Spanish bailout is now inevitable

Spain has a collapsing economy, an imploding property market, banks nursing colossal losses, and 10-year bond yields at 7.5%. It’s time to stop pretending that there won’t be a bailout, writes The Guardian’s economics editor.

Published on 24 July 2012 at 14:53

Policy in Europe is all about playing for time. The big picture ideas for saving the single currency will take years, not months, to come to fruition - but the threat of collapse is immediate.

So the short-term mindset is all about survival: think the football team that parks the bus in order to defend a 0-0 scoreline or the batsmen whose sole aim is to occupy the crease when their team is facing an innings defeat on the last day of a Test match.

For a while last week, there was the real prospect that Europe's backs to the wall effort had succeeded. Last month's summit had more substance than the previous content-free affairs, and the rally in European financial markets last week reflected the belief that enough had been done to keep things calm through August. That, though, was until the Spanish region of Valencia announced that it needed financial help from Madrid, providing the trigger for a big sell-off in the markets that continued on Monday.

The response from the Spanish government was to swear blind one minute that there was not the remotest possibility of a full-blown rescue involving the International Monetary Fund and to impose a ban on the short selling of shares the next. The markets were suitably unimpressed by this display of ineptitude.

Meanwhile, Greece was once again coming under the spotlight as Athens awaited the arrival of officials from the Troika (the IMF, the European Central Bank and the European Union) on Tuesday. Greece is gripped by a 1930s-style depression and, perhaps unsurprisingly, is having trouble sticking to the austerity programme imposed as part of its bailout. It appears that the troika will threaten to cut off Greece's financial lifeline unless the coalition government agrees to an extra €2bn of cuts.

There are three conclusions to be drawn from these events. The first is that Spain is heading inexorably towards a bailout, probably quite soon. It was always a case of smoke and mirrors to imagine that the promised €100bn (£78bn) package of support for Spanish banks would be enough and so it has proved.

This is a country with a collapsing economy, an imploding property market, banks nursing colossal losses, and 10-year bond yields at 7.5%. The question is not whether there will be a bailout, but how big it will be. At least €300bn in all probability.

The second conclusion is that the trapdoor is opening up under Greece. German patience with Athens has run out, and the IMF was forced to deny reports on Monday it was preparing to cut off financial support. The Greek government is now faced with the choice of agreeing to a new range of demand-reducing measures it knows will be both counter-productive and politically toxic in order to be able to pay its bills inside the euro zone, or to devalue and default outside monetary union. A voluntary Greek exit would be ideal for Angela Merkel.

What links Greece and Spain is that the failed approach that has brought the smaller of the two countries to the point of no return is now being tried with the bigger and more strategically important member of the club.

The lesson from Greece is absolutely clear: slashing spending and increasing taxes when an economy is in free fall leads to higher, not lower, levels of debt. Spain is following Greece down the vicious spiral that starts with weak growth and rising unemployment and ends with expensive bail outs that do more harm than good.

For Greece in August 2011 read Spain in August 2012. Same problems. Same failed answers. Same crisis. Only bigger.

Opinion

Seems like déjà-vu

“Markets swept by wind of panic from Spain”, headlines Les Echos. The daily reports that the nightmare of another financial storm is “perhaps about to come true” in a “remarkable remake of 2011” that could have been avoided —

The implementation of all of the widely praised measures decided at the late June European summit would have been sufficient. However, the continent’s leaders allowed themselves to overwhelmed by the torpor of the summer — just like the sages of Karlsruhe [German Constitutional Court] who postponedapproval for the European Stability Mechanism until September. As a result, there is no safety net to protect Italy and Spain from a surge in the cost of borrowing at a time when both countries are battling to put their economies back on track.

“The moment when the Union will have hardly any options is approaching at a remarkable pace”, warns columnist François Vidal —

To prevent contagion throughout the eurozone, the EU will have to fly to the assistance of Madrid and Rome, regardless of whether it wants to or not. It can do so willingly via a modest resumption of the ECB’s programme for the purchase of sovereign debt, which would provide a temporary but sorely needed respite.

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