International dominoes

The news yesterday that the state-controlled Dubai World Corporation may be unable to meet its interest commitments has had enormous repercussions.  The FTSE sustained its biggest one day fall for over eight months and billions were wiped off the values of HSBC and Standard Chartered, the two British banks with the greatest exposure to the Gulf state.

Yesterday’s events followed unnervingly hard on the heels of the warning earlier this week by the IMF’s managing director, Dominique Strauss-Kahn, that half of banks’ toxic assets remain to be revealed.  The Dubai episode raises the spectre of entire states, rather than corporations, defaulting:  already, investors in countries such as Greece, Russia and Mexico are seeing the cost of insurance against default rocketing.

All this has severe implications for the United Kingdom. Last month, there were concerns that the credit ratings agency, Moody’s, was considering downgrading the UK’s triple-A status.  The Dubai experience may cause those concerns to reappear.   Ken Clarke referred to the consequences in his wind-up yesterday:

Foreigners will eventually have to finance the debt. As my hon. Friend the Member for Cities of London and Westminster explained clearly, with the level of debt being run up by other developed countries, we have to persuade people to have confidence in this country to buy sterling-denominated assets and to finance our debt at an affordable price. Several Members warned about the rising level of debt interest as part of the public debt. Of course, as interest rates are brought back to a more normal level, if we are driven to higher interest rates because we have to sell our gilts and have to get somebody to accept the risk of financing our debt, we will find our economy slowed down by rising interest rates and the cost of servicing the debt will go up, perhaps leading us into a debt trap.

The problem is that, because of the imminence of the general election, the Government – or, to be more precise, Gordon Brown himself  – remains reluctant to admit the full scale of the appalling economic difficulties that the country faces; it maintains the palpably ludicrous fiction that Britain’s structural deficit can be brought under control simply by legislating it away.  Its stance is reactive, rather than proactive, and increasingly divorced from reality.

And that is a stance that will cause huge dangers for this country at a time when whole nations, rather than corporations, start to fall like dominoes.