Sean O'Grady: Greece is a problem – but Spain could destroy the euro

Analysis

Like a bacillus coursing its way through a weakened body, the Greek debt crisis is infecting the eurozone, and spreading though a variety of channels. The economist call this "contagion", and it has passed from Greece to Portugal and Spain, and to a lesser extent Ireland and Italy – the unlovely sisters that gave us the equally unlovely acronym PIIGS.

The pathology is common; all used their membership of a hard currency, the euro, to borrow and spend as they could not when they possessed their own, unloved, drachmas, escudos and the rest. Meanwhile, their wages and costs went badly out of line with those in the eurozone's most efficient member states, especially Germany. But, now in the euro, the PIIGS have no currency of their own to devalue and defuse pressures. Hence the austerity programmes aimed at "internal devaluation". The flesh may be willing on the part of ministers in Dublin, Athens, Lisbon and Madrid, but the national spirit to endure cuts in services, pay and higher taxes seems weak.

What are the risks? The euro itself could break up, though probably not because of Greece. Spain however, is the fourth largest eurozone economy and quite another matter, and there are particular causes for concern. Her devolved government makes cuts difficult to impose; her labour market is dangerously inflexible; and the maturity of her debt is the shortest of the PIIGS, so that debt repayments are more frequent. Spain is simply too large to be rescued by France and Germany, and a Spanish crisis would mark the end of the single currency: the euro's last monument will be rows of unfinished apartment blocks on the Costa del Sol.

Beyond that the most serious danger is that the market for government bonds issued by the PIIGS will just freeze up. Greek debt is practically valueless, because there are few real buyers. In this sense, what is happening is similar to the sub-prime crisis, credit crunch and financial crisis of 2007 and 2008 that led to the Great Recession. Investors are unable to judge whether these countries will be solvent, just as they doubted whether Bear Stearns, Lehman Brothers and the rest of them could honour their debts. Then, as now, there is the same tendency of markets to seek out the next victim. And, then as now, there is the same sluggishness on the part of governments to take urgent action, with, one fears, incalculable consequences.

If the trillion of euros worth of Spanish, Irish, Greek, Italian and Portuguese government bonds become devalued then those who hold them will lose money. And who are they? French and German banks are rumoured to hold a lot of Greek government bonds, and UK banks have approaching €100bn (£86bn) of lending to entities, private and public across the PIIGS. Pension funds also hold the bonds, as do investment funds, while banks are required to hold them as reserves. If the banks – already fragile – around Europe suffer further losses through the usual domino effect, then that will reduce their lending to home owners and businesses over here, too. Let us not forget that Alliance & Leicester, Bradford and Bingley and Abbey are owned by Banco Santander, one of Spain's largest institutions.

The last thing the world needs is another financial crisis – but this time without the governments being able to issue debt to bail them out with. Britain will be badly harmed by the crisis engulfing our largest export market and source of investment funds. Our banks will undoubtedly also be victims of a renewed loss of faith.

It will hurt – after all, we are hardly in the best of economic health ourselves.

Key dates ahead

2 May IMF talks in Athens with Greek officials end

3-6 May French parliament expected to approve rescue package

3-10 May IMF board, EU Commission have to formally approve the deal

6-7 May Greek parliament votes on new three-year austerity programme

6-10 May German Bundestag expected to endorse the deal, the last of those required to, the Netherlands and Luxembourg already having given tacit approval

9 May Key elections in North Rhine-Westphalia, Germany's most populous state

10 May European summit formally endorses the deal

19 May Next repayment of Greek debt; €8.5bn must be in place if Greece wants to avoid default

31 May €355m debt repayment due

Summer/autumn 2010 Threat of widespread strikes and unrest in Greece at harshness of deal; risk of political instability or that the government might fall

29 September Further €180m debt repayment due

2011 Greece needs to refinance the equivalent of 18 per cent of its GDP, or €23bn, with almost €9bn due on 20 March 2011. Annual deficit down to 9 per cent of GDP. Return to world growth should help

2012 Annual deficit down to 3 per cent of GDP by year end