Spain Is Trapped In 'Perverse Spiral'

Ambrose Evans-Pritchard Daily Telegraph May 31, 2010

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By Ambrose Evans-Pritchard Published: 5:34PM BST 30 May 2010

Comments 62 | Comment on this article

The downgrade could not have come at a more dreadful moment. The EU's €750bn "shield" for eurozone debtors has halted an incipient run on Club Med banks, but it has failed to restore full confidence for the obvious reason that such a guarantee cannot plausibly be extended from Greece to Portugal and then to Spain. The sums are too large, the number of solvent creditors too reduced, the intra-EMU politics too poisonous.

Pierre Lellouche, France's Europe minister, compares the shield to NATO's Article 4, the mutual defence clause that deems an attack on any one state to be an attack on all. Leaving aside the question of whether Nato's Article 4 was ever credible e_SEnD I doubt it was e_SEnD this use of NATO language illustrates the confusion in EU circles over the causes of the Club Med bond crisis. This is not a war. It is a beauty contest. Eurozone states must attract capital from pension funds and Asian central banks to finance their deficits or default.

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Whether intended or not, Mr Lellouche may have pulled the detonation plug on EMU by boasting that Europe's politicians had created an EU debt union on the sly. "It is expressly forbidden in the treaties. De facto, we have changed the treaty," he told the Financial Times. How will that go down at Germany's constitutional court, already facing a growing in-tray of claims that these bail-outs breach the Maastricht Treaty?

For Spain it has been a horrible week. The central bank seized CajaSur and imposed draconian write-down rules on banks to restore confidence. The Spanish Socialist and Workers Party (PSOE) of Jose Luis Zapatero then rammed a 5pc cut in public wages through the Cortes by a single vote, shattering consensus. The government cannot hope to pass a budget. Its own trade union base is planning a general strike.

The sub-text of Fitch's 32-page report shows Mr Zapatero's self-immolation to be futile in any case. The agency has not downgraded Spain for lack of austerity. Its implicit conclusion is that the policy of 1930s wage cuts - or "internal devaluations" - being imposed on southern Europe's humiliated states as a quid pro quo for the EU shield is itself part of the problem. Ultra-austerity will bleed the economy, shrivel tax revenues and fail to close deficit anyway. "Fitch believes the risk that economic growth will fall short of the government's projections," i

By Ambrose Evans-Pritchard Published: 5:34PM BST 30 May 2010

Comments 62 | Comment on this article

El Pais spoke of a "perverse spiral" in its editorial. "The Fitch note drives home the apparently unsolvable contradiction in which the Spanish economy finds itself. To maintain debt solvency Spain must squeeze public spending: yet this policy undermines the chances of recovery which itself causes further loss of confidence."

Spain's unemployment was already 20.5pc even before this latest dose of shock therapy. There are 4.6m people without work. Dole payments alone account for half the budget deficit. By comparison, the Anuario Estadístico shows that Spain's unemployment never rose above 9.5pc during the Great Depression . The economy shrank by 3pc from peak to trough. The Zapatero slump is worse than anything inflicted by Gil Robles during the Bienio Negro.

It is no mystery why Spain is trapped in depression. The country joined the euro without grasping its Faustian implications, as did others. Germany was equally naive in thinking it could have a currency union entirely on its own terms.

EMU caused Spanish interest rates to halve overnight, with dire results as the Bank of Spain's governor confessed in April 2007. "The single monetary policy has meant that excessively loose conditions for our economy have been almost continuous," he said.

Real rates were -2pc as the bubble reached its crescendo. Nearly 800,000 homes were built in 2007, more than in Britain, Germany, and Italy combined. There is now an overhang of 1.6m unsold properties, six times the level per capita in the US. Total public/private debt has reached 270pc of GDP.

The boom was a debt illusion, just as it was in Britain but with the added twists of lower wealth to offset household debt and a global investment position that is underwater by 70pc of GDP. Britain still has the instruments to extricate itself. The Bank of England has engineered a devaluation of 20pc, restoring competitiveness at a stroke. Spain can try to claw back an even greater loss by cutting wages, but that risks a slow death by debt-deflation as compound interest tightens its vice.

This can end only in two ways. Either Germany tolerates massive monetary reflation by the ECB or Spain will be forced out of EMU, setting off a catastrophic chain-reaction through north Europe's banking system.

Your choice, Berlin.

