Spanish woes threaten euro’s fragile stability


During the Napoleonic Wars, the long-running guerrilla campaign between the French and Spanish was dubbed the “Spanish ulcer”. Now it seems as if the Eurozone has acquired its very own Iberian problem, one that might possibly be too big to solve. Having escaped scrutiny for the first few months of 2012, Spain has exploded back onto the scene, with bond yields surging and talk of bailouts in the air once again. Investors seem to have decided that the latest round of budget cuts will be impossible to achieve, with the twin problems of rising unemployment and a shrinking economy effectively nullifying the effects of debt reduction. Hopes run high that the ECB will step in with some sort of renewed liquidity operation, but this is a holding action at best, and everyone knows that even if a bailout of Spain is a possibility, it would completely exhaust the financial firepower of the EU and leave Italy at risk as the next target. Spain faces the same problems as Greece and Portugal, where the implementation of austerity measures simply deepens the hole and makes it more difficult to stage a recovery. The Eurozone avoided disaster in Greece by the slimmest of margins; it might not be so lucky in Spain.


Since early March, when Spain revised up its 2012 budget deficit target from 4.4 per cent to 5.8 per cent – well above Europe’s new 3 per cent limit – market concerns have seen the Ibex equity index decline most in Europe, and the euro fall back against peers. New PM Rajoy’s transparency may be a welcome change compared to muddied messages from other troubled capitals. However, with its 10-year bond yields back up near levels markets associate with bailout, the ice on which Madrid is skating may be thawing fast. Today’s long-term debt auction could be key – not just for Spain, but Europe as a whole. The effects of the ECB’s two floods of cheap money to improve liquidity and bring down sovereign bond yields have not lasted long. Historical decentralisation of power means implementing reforms in Spain is hard. The countryside and banking sector bear the scars of a huge burst property bubble. 50 per cent youth unemployment means prospects are bleak. Recovery may be possible, but how long it takes is unknown. As slow as Greece or quick as Ireland? The size of any bailout is also an unknown. What we can be sure of, though, is that Spain is not an insignificant continental liability.


Despite equity markets showing in the last few days that they still have some life left in them, the risk of the European sovereign debt crisis flaring up again is very much a real and present danger. Without growth it’s hard to see the likes of Spain being able to get itself out of its precarious position when it is implementing such deep austerity measures and the bond markets are sending some warning shots across the bows. The message from the IMF yesterday was clear in saying that efforts that go too far in reducing budget deficits risk tipping the balance and seeing an economic retrenchment that will be impossible to get out of for years to come.

Yes, it got some short-term debt neatly away yesterday, however the longer term problems remain. The Eurozone peripheral nations need to raise some €1.5 trillion in funds over the next three to four years and bond investors will not make it easy for them. This is a vast sum that the poxy little EFSF or ESM are nowhere near to being sufficiently large enough to insure. In order for Spain to be taken completely out of the equation so that it does not go the same route as Greece, Ireland or Portugal the ECB or Germany will have to utilise its firepower.

Aquae Sulis senesceret Pompeii, quamquam suis comiter co