Anyone out there who thinks the euro zone debt crisis is over – and you know who you are – should take a good look at what’s going on in Spain. If Italy represented the biggest threat to the euro in 2011, then Spain will be the big story of 2012. Whatever numbers you look at, Spain is in a death spiral, a self-defeating circle of recession and austerity that is sending one of Europe’s most important members into an economic dark ages. Spain today represents all of the failings of the monetary union, from its misconceived inception to its misguided approach to the debt crisis.
Here’s just a brief summary of the ugly statistics: (1) The government in Madrid expects the economy to shrink by 1.7% in 2012 – its third contraction in four years. (2) Unemployment continues to rise. It is now more than 23%, and youth unemployment is above a staggering 50%. (3) Housing prices are down 22% from their peak, and are likely to continue to drop, perhaps by 20% or more. This puts extreme pressure on the balance sheets of an already shaky banking sector.
Obviously, this is an economy in severe distress. And what is the government’s response? More growth-killing austerity. In late March, it announced its most severe package of tax hikes and budget cuts yet, aiming to reduce the deficit by $36 billion. What gives? Madrid is extremely worried about the state of its national finances. It missed its deficit target in 2011, and, without the latest austerity package, would have done so again in 2012.
However, the austerity drive is failing to achieve what it aims to do: improve Spain’s financial position and rebuild investor confidence. Instead, investors have been spooked by the deterioration of the Spanish economy. Demand for Spanish government bonds was weak in a Wednesday auction. Since the government announced its latest austerity budget, yields on its bonds have risen, a sign that investors see them as riskier. Yields on 10-year bonds jumped over 5.6%, the highest since January. And why is that? Well, by tanking the economy, the austerity measures are making Spain’s financial standing weaker, not stronger. Despite its new austerity budget, Madrid estimates that the government-debt-to-GDP ratio will INCREASE in 2012, to nearly 80% from 68.5% in 2011. Simply put, Spain is moving backwards.
Meanwhile, what the austerity measures will achieve is further damage to Spain’s growth prospects. New taxes and reduced government spending will further inhibit any hopes that Spain’s economy can turn around. Unemployment will go up further, reducing tax revenues and inflicting even more suffering on the Spanish people. Thus the death spiral. By squelching growth, austerity is making it more difficult for Madrid to meet its budget targets and stabilize debt levels. So it introduces more austerity to meet those goals. And that in turn weakens growth further, pushing the targets farther off. And so on. And so on.
This is just the result of simple math. Let’s say, for example, we have a country with a GDP of $100 and government debt of $100. So it has a government-debt-to-GDP ratio of 100%. Now let’s say we want to reduce that ratio to 90%. We can achieve that two ways. We can reduce the amount of debt to $90. But if the economy is shrinking, we’d have to cut even more debt to cut the ratio. Let’s say GDP contracts to $90. That means we’d have to cut debt to $81 to meet our 90% target. Now let’s flip our math around a bit. We can get to our 90% ratio by increasing GDP to about $111, without cutting the amount of debt at all. Growth can fix a nation’s financial position just as well as austerity. Preferably, a country like Spain would stabilize its finances with a mix of both.
But the leaders of the euro zone have apparently forgotten the importance of growth to solving the debt crisis. Despite endless babble about stimulating growth, the entire focus in Berlin and Brussels has been on just one side of the equation – austerity. When Spain announced it would miss its 2012 deficit target recently, its euro zone partners showed no mercy. Euro zone deficit targets trumped any concern about the jobless in Spain. Rather than acknowledging the extreme suffering of their Spanish brothers-in-arms, they criticized Madrid and pressured the government into further budget cutting. The government in Madrid, fearing a split with the top brass of the zone, were compelled to cut even deeper. The euro zone is, effectively, administering the poison killing off one of its proudest members.
What the pain in Spain shows is the folly of the Berlin-backed, rules-based, austerity-crazed response to the debt crisis. Yes, Spain is responsible for its own problems. But Spain is no Greece, either. Unlike Greece, Spain has no history of fiscal irresponsibility. Its problems are very much a symptom of the global financial crisis. And the rest of the euro zone can’t ignore the role that the monetary union is playing in Spain’s plight, as well. Spain’s inability to depreciate its currency or control its own monetary policy is leaving the country only with a real reduction of wages and costs to regain competitiveness.
And what help has Spain received from the euro zone? Not much. The European Central Bank stepped in over the past few months to flood the euro zone financial sector with cheap loans. That took the pressure off a strained banking system, and led to heavy bank purchases of government bonds, bringing down borrowing costs, at least temporarily. But that’s not a real solution. The ECB’s action won’t improve the underlying strength of the banks or sovereigns. Spain’s stronger euro zone partners refuse to take any steps to stimulate growth or undertake the sort of liberalizing reforms that could give a boost to the region’s prospects, and thus offer a lifeline to weaker economies like Spain’s.
As Spain deteriorates, the chances of the country requiring a Greek-style bailout that could send shockwaves through the entire global economy are increasing. But even if Spain never has a solvency issue, the country is facing years of economic troubles. Even more, the country’s fate is an indictment of Europe’s experiment with the monetary union. When I report in Europe, I’m often lectured that, as a Yankee, I can’t possibly appreciate the motivation behind the introduction of the euro. I look at the exercise simply in terms of costs and benefits, but the euro, I’m told, is something much more – an instrument to forward peace and democracy.
My answer to that is the euro is failing on both counts. It hasn’t helped turn Europe into a strong, competitive economy capable of contending with either the U.S. or a rising Asia. And where is the camaraderie supposedly behind the euro’s lofty mission? What I see is an increasingly undemocratic Europe, where countries are forced to take irrational steps by overbearing neighbors to preserve a common currency offering little good in return. The monetary union has become a place where the countries that benefit from the euro grow fat and refuse to share the spoils with their starving compatriots. That’s a kind of “peace and democracy” I can do without.