Comments: 61

It is not a beauty contest Ambrose, it is an ugly contest. So many seem confused or in denial of a very simple proposition. The PIIGS are the ugliest because of the relationship between their future funding requirements and their likely tax base. Thus, simply fixating on Spains current 50% state debt is merely looking at one variable in the equation. For the UK we are very far from the ugliest given the uniquely well managed (its very long dated) UK debt, our high personal wealth and our own currency. All this opining is moot. People are being asked to lend money. See where they say no and where they say yes. No more need for speculation is there. There it is. No amount of Euro babale and emperors clothes can hide it. Its time. Look what you have done. Still, it could be worse. If you were American you would be hated for it as well.

"...Lena!...Such grace, such charm. Only a German could do it" Obviously your research was superficial..."One year ago, when she was still unknown, the 19 year-old singer unabashedly went naked in a documentary soap on German television channel RTL." Don't believe everything you read about Germans

Chely, I think waging economic warfare is one of the accusations the ratings agencies are least likely of being guilty. However, thanks for the amusing thought. That would require some sort of determined plan designed around an ambition. Sadly, throughout the last decade, the only thing the rating agencies have been guilty of is, not spotting what the man in the street could see, until 6 months later. Quite why anyone would pay good money for such a statement of the entirely obvious is certainly beyond me. Designing an evil masterplan to ruin the Euro - what did we have for breakfast this morning boys ? We will need to look at the records. Sorry, currently processing “breakfasts eaten” for last December at the moment. Fast forward their pronouncements over the next 6 months and “hey, just who would have thought it - the Govts. of USA, UK and Euroland are all spending way more than they generate and they look a bit dogdgy for ever being able to pay back without some sort of inflation bust or devaluation, all of which means that what you get back is not in the same colour beads as loaned. Chely, get over it. Euro and EU cannot exist as at present. The party was good while the bubble inflated. Now it is crunch time. Default, exit, or political union with loss of sovereignty. Quite which is best for the various populations is for the crystal ball. What most Europhiles don’t understand is the animosity built up by continued duplicity over the nature of the game and the total erosion of confidence in our elites as they bungle and drop the ball at every pass. The banksters must be wetting themselves as each time they get bailed out or the loss socialised. As the spotlight moves, so it presents another opportunity to go in & loan to what is effect a NINJA nation and then make a tidy profit on exit. The biggest thing the Anglo-Saxon nations have is a intolerant population AND one that respects the supremacy of democracy. Gordon Brown did not enter the Euro because of towering intellect (see moment of choice for sale of gold reserves, “hmm now let me look again at that 40 year gold price graph, the lowest point is where ?”). He did not enter because it was a bridge too far to take the population. Maybe I and others like me will be proved wrong and perhaps the elites have now neutered democracy in the UK. However, currently I view the good work the DT has done in the last 2 years and think, “thank god”. We bungled our way to a 2nd global conflagration. But at least, at the last, we were able to kick out the wrong leader “peace in our time” Nev and get in somebody who told us the unvarnished truth …” blood toil, tears and sweat, ...the whole fury and might of the enemy must very soon be turned on us now. Hitler knows that he will have to break us in this island or lose the war”. Democracies have a great advantage, they decide what they do. They should decide what wars they want to fight. Tan boy Blair did huge damage to our institutions. But maybe, just maybe, it was the Jenner like inoculation that will save the patient. Either that or we will go down like France in 1940. Somebody has got to let a few banks fail. The fall-out will be serious. Maybe the UK will have to devalue even a complete quantum more. What is sure is that the Euro project looks like a parody of democracy. You couldn’t make up the story that is the last 15 years of votes on Lisbon etc. Given the great deception perpetrated, “political union by response to planned-in calamity”, one is then taking quite a gamble on a dictatorship of self-serving elites, having the necessary strength of character to make the hard yards, in very tough times. Everyone I know on this little island is getting ready for a very tough future. We face huge degradations in our standard of living and only somebody who believed in the tooth fairy could imagine that education, care for the elderly and health will be immune from the pain. We are going to have to re-learn some very hard and painful lessons. Our young men and women in Afghanistan are every bit the equal of the defeated army of Dunkirk and the identical attitude is now rising. S*d it that I leave my children a massive legacy they can never pay off in their life-time. “Whatever it takes”, for the right leadership, we will do. But those b*stards with their duck houses, porn films, improper payments to their “lovers” for rented flats, and moats – stuff them. DT well-done – your timing with Laws was immaculate. As was said about the king, forever after Cromwell, the rope was ever present around the neck – the nation was thus well served. This lot were just starting to think the rope was back in a locked box. Perhaps our MP’s will now stop playing the games of tan boy and his surly mate next door. Thanks Ambrose and thanks DT. We need the vision of what we could become, in front of us, at this time. Chely, we have a fair few holes in our lifeboat as well. It does not look good. Getting it launched off this sloping deck will be as hard for us as for you, with yours. The big splash comes not at launch time, but when the retarded time machine in the rating agencies’ office clicks onto our big sister in the west. Then the tsunami will come east.

