Mario Draghi’s promise to do “whatever it takes” to save the euro never did look like inducing any more than a temporary lull in the storm; still less did the German Constitutional Court’s thumbs up to the European bail-out fund and the trouncing that eurosceptic parties received in the Dutch election.
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8:40PM BST 27 Sep 2012
Yet the eurozone crisis has sparked back into life more swiftly than even I would have anticipated, with the epicentre returning to a fast-shrinking Spanish economy. Political and economic developments are once more threatening to combine into an uncontrollable firestorm.
To understand why, it is first necessary to explode some myths about the nature of the eurozone debt crisis. This is not at root either an isolated banking crisis or indeed a fiscal one, though that’s how public policy in Europe attempts to define it.
As many of us have long argued, both these phenomena are but symptoms of what in essence is just a good old fashioned balance-of-payments crisis. This has been greatly exaggerated by monetary union, which is also preventing the application of time-honoured solutions. Utopian pursuit of the single currency is damning Europe to economic oblivion. Political hubris has eclipsed economic common sense.
After monetary union, capital flowed in ever-increasing quantities from Europe’s surplus to its deficit nations; Germany and others were in essence lending the periphery the money to buy German goods and services. Monetary union precluded the sort of interest and exchange rate discipline that would normally serve to keep things in check.
Cheap money fuelled unsustainable construction and credit booms in the periphery and encouraged governments to spend more than they should. Relative to the core, wages and prices rose, rendering these countries progressively less competitive and deepening the problem of trade imbalances. The deficit countries borrowed to spend, rather than earning it.
Since the onset of the financial crisis, the process has gone violently into reverse. Money has fled the periphery, starving it of credit and exacerbating the economic downturn. Tax revenues have collapsed, causing budget deficits to soar and fiscal crisis to take root.
With a shrinking economy has come a mounting bad debt problem, which Spain and others have yet fully to recognise. Confidence in the banking system is at rock bottom, leaving Spanish banks progressively more dependent on the European Central Bank printing presses to fund their lending.
Spain is looking for some €60bn to recapitalise its banks but this is widely thought a gross underestimate of the true size of the problem. City analysis puts the amount needed to restore credibility at nearer €150bn, or 15pc of GDP. Touchingly, the Spanish government still seems to think that much of this new capital can be raised in markets. In truth, the only two banks thought remotely capable of tapping the capital markets, Santander and BBVA, are also the only two likely to be judged in forthcoming stress tests not to need it. If even British banks are thought “uninvestable”, what hope Spanish banks?
Worries about whether Spain can last the course has caused further capital flight, depriving Spain of the very low borrowing costs normally associated with countries facing rapidly weakening inflation and depression. Much of this money has flowed into Germany, further depressing its own already low cost of borrowing.
A politically explosive polarisation has established itself, whereby some countries face ruinously high borrowing costs, depressing the economy and increasing the challenge of fiscal consolidation, while others have very low costs and therefore a significant competitive advantage.
There are three elements to renewed crisis in Spain. First, Spain as a nation state is manifestly coming apart at the seams under the pressure of rising unemployment and crippling austerity, with Catalonia now openly threatening to secede. Spain’s age-old battle between the forces of regionalism and centralism is back with a vengeance.
Second, an unholy alliance of Northern states – Germany, Holland and Finland – has reneged on promises of direct support from European bail-out funds for the beleaguered Spanish banking industry.
This makes the political and fiscal situation in Madrid even more precarious. Spain had hoped that if banks could be recapitalised directly from the bail-out funds, it might avoid the humiliation of a full-scale sovereign bail-out and acceptance of a reform programme imposed by the EU and the IMF. The original summit agreement also seemed to recognise that the banking crisis was separate from the sovereign fiscal crises, and in some sense the responsibility of Europe as a whole.
In this way Spain might have avoided piling on further sovereign debt to rescue its banks. Spanish banks would be a collective, rather than a sovereign, responsibility.
But it now appears that any money for bailing out Spanish banks must be part of a wider sovereign package with corresponding guarantees and conditions.
This reversal in position by the surplus nations of the North is being taken as an act of extreme bad faith, not just in Spain but in the troubled eurozone periphery as a whole. Trust in European solidarity is being shattered.
Finally, Mariano Rajoy, the Spanish prime minister, has been digging his heels in over requesting any form of bail-out, despite the evident need for one as the Spanish economy slips ever deeper into recession and the budget deficit widens back into double digits. There is now no chance whatsoever of Spain meeting its fiscal targets.
Less than a year after sweeping to power in a landslide victory, Mr Rajoy is already fatally wounded. He promised never to apply taxpayers’ money to bailing out the banks. He already has. He promised not to follow Greece, Ireland and Portugal into a sovereign bail-out. Now, other than leaving the euro, he’s got no choice. Even on gay marriage, Mr Rajoy has failed to deliver as promised.
A further €40bn package of austerity measures has been announced in a desperate bid to get ahead of what Brussels wants of Spain and, we must suppose, thereby obtain a somehow unconditional bail-out, allowing national pride to be salvaged. These measures are almost bound to be self-defeating, for they threaten further to shrink the economy, thereby making deficit reduction tougher still. Spain is chasing its tail into austerity-induced fiscal and economic meltdown. Mr Rajoy is a dead man walking.
Other than leaving monetary union and defaulting on its euro debts, which for the moment even the rebellious Catalans don’t seem to want, is there any way out for Spain? The answer looks ever more likely to be no.
Membership of monetary union is preventing the application of appropriate monetary policy to the periphery sovereigns. The single currency has also denied Europe the natural market mechanism of free floating exchange rates to correct deficiencies in competitiveness and reduce external indebtedness.
There is only one conclusion to be drawn from all this; though the short-term costs would be profound, Spain must leave the single currency.
Spain is damned if it leaves, but damned for eternity if it stays. Eurozone policy as it stands offers no plausible way back to prosperity.