Stunted growth and Euro-reckoning

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Image caption Volatility is expected to continue as a result of the eurozone crisis

The latest forecast from the Fraser of Allander Institute this week is yet another grim reading of the economic tea leaves.

It slashed an already dismal growth forecast for this year in half, to merely 0.4%, and cut next year's below 1%.

Average UK forecasts are tumbling as well, but they are still more than double the projected Scottish level for this year, and well ahead of next year's Fraser of Allander forecast.

Why? Professor Brian Ashcroft, director of the Strathclyde University economic commentary, puts it down to the extra £1bn cut this year in Scotland, resulting from Holyrood having its austerity medicine administered later than the rest of the UK.

There may be more complex reasons he didn't have time to explain. There usually are.

But when you consider how closely the UK and Scottish economic fortunes have been tied together through the downturn (Scotland's been the bit of the UK that's behaved most like the UK average), it looks like the first parting of the ways for quite a few years.

Economic future

The factor that's changed since Fraser of Allander last predicted, in summer, is the eurozone uncertainty fuelling a huge market fall in August and lots of volatility to follow.

And that's a reminder that the political blame game applied to the growth forecast differential at Holyrood and Westminster shows how parochial we can get about this.

The eurozone crisis is a much bigger juggernaut driving our economic future. And neither Westminster nor Holyrood can control it.

To get at least one measure of how dangerous it is, I can share with you some modelling done by one of our foremost finance houses. It doesn't want named. Suffice to say it's got serious economists to crunch these numbers.

The model looks at the impact of disorderly default on the core capital held by Europe's banks, and it does so in two tranches. The lesser would be Greece, Portugal and Ireland defaulting. The greater would add Italy and Spain. It won't be lost on you that these Mediterranean giants are now very much in play.

In short, the reckoning, or rechnung, doesn't look good for the Germans. But then, it doesn't look good for anyone.

Eye-watering figures

The assumption is of a 50% loss - or "haircut" - on government debt (the level already assumed for Greece). It goes on to assume there's nothing to be salvaged from bank debt, and lending to individuals, households and companies takes a 40% write-down.

This model looks at the impact on four countries for which figures are more readily available: Germany, France, the UK and Belgium - the latter because its bank sector is exposed to its French neighbours.

If Greece, Portugal and Ireland hit that level of default, half of German banks' capital buffers are gone, a third of Belgium's and a quarter in France and the UK.

But there are indirect effects as inter-bank insurance and lending unravels, and that wipes out 100% of German banks' core tier 1 capital.

Belgium's left with only 7%, France with 25% and the UK with 50%. Britain would take a hit from Ireland in particular, but RBS and Lloyds Banking Group have already written down a lot of their exposure.

And what about adding Italy and Spain? The figures are eye-watering.

The direct effects would require governments to recapitalise German and French banks with 125% of their current core capital, meaning nationalisation.

Chilling reminder

But add in the indirect effects, and you find it would require 275% of German banks' core capital, 270% in Belgium, 225% in France and 130% in the UK.

At that point, Germany is only able (it would hope) to meet the bailout requirements of its own banks, while it is every other eurozone country for itself.

That impacts directly on the banks' ability to lend to businesses, individuals or, indeed, governments.

And it's hard to see how you would keep the eurozone together in those circumstances.

For Germans, the crunch decision is getting very close - between bailing out their profligate, indisciplined partners at vast expense, or letting the euro project collapse.

These figures are a chilling reminder that the impact comes back to wallop Germany hardest of all.

And for Britain, it's not much consolation that it won't face quite as big a disaster as Belgium.

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