They do not have time to amend the EU treaties. What they need to do is the FED, BoE, and ECB sweep up all government, mortgage and corporate bonds to prevent the insolvency of major financial institutions when they announce that the inflation target is being changed to 5%. Governments then need to start borrowing from the central banks on overdraft at 0% interest and use the cash to dramatically slash income and consumption taxes to boost demand and get people back to work, instead of pouring wealth down the drain as miilions of people are idled. Whatever it takes, de facto or not, the system is reaching melting point with all this farcical talk of austerity, which as Fitch says, is a certain downward spiral that will just make fiscal positions worse. Cameron suggesting the BoE might have to raise interest rates to counter imported inflation. What a farce. Talk of the need to rebalance with Germany and China become the borrowers and consumers. That can only be done very slowly over a decade or two in Germany's case and a century or so in China's case, or are we going to somehow transport all their factories over to the big spenders and importers. For God sake, get real. Nothing I hear them saying is real. 'We are irrevocably committed to price stability' they chant. Dream on, from here prices either go up steadily and keep going up steadily or go down fast and keep going down fast until we are all reduced to the poverty line and there is geopolitical hell. Some people say AEP is endlessly alarmist, but in fact he just sees the dangers clearly and spells them out in the least alarmist way that will make people sit up and take notice before it is too late. This is now becoming deadly serious.

Either way Cameron must grasp the opportunity to create a two-speed europe with Britain in the slow lane, it will create a happier Britain, able to be a positive and constructive neighbour for once, and it will create a more effective EU: http://jedibeeftrix.wordpress.com/2010/03/25/opportunity-or-threat-2-%E2%80%93-will-camerons-opportunity-arise-at-all/

CrashGordon on May 31, 2010 at 09:43 AM “Cac And dax both up in early trading !” The day is young. The week is long. The Crash is nigh, Gordon ;-)

http://www.businessinsider.com/guide-to-the-spanish-debt-crisis-2010-5#-7 Check out this slide show for why SPain is in BIG trouble - terrifying.

It could end a third way, managed default. That would be the most just conclusion, avoiding the risk of theft and instability by inflation, while keeping Spain in the Euro, if it's stupid enough to want it that way. However they play it, this crisis will not be behind us until the losses are attributed. For these, better the creditors take the hit than the taxpayer or saver, better deflation than inflation, as the evidence of the 1930s indicates.

Can the EU move to full union whilst avoiding any referendums and so maintain its 'pretend democracy' status and the eurozone? Full union means Germany taking on liabilities for the debts that PIIGS countries cannot pay back as there is little hope that some of these debts can ever be payed off otherwise (Greece for example). Germans would never have voted to replace the Deutschmark if there have been a referendum. Likewise they would never vote to support these countries in the way of life they have grown accustomed to which is better that Germany's for pensions etc and at the cost of Germany. There might be riots in Germany at having to permanently pay largess ot the PIIGS which will further reduce German wealth and lifestyle. Certainly parties will fall over this issue. There is zero change of the PIIGS countries ever developing a real economy like Germany's even if you delivered euros to them by thousands of container loads. They have a totally different outlook on life from Germans.

@Charles Lee 8.38am "You speak in total ignorance", you claim. "There is now a total freeze on recruitment in the vast public sector" You are wrong, of course. Britain has just recruited its second "Chief Secretary to the Treasury". This salary did not disappear from government expenditure. In recent days a local school has just recruited two teachers, both are newly qualified and therefore on the lowest point of the salary scale, replacing mature, experienced, therefore higher salaried teachers. There is no "total" freeze. What there must be is a "total" freeze on is agency workers in the public sector, especially doctors in the NHS and IT "consultants", and public sector bonuses.

pumpernickel on May 30, 2010 at 07:03 PM Cac And dax both up in early trading !

Jon Livesey wrote "Unless you think markets are crazy, that says UK debt levels are not particularly serious, and no disaster is indicated." Did the markets manage to call the value of Greek debt right for the last ten years, or were the markets crazy to overvalue that asset? Did the markets manage to call the value of Spanish (or British or American) property right for the last ten years, or were the markets crazy to overvalue those assets? Did the markets call the price of oil right in 2008, or ...? Who is to say that UK and US debt are not now likewise being overvalued by crazy markets made up of less than 100% rational investors? Letting free markets do their work clearly works better than any other system, but believing that prices set by free markets always correspond to the value of what is being exchanged is an extreme form of market fundamentalism. After all, every speculator knows that prices are wrong more than they are right!

"Don't worry chaps. I can assure you that the FTSE will be unchanged tomorrow." I think you're right, Eddie. We've fallen off a skyscraper but, passing the 50th floor, we're still in one piece, so why worry?

