David McWilliams: Growth and monetary apartheid is a Catch-22
Published 25/04/2012 | 17:00
Financially, Spain is like Ireland but it is much, much bigger. There is little doubt that Spain will need a massive bailout. The question is, who has the money to bail out Europe's fourth-largest economy, and when Spain topples what happens to Italy and what happens to the euro?
The European response to the fact that the market gave up on Spain and Italy last November was to unveil the largest "cash-for-trash" scheme Europe has ever seen. The ECB, which isn't allowed to buy government debt directly, lent close to €1 trillion to the banks and they in turn lent this on to the governments.
So we have bust banks lending to bust governments and we are calling it success. For a few months, as expectations of growth sprang eternal, bond yields fell because there was this gush of liquidity coming from the central bank. But many sceptical investors sold into this liquidity, using the "fake" demand driven by the ECB as an opportunity not to buy, but to sell.
Why would they do this?
Because they looked under the bonnet and saw a massive problem about to blow up in the ECB's highly leveraged face.
Spain is a ticking time-bomb.
Like Ireland, because there was so much credit about in its boom, it appeared to run a tight fiscal shop. Exactly like us, the Spaniards suffered the credit-induced property boom. This acts as 'financial botox -- it makes everything look fitter and healthier than it is. It's the economic equivalent of a 20-year-old face on a 50-year-old skull.
Spain's banks, like ours, bathed themselves in toxic debt. Just to put this in context, the Spanish banks' book values (assets minus liabilities) have risen eightfold since 1998. That is 80pc more than US banks and twice the growth for the rest of the eurozone.
Now we have the usual story playing out. The extent of the boom presages the extent of the bust. What is borrowed will be defaulted on and the cycle goes on. We know all this from the bitter experience of many thousands of Irish "investors" who have seen the values of their dream homes around Malaga collapse. The Spanish property market continues to tank. Like the Irish banks, non-performing loans are up to an 18-year high of 8.2pc. This will continue shooting upwards.
Unemployment is at 25pc and one in every two young people is out of work. The government is offering nothing but budget cuts.
It is interesting to note that every time the Spanish government says it will respond to the crisis with more austerity, money flows out of Spain not into Spain as the government expects. The conclusion has to be every time the Spanish elite tries to gain credibility by promising to be tougher than everyone else, the very credibility they crave is chipped away at.
In Madrid, we have also seen violent demonstrations, which look likely to re-ignite. The stock market is tanking and, of course, despite all the official assistance, bond yields are rising again.
Even if things all around Europe were stable, Spain would have difficulty keeping the show on the road. But things in Europe have taken a dramatic, but not unexpected turn; which is a turn for the better or worse, depending on your view of the world.
In France, it looks like Socialist Francois Hollande will be the new president of France unless Nicolas Sarkozy can turn things about. This is not out of the question, but the balance of probability must point to a Socialist president.
Mr Hollande has promised to roll back on deficit-cutting programmes and renegotiate the fiscal compact treaty. By the way, the fiscal compact is dead in the water now for obvious reasons. All the recent evidence indicates that fiscal rules without flexibility make things worse not better.
But maybe Holland will give the EU head honchos more to worry about than Mr Hollande.
The coalition government is gone. Geert Wilders's Freedom Party, which up until now has supported the ruling Liberal Party, says he won't agree to the roughly €15bn ($19.8bn) in budget cuts needed to bring the country's deficit under control. This is nothing in the overall context of one of Europe's richest and most dynamic economies. But it does show you that the national mood across Europe sees through "austerity at all costs" and is unwilling to accept the status quo that has prevailed up to now.
Mr Wilders, who uses the term "Brussels diktats" to wild applause every time he mentions the EU, is pushing for an exit from the euro and a return to the guilder.
All this is good news for us because it might sharpen the debate around the fiscal compact. The evidence from Spain is that applying the fiscal compact rules causes capital to panic. The reason for this is the following: the more austerity imposed, the less likely it is to work. The less likely it is to work, the greater the risk in that particular country, because if there is no plan B, anything can happen when plan A fails.
This is causing money to cascade out of Spain as it seeks refuge in Germany. German bond yields fall and the spread between Germany and the rest widens, making a mockery of the idea that we have a monetary union. After all, in the monetary union there is meant to be no difference in interest rates amongst the members. That was, you might remember, one of the selling points of the single currency.
What we have instead is a monetary apartheid where capital is now regarded differently. We have first-class capital and second-class capital and even third-class capital.
German capital is first-class capital and it is treated differently to capital in other countries. Spanish capital and thus its citizens are now financially second-class citizens. This monetary apartheid will persist as long as there is not growth but there can't be any growth as long as there is monetary apartheid.
So we will lurch from one crisis to another and the ECB will keep printing more and more money to try to prevent Spain from going the way of Ireland, Portugal and Greece. But the more money it prints, the farther away it gets from the strong, no-nonsense currency that the Germans and Dutch signed up for.
Ultimately, the Spanish and Italians will get fed up with austerity and the Germans and the Dutch will get fed up with bailouts.
As we have observed over the years in economics, what is important is rarely complicated and what is complicated is rarely important. Things are only going one way for the euro and that won't be pretty.