Equity markets have been intoxicated by the new year spirit. The rest of us should not get carried away: 2012 promises to be a difficult time with the possibility of economic calamity far greater than that of steady growth.
With this backdrop, George Osborne, Britain’s chancellor of the exchequer, needs to prepare to take two unpleasant decisions. The first is urgent, while the second will arise if the chancellor fails with the first.
More than ever in 2012, Britain is not the master of its own destiny. Its economic prospects depend on a reasonably successful resolution of the eurozone sovereign debt crisis. Were the eurozone to implode, Britain could not insulate itself from a tsunami of trade, banking and confidence crises. The contractual uncertainty of doing any business with the eurozone would be highly damaging. On this, there is almost unanimity. The Treasury agrees, as does the Bank of England, the Office for Budget Responsibility and all bar two of the economists in the Financial Times' new year survey.
The overriding economic imperative for Britain must be to help prevent a eurozone disaster. Bulldog spirit in Europe is fine as a pre-Christmas pantomime, but protects not one single British job.
Refusing to contemplate joining a pan-European contribution to the general funds of the International Monetary Fund – money that does not show as borrowing because it is almost impossible to lose – was a particular low point for the coalition last year.
To decry the government’s attitude to the eurozone crisis is not to deny the difficulty of Britain’s position. There is no point in mindlessly signing up to every supposedly-comprehensive, but flawed eurozone rescue plan simply out of solidarity with our closest economic partners.
Instead, Osborne would act both in Britain’s interests and those of the eurozone if he were to push for a solution that sought both to address the underlying competitiveness deficit of the peripheral states and their medium-term financing needs. A strictly conditional offer to put British money at risk if the eurozone can agree a strategy with which Britain agrees would keep London relevant to the conversations. It would also add weight to the forces seeking not simply an austerity pact, but a strategy that provides incentives and time for both the surplus and deficit eurozone countries to adapt.
It can also work. We know that investors are desperate for leadership and coordination in addressing the eurozone crisis. Just look at the irrational jump in equity prices when the world’s leading central banks joined forces with an almost irrelevant cut in the interest rate on US dollar swaps in December.
To modify his stance, Osborne would have to show courage. He would have to put Britain’s interest above his immediate popularity with his supporters and argue his case forcefully. Such acts are in the job description of successful chancellors.
The only reasonable defence of Britain’s position on the sidelines is that it has concluded that the euro is already a dead duck. In these circumstances, greater participation merely throws good money after bad. I am sure such fatalism is not the view of ministers, but if it is, Britain should be told.
If 2012 is to bring the demise of the eurozone, Osborne will then have to face his second unpleasant decision: whether to abandon plan A on the deficit and with it the government’s central economic strategy. As my colleague Martin Wolf rightly argues, if the public and private sectors were to retrench simultaneously, that is the recipe for a slump. Fortunately, there has been no evidence of a paradox of thrift dominating the private sector as the deficit reduction program reaches its second birthday. Growth has been weak, but not nearly feeble enough to demand a change of course.
But if the eurozone crisis were to escalate and create – as in late 2008 – a sudden private sector desire for saving, Osborne would have little choice but to abandon austerity so as to avoid embracing a depression. He could not count on the Bank of England riding to the rescue because it simply does not have the firepower left to offset a sudden slump.
As we enter 2012, it is clear that the most likely victim of Britain’s refusal to engage with the eurozone is the government’s own deficit reduction strategy. And without that, the coalition has no raison d’tre. Happy new year, Mr Osborne.
Copyright The Financial Times Limited 2012.