Spain's Fiscal Deficit Deepens: Attempt To Close Gap Through Austerity Would Cause Economic Collapse

Includes: C, DIA, IBM, QQQ, SPY, XOM
by: James A. Kostohryz

Spain has just revised upward the estimate of its 2011 budget deficit. The current estimate stands at -8.51% of GDP (that deficit number could still be revised upward).

It is absolutely clear that there is no possible way for Spain to meet the current -4.4% of GDP budget deficit commitment recently agreed to with the Germans and the rest of the EU without causing a horrific economic collapse of Greek proportions. If the Spaniards were to attempt expenditures cuts and tax increases to close the projected fiscal gap, an massive economic contraction would result which would make the fiscal situation even more tenuous and increase the risk of default manifold.

Given the current run rate of economic growth of -1.0% and conservatively assuming a multiplier of 1.0, expenditure cuts and tax increases calculated to close the fiscal gap would cause an economic contraction in the neighborhood of -5.0% of GDP. In all likelihood, just as occurred in the Greek case, the economic collapse would be deeper, and the measures would be self-defeating, producing a budget deficit even worse than the -8.51% figure registered in 2011.

By all accounts, even without additional austerity measures to close the projected fiscal gap, economic activity in Spain will contract significantly in 2012 relative to 2011. This means that it should be expected that Spain's fiscal deficit in 2012 should be worse than it was in 2011. My own conservative estimate is for Spain is a budget deficit of 9% of GDP for 2012 - and it could very well be worse.

Any bets that Germany is going to continue to approve financing and/or financing guarantees of deficits of this magnitude? It is important to note precedent: With much smaller sums at stake, Germany has been unwilling to be flexible with Greece - a situation that has resulted in an economic collapse of unprecedented proportions in the post-WWII period.

Spain and the rest of the PIIGS are on a collision course with Germany and the rest of the EU. The unfolding of this crisis is very near.

Reward-to-risk ratios are not good for investors considering equity investments in stocks such as Exxon Mobil (NYSE:XOM), IBM (NYSE:IBM) or Citigroup (NYSE:C) or equity index ETFs such as SPY, DIA, or QQQ.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.