Spain is spiralling into the
vortex of debt-deflation. This has nothing to do with Greece. It is not the
result of fiscal extravagance over the past decade, or other such Wagnerian
myths.
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In Spain, unemployment has reached 24.4pc, or 32pc in Extremadura. More than 1.5m households have no earner at all.
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The country’s collapse is the mathematically certain - and widely predicted -
result of ferocious monetary and fiscal contraction on an economy struggling
to deal with a housing bust.
Monetary tightening by the European Central Bank caused Spanish real M1
deposits to fall at an 8pc rate in mid-to-late 2011, guaranteeing the crash
into double-dip recession that we now see.
Indeed, the ECB even let the broader M3 money supply contract for the whole
eurozone late last year, badly breaching its own 4.5pc growth target. This
was not purist hard-money discipline. Let us not dress it up with the
bunting of ideology, or false authority. It was incompetence, on a par with
the errors of 1931.
Spain’s Bankia fiasco has merely brought matters to head, though the details
are shocking enough. A €4bn bail-out in mid-May. A €23bn bail-out two weeks
later. You couldn’t make it up.
Investors have noticed that Deloitte exposed the rot, not the regulators.
Bankia is the creation of the ruling Partido Popular, thrown together from
regional cajas under its control. It was a sink for €30bn of bad debts from
property developers, an instrument to "extend and pretend", to cover up the
systemic awfulness of the housing crash.
Clean-up chief José Ignacio Goirigolzarri says Bankia is unique. The debacle
tells us nothing about the rest of the Spanish banking system. Let us hope
so. Standard & Poor’s is not waiting to find out. The agency downgraded five
banks to junk. It raised its alert on Spanish macro-imbalances to “very high
risk”.
Edward Hugh from Spain Economy Watch says Spanish banks have made €2 trillion
of loans from a deposit base of €1.2 trillion, a sobering figure for lenders
largely shut out of global capital markets.
The Centre for European Policy Studies (CEPS) thinks Spanish banks will need
to write off €270bn, implying “Irish” damage to Spain’s debt trajectory. If
CEPS is right, public debt could jump towards 110pc in short-order.
For now the ECB is holding the line with its three-year lending blitz. Spanish
banks have taken up €316bn, allowing them to avert disaster as their debts
comes due. But there are toxic side-effects. Banks must provide collateral
at a steep haircut, “subordinating” other creditors - that Ebola virus
infecting EU rescue schemes.
Spanish banks are parking the ECB money in Spanish bonds for the time being, a
costly form of patriotism. The latest spike in yields has devalued their
holdings, leaving them nursing a big loss.
There is another insidious effect. As the banks buy the bonds, foreigners
sell. External holdings of Spanish debt fell from 50pc to 37pc between
December and March. This does at least mean that much of the rising cost of
debt payment is recycled within the Spanish economy, limiting the
macro-damage. But it also makes it easier for Spain to leave the euro.
Investors have noticed this, too. The eurozone is disintegrating.
As for the Spanish economy, it is literally imploding. The budget deficit was
8.9pc of GDP last year, barely down from 9.3pc in 2010.
We now learn that
the regions have flattered their accounts by failing to pay suppliers €17bn.
Valencia is 765 days late on bills, mostly to pharmaceutical companies and
healthcare services. The debt of the regions has reached €135bn, or 12.6pc
of GDP, chiefly because they look after the elderly and bear the brunt of
Spain’s demographic burden.
Catalan chief Artur Mas tossed nitroglycerine into the mix last week by
warning that his fiefdom would run out of money by the end of the month.
Skittish markets have little feel for the game of brinkmanship between
Barcelona and Madrid. They don’t know that rich Catalans keep Spain afloat,
not the other way round. His mischievous comments pushed the 10-year yield
spread over German Bunds to a post-EMU record of 496 basis points.
Yet at the end of the day, such unforced errors are details. Spain is
prostrate because EMU policy settings have been ruinous for most of the past
decade.
Interest rates in the mid-2000s were far too low for the needs of a
dynamic catch-up economy. Real rates were -2pc for year after year. That is,
750,000 homes were built in 2007 for an annual market of 250,000.
The Bank of Spain tried in vain to check the flood of cheap capital from North
Europe. Madrid ran a primary surplus of 3pc of GDP in 2007. Public debt fell
to 42pc (Germany was 65pc at the time). Yes, Spain could have done more. It
could have adopted Hong Kong controls on loan-to-value ratios on mortgages -
80pc, 70pc, 60pc, etc, until you choke the boom - but that is not what the
EU or ECB said at the time. The EU Council gave Spain three gold stars and
commendation that year, saying its “budgetary strategy provides a good
example of fiscal policies”. Honeyed words, even as intoxicating credit was
reaching red alarm levels.
Europe’s 'Maquina Infernal' has since switched tack, inflicting slow deflation
instead. The ECB - not content with monetary blunders alone - has become the
enforcer of a pro-cyclical fiscal blunders as well.
It told Spain and Italy
to slash spending as the quid pro quo for bond rescues last summer. Spain
complied. Italy’s Silvio Berlusconi demurred, understandably since Italy was
already near primary budget surplus. He was summarily toppled.
The damage from this double-barrelled contractionary shock on a fragile
Spanish economy is before our eyes, conforming with precision to textbook
time-lag theories. Private sector credit has fallen for 18 consecutive
months. Industrial output fell 7.5pc in March. Brussels expects the economy
to shrink 1.9pc this year, with the crunch yet to come.
Unemployment has reached 24.4pc, or 32pc in Extremadura. More than 1.5m
households have no earner at all. They have exhausted their benefits,
surviving on savings and - for now - on €420 a month in back-stop support.
Faced with such woes, any sovereign country would call for full engine reverse
with every policy lever. The Faustian Pact of EMU allows no such escape.
Europe has ordered premier Mariano Rajoy to cut the budget deficit from
8.9pc to 5.3pc in a single year, four times the therapeutic pace.
He cannot devalue. He cannot cut rates or print money. He cannot mobilize a
lender of last resort to eliminate all risk of sovereign default.
He can
only lament. "Europe has to come up with an answer because we can't go on
like this for long," he said.
It is hard to imagine Isabela I using such language; or Juan Cortes, who
brought down the Aztec Empire with a few hidalgos by sheer grit and astucia.
Yet Mr Rajoy’s words are prickly. My ear catches a threat, though I may be
guilty of romanticizing the "levantamiento" against foreign insolence in
1808.
There is, of course, a hint of revolution in Europe’s air. A Latin Bloc has
come to life. Germany is on the back foot. Yet are the rebels willing to use
majority control over the ECB to force an immediate and transforming shift
in policy, against German protest?
Will they risk a German withdrawal from
monetary union?
If not, they deserve the fate that awaits them.
