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DERMOT MURNAGHAN:
Well now, six eurozone countries could have their credit rating downgraded in the next few weeks, amid uncertainty over how that financial crisis will be resolved. Belgium, Spain, Slovenia, Italy, Ireland and Cyprus are all facing possible further downgrades by ratings agency Fitch but France’s status as well is not under threat despite reports that it was on a hit list of countries that could be downgraded. Well here to discuss that more is former Conservative Chancellor, Lord Lamont, Roland Rudd, founding chairman of Business for New Europe and Linda Yueh, Bloomberg’s economic correspondent, a very good morning to you all and if I could start with a broad question for you Lord Lamont, do you feel that in twelve months’ time when perhaps we may gather here again, the eurozone will be more or less in the same shape it is now with the same number of members?

LORD LAMONT:
I think in twelve months’ time the same number of members will be in the eurozone but I think in three years’ time it will be rather less than that. I think they are determined to get through to 2012/13 and I think they will spend whatever money is necessary but I think by say 2013, the long term logic will become more and more clear that there are certain countries who simply cannot go on deflating in order to become competitive with Germany. I think in the long run the euro will have to adjust, I think the alternatives are either shrinking or breaking up and obviously they would go for shrinking rather than breaking up.

DERMOT MURNAGHAN:
Let’s just go round the table on that, an interesting projection. Linda, what do you think, that the fissures will take a while to deepen and widen and then perhaps more chance of an orderly reorganisation of the zone?

LINDA YUEH:
Oh well, if only orderly could be possible! Yes, I think I would agree, politically they are very keen to prevent anything which could cause a shock before the liquidity backstops, the rescue funds, the IMF, the ECB or whatever is needed, are prepared to stabilise these zones so I think in the next year or so, Germany, France, will probably spend money to try and keep it together but yes, in the medium term the issue really is are there countries which could 1) actually grow in a fiscal union, because remember the deficit targets are even tighter than before, and then secondly, over the longer term is it really in the interests of countries which don’t grow as well as Germany, to share a currency because just look at Greece as a hypothetical example, by 2020 it is going to have a debt to GDP ratio of 120%, that’s in nine years’ time, following nine years of austerity. So if we look at Greece, and perhaps other countries, the question is do you really want to stay in the single currency if that’s the price that you have to pay, if you have no realistic growth prospects?

DERMOT MURNAGHAN:
I can see you are going in the same direction, Lord Lamont. Roland, do you go in that direction? There are those who argue, well if that is the projection why not lance the boil and do it sooner rather than later?

ROLAND RUDD:
Well I think we all agree with the first part of what Lord Lamont said, which is it is going to hold on for the first year but I will actually go further and think it will hold for longer than that because from Greece’s point of view, it looks in one sense quite attractive to come out and have devaluation and you have a huge amount of tourism, but on the other hand you are going to have wide-scale nationalisation of their banks, this extraordinary outflow of capital which has begun but would be on a much more extreme basis and I think there would be a lot of anger and a lot of political ramifications so I suspect from Greece’s point of view it will stay, the reforms they are now implementing – it is the first time you have had a government which really is intent on implementation and that’s the big difference from what they’ve had in the past.

DERMOT MURNAGHAN:
I mean I asked Linda that point, what do you think Lord Lamont about that, the point that Linda made, how do these weak economies within the eurozone grow then? I’ve just been talking to John Bruton, you know him, the former Prime Minister of Ireland, how do they grow under these constraints?

LORD LAMONT:
In the long run I don’t believe it is sustainable. I have never believed it is sustainable but I think you just cannot expect every country to have the same productivity as Germany. When you look at a country like Italy, since the founding of the euro its Labour unit costs have risen something like, I don't know, 40-50% higher than that of Germany. This is not sustainable in the long run. Of course you have to modify it slightly in that not everything Italy exports is competitive with German exports, but even so this is a huge lack of competitiveness compared with Germany so I don't think it is sustainable in the long run. Just going back to the point that Roland made, I think of course if one country leaves the euro, this is the very awkward thing. Let’s say that Greece, which plainly ought to leave the euro, if it did leave the euro immediately people are going to say is an Irish euro the same as a German euro, is an Italian euro the same as … people are already saying that, of course. That is the difficulty but in the long run the thing I believe is not really going to make sense and at some point … you see the euro is not like a fixed exchange rate system or Breton Woods or the ERM, the markets can’t easily break it. What can happen is a country simply runs out of money or more likely, financial institutions get into tremendous trouble because of their holdings of bonds and that is what I think will at some point, I hate to say this, trigger actually a very severe situation.

