Last Spring it was Greece that was in crisis mode—then last week, it was Ireland—and coming up next is Portugal—but all those pale in comparison to Spain.
If I had to bet on which country will bring about the end of the euro—and perhaps even the end of the European Union—I’d have to say it’s Spain. Right now, no one is talking about Spain—Spanish spreads are as quiet as a guilty man in a police line-up—everyone’s too concerned over Ireland, and the upcoming Portuguese Situation.
But Spain is the key—Spain is what you should be paying attention to, if you want to find out what will happen to the European Monetary Union (EMU), and the European Union (EU) itself.
First, a recap of last week’s exciting episode of I’m an Insolvent Nation—Get Me Out Of Here!:
Ireland got into trouble with the euro bond markets after German Chancellor Angela Merkel made some not-very-clever remarks about Irish bond-holders needing to take some haircuts. The bond markets started to panic—yields on Irish debt started to widen—and then once again, it’s Sovereign Debt PanicTime™ (patent pending).
The EU in conjunction with the European Central Bank (ECB) and the International Monetary Fund (IMF) put together a rescue package—but the Irish refused to take it, as they realized they would have to give up some of their hard-won sovereignty in exchange for this lifeline. To accede to this package, they’d likely have to slash government expenditures, take on “austerity measures,” and likely raise their precious 12.5% corporate income tax rate, which has been the carrot the Irish have used to get so much foreign investment over the last decade.
But the Irish deterioration in the bond markets began to pick up speed—finally on Sunday night, after a week of dithering, Irish Prime Minister Brian Cowen officially asked the European Union for a bail out. (A quick explanation for the layman, as to why the bond markets are so important: Because Ireland is running a deficit, it needs to sell bonds—that is, borrow money—in order to finance its fiscal shortfall. If the bond markets do not have much faith that Ireland will pay back the bonds it emits, then the price of Irish bonds will go lower, which means the yields will go higher. In other words, Ireland will be forced to pay more for the money it is borrowing. The more it has to pay to borrow money, the greater the deficit, until finally, you get to the point where you cannot borrow enough to cover your deficit: In other words, you go broke. This was what was happening to Ireland, in simplified terms.)
Just like they did with Greece, the European officials colossally messed up the bail-out package for Ireland. It turns out that—far from having put together a detailed package that could be swiftly implemented, and thereby restore confidence—the EU/ECB/IMF troika have only a flimsy framework for the Irish bailout. The vaunted European Financial Stability Facility? It’s not even fully funded yet!
So on Monday, the markets were jubilant—“Ireland is saved! Crisis averted!”—but then today Tuesday, they’re down in the dumps, as it is becoming increasingly clear how unprepared the European officials are. Their “rescue package” is vague on the details—to put it mildly.
Coupled to that, the bail-out announcement sparked a political fire-storm in Ireland—Cowen’s coalition partners, the Green Party, exited the government, and elections are now scheduled for January. There are even calls from Cowen’s own party for his immediate resignation.
This is bad enough—so what does the IMF go and do? Why, with exquisite political tone-deafness, it sends the clear message that Ireland is going to have to crawl if it wants the bail out: John Lipsky, a muckety-muck in the IMF, says to Reuters:
Our work there [in Ireland] is technical, not political. Decisions have to be made by [the Irish] government.
In other words, the IMF isn’t going to negotiate with Ireland—it’s going to dictate.
Or in other words, the IMF is saying, Beg for the money, Ireland!
So any effective clean-up of the Irish situation is going to take a while—assuming it actually happens. And just like the Greek bail-out last spring, it will be messy messy messy: Half-measures, dithering, “adjusted” figures, until finally the European officials wind up throwing twice as much money at the problem as originally expected. We might as well call the movie now playing in Dublin, Doin’ It Greek, Part II: Ireland! To add insult to injury, all this politico-economic theater didn’t staunch what most worried the EU and the ECB: Contagion.
All the smaller, weaker European economies in the EMU are in the same boat as Ireland: They are all insolvent. Not just the PIIGS—Portugal, Ireland, Italy, Greece, and Spain—but also Belgium, and maybe even France, if we steel ourselves and look at the numbers.
Right now, though, contagion has reached Portugal—the next-weakest link in the European chain: Portuguese debt yields are widening by about 50 basis point this morning, to 4.328% over the German bunds (10-year)—even after the Portuguese government implemented a second austerity package this past October, following their May spending cuts which did not convince the bond markets.
That’s because the Portuguese have a huge fiscal deficit: 9.4% of GDP. They are cutting spending, and they are raising taxes too—but still, their bond yields are rising: The market doesn’t think that Portugal will make it through this crisis intact. Just like Greece, just like Ireland, the Portuguese will need to be bailed out.
And so that clears the way for the bond market’s anxieties to focus on the real elephant in the drawing room: Spain.
