It’s not often that I feel sympathy for a politician.
But you have to feel for Spain’s prime minister, Mariano Rajoy. Three months into his government, and he’s facing a general strike from the unions on the one hand, and a potential buyers’ strike from investors on the other.
The unions are striking because they’re fed up with economic reform that might reduce their power. Investors are threatening to stop buying Spanish government debt because they want even more reform.
What’s a prime minister to do? And more importantly, what does his dilemma mean for you?
Spain – The Weakest Link in the Eurozone
Spain’s economy – more so than Italy’s – has always been the major fault-line in the eurozone.
Sure, Greece causes a lot of noise and commotion. There was always the chance that Greece would throw a hissy fit and pull out of the euro unilaterally. Better-behaved small countries like Portugal and Ireland barely warrant a mention in the papers these days.
Even so, people always knew that in terms of size, Greece by itself didn’t matter. It was the knock-on impact that everyone worried about. The big fear was always that the market would say to itself, “If Greece can go bust, maybe it will be someone who matters next time.”
So the point of all the bail-out packages wasn’t so much to save the smaller countries. It was to prevent fears about the small countries from spreading to the “too big to fail” ones.
For a short while, it seemed as if the European Central Bank’s LTRO (Long-Term Refinancing Operation) had done the job on that score. Now it’s starting to look as though that was over-optimistic.
Investors are fretting about Spain again. The government’s cost of borrowing over ten years has risen by around 0.5 percentage points since the start of this month.
The trouble is, Spain missed its 2011 budget deficit target (in other words, it ended up overspending by even more than expected). As a result, it set itself a softer target for 2012.
Markets don’t like to see this sort of target slippage. For now, they don’t care so much when it’s the US or the UK. Those countries have their own currencies and central banks who are prepared to print as much money as it takes to pay off their creditors.
Europe isn’t prepared to do that (although it might be getting closer to doing so). And as private investors in Greek debt have discovered to their cost, there’s no guarantee that a eurozone country with problems will make good on its debts. So naturally, investors are warier of European government debt than perhaps they once were.
Spain’s Big Economic Problems
– Debt and Unemployment
The Spanish economy’s big problem is private sector debt, which might end up on the government’s balance sheet. Spain had a massive property bubble. The fall-out from that bubble continues. Prices haven’t been allowed to fall as far as they really need to. And that means no one can be sure just how much bad debt is still sitting on the banks’ books.
When banks don’t know just how bad a state their balance sheets are in, they stop lending. That makes it even harder to dig an economy out of trouble.
Spain’s economy also has the usual European problem of overly restrictive labour laws that discourage hiring. This is something the government is trying to tackle. The general strike today is partly about an overhaul of labour rules. A new bill passed in February makes it easier to cut wages, reduces the power of the unions, and could cut the cost of firing staff.
Given that unemployment is standing at 23%, and an incredible 50% among young people, you have to wonder who’s left to go on strike. As one Spanish political communications professor tells Bloomberg, the unions “have a lot at stake as Spanish society is very much questioning their role… [They] don’t represent the unemployed.”
This is one of the rarely-appreciated benefits of having a ‘hard currency’ like the euro. When it’s harder to take the easy way out (allowing your currency to weaken) then sometimes you are forced to take genuinely tough measures to change the way your economy works.
Of course, the trouble is that it takes a strong government to cope with the resulting social upheaval. And if your economy is in such a deep hole that people don’t get to see the benefits of reforms, only the pain, then it’s even harder to push reform through.
So What Happens Next for Spain?
Spain’s economy can’t be allowed to go bust. And it won’t be. We’re going to see the usual back and forth about bail-out funds and arguing between the Germans and the rest of Europe. But the most likely outcome still seems to be some form of European quantitative easing. The ECB has already taken a pretty big step in that direction with the LTRO.
But what does all this mean? The short answer is that the future for Europe holds continued loose monetary policy, and a banking system in many countries that’s largely reluctant to lend.
Editor, MoneyWeek (UK)
Publisher’s Note: This is an edited version of an article that first appeared in MoneyWeek (UK).
From the Archives…
2012-03-23 – Kris Sayce
2012-03-22 – Michael Robinson
2012-03-21 – Aaron Tyrrell
2012-03-20 – David Thomas
2012-03-19 – Dr. Alex Cowie
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