Europe on the brink: the web of debt that threatens the world


The falls, which continued in early European trade, came as fund managers warned that if Europe’s sovereign debt woes were not dealt with they could soon infiltrate the arteries of the global financial system. Investors’ fears centre on $3.9 trillion worth of debt owed by Portugal, Ireland, Italy, Greece and Spain to other European nations.

Markets are unconvinced the US$145 billion rescue package for Greece is enough to prevent the country defaulting, and on Thursday night Moody’s warned the banking systems of Britain, Ireland, Italy, Portugal and Spain faced ”very real, common threats” through the massive build-up in sovereign debt.

The head of credit trading at UBS, Luke Fay, said expectations were building that the European Central Bank would be forced to intervene to address plunging investor confidence.

To prevent a repeat of the credit market meltdown of late 2008 some investors expect the ECB to start buying euro zone bonds – as the US did in its program of ”quantitative easing”.

”We’re getting to the stage where this is becoming a systemic problem and the market is now expecting the ECB to act,” Mr Fay said.

Under the worst case scenario, the flow of capital between banks could dry up, bringing interbank lending to a halt. This could spark a plunge in confidence, significantly increasing global borrowing costs and ultimately damage global economic growth and recovery.

”If you can’t effectively price and transfer credit through the system, it affects everybody,” Mr Fay said.

Despite this, on Thursday night the ECB said it had not considered buying euro zone bonds.

The chief currency strategist at Westpac, Robert Rennie, said the ECB’s ”tough love” approach was stoking fears of a credit freeze, and investors were flocking to safe havens such as US Treasury bonds. The Australian dollar, seen as a risk asset, has plunged 3¢ in the week to less than US89¢ .

”What we’re really dreading here is a sovereign default in Europe,” Mr Rennie said. ”Given that we have a series of European bond redemptions over the next couple of weeks, the chances of a default are definitely rising.”

Besides Australian banks’ $56.4 billion in exposure to Europe at the end of December, most analysts say the economy has few other direct links. But the market plunge could have serious effects on confidence.

Prasad Patkar, of Platypus Asset Management, said: ”If there’s any prospect that we could have a GFC Mark II, then people don’t want to be caught holding stocks of risky assets.”