According to IMF numbers for 2009, the gross domestic product of Greece was $331 billion, Ireland was $221 billion, and Portugal was $233 billion—but Spain’s GDP in 2009 was $1.468 trillion. Roughly twice Greece, Ireland and Portugal combined. In other words, close to half of Germany’s GDP.
And what is Spain’s fiscal deficit? Last year, it was officially 7.9% of GDP—twice the EU limit. Not Irish or Portuguese or much less Greek numbers, but still up there—officially. Why do I say “officially”? And now put “officially” in scare quotes? Because of a very disturbing anonymous paper, released last September 30.
Written by a local economist, it basically said that the Spanish GDP numbers for 2009 were cooked—and then went ahead and showed the whys and hows of this analysis. FT Alphaville originally ran the piece—and it was picked up by everybody, freaking everyone out. But then Alphaville up and retracted the paper under political pressure, excusing their cowardice by saying “life is too short.”
The anonymous Spanish paper gave a credible analysis, which I for one believe. And considering the mess going on in Greece, regarding faked GDP data—and knowing the Spanish—I wouldn’t be a bit surprised that Spanish GDP figures have been faked in Madrid, in order to keep everything copacetic.
But even if they haven’t been, it’s not as if the official numbers are painting a rosy picture: Spain has nearly 20% unemployment, near 10% yearly fiscal deficit to GDP, and no clear way how to get out of this hole that it is in. So much of Spanish growth over the last decade was fueled by real estate development and over-levaraging, that there’s no clear way forward for the Spanish.
Now, if there is a Greek/Irish-style crisis with Spain—in other words, if there is a run on Spanish debt—how much will the EU/ECB/IMF have to pony up, to bail out Spain?
Let’s look at Greece and Ireland:
Originally it was thought that €45 billion would be enough to bail out Greece—but the final tally for that shindig looks to be something like €90 billion (about $122 billion). At this time, bailing out Ireland is going to come to something similar over the next 3 years—€90 billion—assuming, of course, there aren’t any hidden nightmares in the Irish banking sector, which is the reason Ireland is going under. In both these cases, essentially three times the yearly deficit was the ballpark figure for the European bailouts.
Therefore, to bail out Spain, and plug up its fiscal balance sheet hole over the next three years would cost €450 billion—minimum. That’s about $600 billion. Look at that number again—look at it closely, and take your time: €450 billion. That’s twice the size of Ireland’s total GDP for 2009.
In order to figure out how much each party would have to shoulder of this €450 billion price tag, Bruce Krasting, in some private e-mail exchanges, thought that the percentages that the EU, the ECB and the IMF were shouldering for the Greek and Irish bailouts could serve as a template.
Fair enough: If we go by Greek and Irish percentages, then roughly a third of that €450 billion price tag to bail out Spain would be shouldered by the IMF—and as everyone knows, the U.S. puts up 20% of IMF money. So the U.S. would be on the line for €30 billion—$40 billion—to save Spain.
Then Bruce delivered his verdict:
The U.S. is going to say "Yes" to that and "No" to California? No way. Not going to happen with this new Congress.
BK is one smart customer—I completely agree with his analysis: No way will the U.S. shell out $40 billion to save Spain. Therefore, the IMF’s participation in a Spanish bail-out will be severely reduced, if not marginal. Therefore, bailing out Spain will be a strictly European affair.
Does Europe have €450 billion to bail out Spain? That is, does Germany have €450 billion to bail out Spain? No it does not. It does not have the money for such a bailout—and even if it did, it does not have the political will to push through such a bailout. Period.
But even if—by some monumental financial miracle coupled to an equally monumental political miracle—Europe somehow managed to find the money to bail out Spain without depreciating the euro? What then?
The Spanish economy won’t be improving any time soon—and neither will the economies of the other smaller countries like Greece, Ireland, Portugal, Belgium. Not when they’re locked into the euro, and are therefore unable to depreciate in order to spur growth and investment.
See, even if there is the money and the political will to save Spain—which I don’t believe—the only way to bail out Spain in such a way that it has an economic future is to cut it loose from the euro. If it is kept locked in the EMU, the euro will become a weight around its neck, dragging its economy down until in a few years, there will be the need for yet another bail out of Spain. That goes doubly so for the smaller countries, like Greece, Ireland, Portugal, Belgium.
Therefore, I believe that if and when there is a run on Spanish sovereign debt, and Spain slips into the position of having to be bailed out like Greece and Ireland, that will be Crunchtime Europe: That will force an inevitable realignment of the European economy, and the European continent.
Though they remain in the European Union, the weaker economies exit the EMU and go back to local currencies, which they quickly depreciate, while their euro-denominated sovereign debts are restructured and paid off over time. The euro becomes the currency of France, Germany, Holland, Finland and Austria.
I can imagine a number of worst cases, all of them different, except for one thing in common: They’ll all be bad.
Disclosure: No positions