DERMOT MURNAGHAN:
I mean could it, because we have the Japanese example, don’t we Linda, the Japanese example where 20, 22 years’ ago effectively very similar things happened there. A very different economy but, you know, the banks are carrying and have carried for an awful long time, a lot of duff loans and nothing spectacular happens there, they just bump along for two decades.

LINDA YUEH:
Yes, indeed and I think probably one of the extraordinary things about Japan is how much of the debt is domestically denominated and domestically held. That is the key difference within the eurozone because of course history tells us there are countries that default and they do leave and capital outflows and capital controls actually worsen that process, however within the eurozone itself, the amount of financial integration across holdings is so substantial, there is a real concern that if you do get one country which leaves and the markets fear other countries may go, you just get this widespread movement of money out of the eurozone as a whole and that could lead to a second banking crisis.

DERMOT MURNAGHAN:
That’s the rock and the hard places isn’t it? What can be done? You can’t afford the unimagined consequences of somebody orderly or disorderly leaving the eurozone yet we do not ever seem to be getting towards a position where the ECB, aka the Germans, are going to put up substantial amounts of money to shore the whole thing up.

ROLAND RUDD:
You can have an orderly default but what you can’t have is an orderly withdrawal from the euro because not just the economic but the political ramifications would be huge, so I think ultimately the ECB will do what it takes to ensure that that doesn’t happen.

DERMOT MURNAGHAN:
Just on that, but only just as much as it has to do rather than, I mean there are calls to go beyond that and say you don’t get past us, we will throw whatever money necessary at this problem, to the markets.

ROLAND RUDD:
Yes, the interesting thing is, you have quantitative easing in the United States and you have quantitative easing in the UK and you don’t in the rest of Europe and I think that’s going to change but if I can just say one other thing, there are other things that these governments can do, there are two big things they need to do. One is in terms of privatisation and they need to be absolutely serious about dealing with that and Greece has started doing that and so has Italy but also it is about tax collection and the really interesting thing about Italy is wealth to GDP is around 588%. Now it is almost double that of Germany, one has to remember that the Italians are very wealthy individuals and you have this extraordinary support from the business community for a wealth tax if it’s used to reduce the deficit and that wealth tax could come in at something like 400 billion euros which would make a real dint in the 1.9 trillion debt.

DERMOT MURNAGHAN:
We are running out of time but just to focus it down because of where we are on the UK, I mean how big are the threats economically, Lord Lamont, in your estimation given what we’ve discussed her, not in the eurozone but of course our major trading partner?

LORD LAMONT:
Well that is the main point, it is our exports, our trade with Europe that is the threat to us. British banks are less exposed to the debt of the peripheral countries but of course they are exposed to banks who are exposed to the peripheral countries. Can I just make one counter point to our general consensus? Everybody talks about the cost of break up, fair enough, I agree it is quite horrendous but the cost of going on is absolutely horrendous as well. I have seen estimates prepared by a Spanish economist showing that if certain things happened, including France having a down grading which may or may not be likely, you could end up with Germany having to pledge 50% of its GDP or spend 50% of its GDP to rescue the euro.

DERMOT MURNAGHAN:
Pledge and spend are two different things but if you can answer a bit about the UK but also on that, you can’t ultimately – as I think you found out – buck the market Linda.

LINDA YUEH:
Well I think the strain is really showing in terms of Germany because it is already the case there that the GDP ratio is over 80%. If you add on their pledges to the temporary rescue fund, it pushes it over to 90% of GDP, that’s ultimately why fiscally the eurozone can’t really sustain itself in terms of a rescue and this is why they look to the IMF and the ECB and I think ultimately this will be the constraint that moves the eurozone down one direction or the other. Quickly on the UK, I completely agree the issue is twofold. One is of course trade, 54% of our exports go to the eurozone, we need it to grow well but secondly, it is really the banks. There is a lot of pressure on British banks and you already begin to see some warnings of a looming credit crunch because US money markets look at European banks and say, I don't know about that.

DERMOT MURNAGHAN:
Sorry to hurry you on, but are we powerless then? There is not much we can do against those forces, the eurozone has to sort themselves out, we’ve seen that at the recent summit, I’m not going to even try and attempt intellectually to help them out on that, then we have got bigger forces there with banks and bond markets.

ROLAND RUDD:
Well I think there are two overriding priorities for the UK, one is to ensure the survival of the eurozone and the second is to get a deepening and widening of the single market because it’s not complete, there are many other areas in the whole area of digital, services and in telecoms where we can open it up more and we can only do that if we have a seat at the table, if we are there at every conference, at every treaty, arguing our case to widen that market because after all, it is a British invention and it does work pretty well.

DERMOT MURNAGHAN:
And thereby hangs another tale! Thank you very much indeed, Roland, Linda, Lord Lamont, very good to have your thoughts on the eurozone and what lies ahead for it in 2012.