hope the former force swamps the latter.