STAFF NEWS & ANALYSIS
Now Spain Takes a Tumble
By Staff News & Analysis - June 17, 2010

EU leaders say no plans to discuss Spain bailout … European Union leaders say they aren't planning to talk about possible financial help for Spain at a Thursday summit amid rumors that it could follow Greece in seeking a bailout. German Chancellor Angela Merkel told reporters Wednesday that she will push for tighter budget rules and will encourage Spain to keep up efforts to make labor reforms and budget cuts. "One should first see what Spain has achieved in recent weeks," she said on her way to a meeting of center-right leaders in Brussels. Under pressure from markets and other EU nations, the Spanish government on Thursday agreed labor market reforms to encourage companies to hire — and make it easier to fire — workers in an effort to cut its jobless rate, the highest in the eurozone at around 20 percent. The determination to make long-delayed structural reforms — usually one condition of International Monetary Fund loans — and a scheduled meeting between the Spanish prime minister and IMF head Dominique Strauss-Kahn have fueled rumors that the country could be seeking financial aid options. European government and European Union officials on Thursday rejected a report in the Spanish daily El Economista that said the IMF, the European Union and the U.S. Treasury are preparing a package for Spain that includes a euro250 billion ($307 billion) credit line. Adding to market worries over the potential costs of rescuing heavily indebted Spanish banks, the report sent Spanish government borrowing costs to a record high against benchmark German bunds on Wednesday. – Bloomberg Business Week

Dominant Social Theme: Spain has no problems.

Free-Market Analysis: The EU is the mother-of-all power-elite dominant social themes, and it is getting harder to salvage all the time. Of course, as we have pointed out before, these promotions never really die but only reincarnate and continue in some fashion or other. But the EU's difficulties are real, and they have been complicated by the depth of the economic crisis and the Internet's communication technology.

There is of course the argument that the elite, which created what is today the EU, expected, welcomed and indeed in some sense caused the current sovereign meltdown in order to further a closer political union. But one need only look at the panicked responses of top EU bosses to begin to believe that no matter what the initial plan was, the result has been far beyond what anyone imagined, and in a negative way.

We would hesitate to declare, along with EU leaders, that a bailout of Spain is not being discussed. We think there are all sorts of conversations going on right now in terms of how to deal with a potential Spanish default. The trouble is that Spain is not Greece. It is a very big country with a very big debt. The UK Telegraph has reported on what is probably the truth regarding the issue, as follows:

Spanish debt wilts amid €250bn rescue plan confusion … European debt markets remain under high stress on persistent reports that Spain is in secret talks with EU officials and the International Monetary Fund for a support package of up to €250bn (£208bn), the largest rescue in history. Spain's finance minister Elena Salgado reacted angrily to reports in a Spanish newspaper that the plans were well advanced. The relentless rise in bond yields replicates the pattern seen in Greece at the onset of crisis. Spain must raise €25bn of debt in a cluster of auctions in July.

"We're in a dangerous and stressful situation," said Gary Jenkins, a credit expert at Evolution Securities. "Spain is a big enough borrower to wipe out the EU's rescue fund." Elena Salgado, Spain's finance minister, reacted angrily to a report in the Spanish daily El Economista claiming that the support plans are well advanced. "It has been denied by the Spanish government, by the European Commission, and by the IMF. How much more can we deny it?" she said. The story refuses to die, however. Three German newspapers have run similar stories over recent days, citing German sources. The markets are convinced that some form of contingency planning is underway.

The idea of the European powers-that-be, in issuing these denials, is obviously to influence markets favorably by denying there is anything wrong. Are EU leaders trying to buy time? The price of Spanish debt will likely continue to drop, nonetheless which makes new issuances more and more problematic. The questions will not subside just because no one at the top wishes to talk. The problem is that Spain owes too much money to too many banks and does not have the wherewithal to pay the money back.

A bailout, if it comes, will probably be similar to a Greek one. And one way or another it may well involve the sale of assets to private outside corporations, government cost cutting and tax hikes. The trouble is that such "austerity" measures tend to deflate the economy and thus contract opportunities. This was pointed out in a recent and unusual letter written by 100 Italian economists and reported by the UK Telegraph as follows:

The rebellion against the 1930s fiscal and monetary policies of the Euro-complex is gathering pace. Il Sole has published a letter by 100 Italian economists warning that the austerity strategy imposed by Brussels/Frankfurt risks tipping Europe into a self-feeding downward spiral. Far from holding the eurozone together, it will cause weaker countries to be catapulted out of EMU. Others will leave in order to restore sovereign control over their central banks and unemployment policies. At worst it will blow the EU apart, leading to the very acrimony that the European Project was supposed to prevent.

The Spanish problems will eventually be resolved through a bailout, we predict. But if so, that will not leave much money for further EU bailouts. The problem the EU has, then, in addition to a possible showdown over further centralization, is that the sovereign debt crisis is not amenable to stopgap measures. There are yet more countries in Southern Europe that will likely have as much difficulty as Greece (and now Spain) in rolling over debt.

Obviously economists in Italy are foreseeing that what is taking place elsewhere may soon affect that country as well. And of course Portugal has also been mentioned, and now and again France. Even if all these countries were to take well to austerity measures it is very difficult to see how Europe, or even the IMF, can sustain liquidity. One begins to talk about the general bankruptcy of the Western world.

After Thoughts

The idea that half of Europe is going to submit to extraordinary austerity while the other half provides bail-outs still seems an extraordinary assumption to us. If Spain goes out and Italy as well, what does the EU do? Arrange another US$1 trillion bailout? When does it end? And how?

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