Why ‘saving’ Spain could destroy it

Published in Business Spectator (Melbourne), 7 June 2012

If newspaper reports last weekend are to be believed, Germany is pressuring Spain to accept a European bailout. The story is all the more credible as the Spanish government has strongly denied any such bullying. Veteran Euro crisis observers remember that Ireland’s bailout began in precisely the same way.

It thus seems safe to assume that rather sooner than later Spain will be the fourth EU country to receive billions from its European neighbours – only on a much larger scale. And we are seeing this hope played out in a rising stock market. This despite Madrid’s continuing insistence that it will not accept such help, and that any aid must be given directly to its banks. All up, Spain’s banks are thought to require between €75 billion and €100 billion worth of extra liquidity.

But what is less clear is how a Spanish bailout would help Spain, let alone save the eurozone. It is also far from obvious whether Europe is even able to raise the funds needed for the bailout in the markets. Indeed it is not even clear how to make sure that a first aid package to Spain does not turn into permanent life support.

In the previous three bailouts – Greece, Ireland and Portugal – the official reasoning was always the same. If the crisis does not stop here, it will spread to other countries! It hasn’t worked: Greece was bailed out, and the crisis moved on to Ireland. Ireland was bailed out, and the crisis moved to Portugal. Portugal received a bailout, and yet we are talking about Spain now. So what are the chances that a Spanish bailout will be the last?

There are lessons to be learnt from this experience. Isolating a country from capital markets may halt an immediate crisis but it does not solve any of the underlying problems. Because of that, the euro crisis will resurface in another form and in another country, and then the rescue efforts will begin once again.

Another problem with the previous bailouts is that they have always been advertised as temporary measures to give countries some fiscal breathing space. However, in all three previous instances it now looks as if ongoing financial support will be required for the foreseeable future. Taking a country out of capital markets is easier than reforming it enough for its return.

Crucially, what the EU’s rescue packages are lacking is an understanding of the nature of the crisis. As long as German chancellor Angela Merkel was able to dominate European policy, i.e. before the French presidential elections, the answer to any problem in the European periphery was ‘austerity’. Greece’s state apparatus is bloated? Austerity! Ireland presided over a property bubble that burst? Austerity! Portugal lacks an industry able to compete within Europe? Austerity! And though it is hard to argue against spending cuts when budget deficits are ballooning, Merkel and her allies refused to consider that a more sophisticated response to Europe’s many crises might have been required. Even if it means that some countries have to leave the eurozone.

Now Spain faces the same fate as the other ‘saved’ countries before. Once again, Merkel’s fairy tale of profligate Southern Europeans needing a bailout by frugal Germans does not hold. Like Ireland, Spain is paying the price for a burst property bubble, which caused a banking crisis. And like Portugal, Spain lacks an economy productive enough to compete within the eurozone. To neither of these two problems austerity can provide a satisfactory policy answer.

As Spain will be bailed out, the rise of Spanish yields may be stopped for the moment. But apart from that, none of Spain’s fundamental problems will be addressed. If the Spanish are lucky, the Germans will not impose as strict an austerity regime on them as on the Greeks. In a best case scenario, Spain’s banks will be prevented from collapse but unemployment will remain stubbornly high and economic growth anaemic. Only a cynic would describe this as a successful operation.

The truth is that Spain’s problem is not its budget deficit, nor the country’s banking crisis. The core of Spain’s problem is its membership in a eurozone which prevents any economic recovery. The Spanish, like the other euro periphery nations, are locked in a monetary union which inevitably reduces them to intra-European beggars while limiting their ability to grow their way out their economic malaise. No European bailout package, however lenient its conditions, can change that.

So Spanish Prime Minister Mariano Rajoy is resisting help from his European neighbours because the futility of such an exercise is apparent. Besides, the humiliation to go cap-in-hand to Brussels and Berlin would be seen as a declaration of failure for the recently elected Spanish government. Yet rising yields and new financing needs in Spain’s banking sector will hardly leave him any other choice – apart, of course, from pulling Spain out of the eurozone’s monetary corset.

Almost two years ago, this column argued that Spain’s banking crisis was so severe that the country will eventually need an EU bailout (Nothing can save Spain, June 17, 2010). Back then, I also argued that pushing the country into fiscal adjustment will only cause pain without leading to the much needed economic rebound. Nothing has changed since. If anything, Spain’s situation seems worse than two years ago (although it’s hard to top the previous grim headline).

At least there may be one positive parallel between then and now. The Spanish are once again the odds-on favourites ahead of a major soccer tournament. But the prospect of winning the Euro 2012 is still only a small consolation prize to compensate for losing the battle within the eurozone.