Spain: 2 Recent Developments With Long-Term Consequences

Includes: EWP
by: William Larson

Unemployment within any nation is a serious issue. It is as destructive as inflation and has the potential to become a self-perpetuating negative influence on the economic health of the nation.

The effects of high unemployment are often subtle and long lasting. They tremendously impact the ability of a nation to recover from periods of recession.

Some of these effects include social unrest, higher crime rates, sustained erosion of consumer and business confidence. In addition, high rates of unemployment reduce a nation's GDP equal to the combined loss of production of those unemployed.

Unemployment in Spain

Friday's unemployment report from Spain further underscores that nation's dismal economic conditions, and the challenges that lay ahead if recovery is to occur. Unemployment in Spain now totals 24% and climbing, which means that some 5.6 million people are without work. Among 16 to 24 year olds, unemployment tops 50%.

Among Spain's 14 million households, approximately 1.7 million have nobody who is employed. This is the worst unemployment crisis in the history of the nation, and it's likely to get worse. Some forecasts call for unemployment to rise to as much as 35% before abating.

The loss of tax revenue from the portion of the population that is unemployed is also significant. This loss of revenue further exacerbates an already bad situation by forcing the government to borrow more money at high interest rates, decrease spending, or do both.

A grim unemployment picture is just one of Spain's current economic ills, albeit a substantial one. Other concerns include a budget deficit that has previously defied all attempts at reduction, a dwindling GDP forecast to decrease by as much as 2% this year, and a host of regional governments that are resistant to attempts at reform.


Credit Downgrade

To add insult to injury, this week Spain was hit with a two-notch credit worthiness downgrade by Standard and Poor's. The nation's credit rating went from A to BBB with a negative outlook warning indicating that the government's budget deficit is likely to deteriorate even more than previously thought due to economic contraction.

The result of the S&P downgrade will mean higher borrowing costs, something that Spain cannot live with very long unless its economy improves substantially or if outside help is provided. Of course, the ECB could restart direct bond purchases, but that could lead to concern among existing investors about the possibility of subordination to the ECB in the event of restructuring.

The Bottom Line

The Spanish economy remains in a state of huge crisis, and the eurozone's meager rescue fund is insufficient to bail it out. Until permanent solutions are found and implemented, look for the economic problems of Spain to weigh heavily on the markets of the world, which will also be pondering similar problems with the economies of Italy and France.

Eurozone economic concerns are likely to make for a choppy year for stocks.

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