As we are dealing with a new type of economic crisis perhaps AEP has developed a new type of weapon - the bath-grenade. Detonation is initiated by the removal of the plug. The idea came to me like a brick out of the sky.

A fall in the Euro helps exporters as does cheap imported labor, so corporations do better. However a fall in real wages and reduced value of the Euro translates into citizens having less purchasing power resulting in reduced economic activity. Misery for millions. QE is the opposite of stimulus

Glad to see that you have finally woken up to what we have been saying for years!. Without full economic union for all members of the euro bloc, the currency is doomed as it has been from outset.

"Mr Lellouche may have pulled the detonation plug on EMU" There's a mixed metaphor for you. I think you either "pull the plug" or "pull the detonation pin". (Horrifying when you wake up on a lazy Bank Holiday morning in full pedantic mode......my apologies to everyone)

"The fact is that Britain unlike Ireland, Greece, Italy and Spain has not yet taken any action to cut public spending - yet." You speak from total ignorance, Chelyabinsk. There is now a total freeze on recruitment in place in the vast public sector. As people retire, die or resign for whatever reason, their salaries will steadily disappear from government expenditure, and in time this will have an enormous effect on the quality of the service offered, its cost and its effects on the wider economy. The speed with which the recruitment freeze was implemented indicates that it was in the pipeline, whoever won the election

Dear Sirs debt figures are nor proper, neither true; What about all the worthless derivates that western banks have off balance? Dont you realize we are all paying for those? Spanish banks, by the way, hardly own any c'mon, lets open our eyes Regards from sunny Barcelona

Britain is in the same "perverse spiral" as Greece and Spain. Britain also faces the "unsolvable contradiction". To maintain debt solvency Britain must squeeze public spending, yet this policy undermines the chances of recovery. Despite having the much vaunted benefits of a floating currency Britain will still have to endure draconian spending cuts. To say that "the US and UK are in the process of expanding" (6.17am 31 May) will cause even the staunchest of AEP's followers to gasp in disbelief, others will simply burst out laughing. The fact is that Britain unlike Ireland, Greece, Italy and Spain has not yet taken any action to cut public spending - yet. Britain's emergency budget on 22nd June will change all that. As to Fitch. It is a US ratings agency with headquarters in New York and London. This is the second time that this ratings agency downgraded a country in the middle of a sovereign debt crisis. It did it to Greece recently. It is a blatant hostile act of economic warfare. It is wholly unjustified because the move to downgrade was made AFTER Spain had taken action to curb its budget deficit. Fitch is one of three US rating agencies that failed to do their job in warning investors of the lack of solvency and liquidity and extreme dangers of derivatives and imprudent lending in the US banking system. This allowed sub prime mortgages to be passed off as triple AAA rated investments. The subsequent discovery of toxic junk bonds throughout the global banking system, much of it sold from London, caused the banking system to go into paralysis, requiring governments to bail out the banks. How AEP has the gall to quote a thoroughly discredited US rating agency as an authoritative source is a question he needs to answer. The EU wants to dispense with the reliance on the three US rating agencies and create independent European based rating agencies. @6.17am 31 May Anders is right. The EU has the money and the means to deal with the problems in the EU - but most important of all - it has the will. Unlike America the EU has a strong core. "jon livesey" makes baseless assertions, which are simply ridiculous and untrue. For example, "UK debt levels are not particularly serious".

So Mervyn King devalued the pound by 20%. He had better send a parcel to the Prime Minister.

European states must attract funds from pension funds and Asian central banks to fund the deficit or default. Good point and simple. But what about lots and lots more QE until parity with the Rupee is achieved? I have never understood how in a global economy the west can earn 10 times Asian wages or whatever the difference may be, indefinitely. It boggles my mind to think that said states are dependent on further credit, and if default did occur by how much would state spending have to be cut. What in that case would the Euro be worth, how far would equities fall and what would pensions be worth. The effect on financial institutions? If we had an enormous collapse I do not believe this would be the end of the EU, on the contrary, such a crisis would not be wasted. But just how they would cope with the angry hungry mobs I don't know.

Some day the chickens come home to roost...Spain was used to low service and poor quality and to high Peseta numbers. They killed the goose with the golden eggs and today they are making it all even worse by raising taxes.

When you discover you have cancer and it has spread throughout your body, it is not the discovery that is the problem, it is what the cancer has already done to you. If there is any hope of treatment, it will inevitably be harsh and further damaging to the body. The actions of the Spanish government are necessary (they can't keep spending money they don't have because no one will lend it to them). They ought to get out of the euro to give themselves more control, but even if they do that, it will still be tough (though tougher if they stay in the euro). But the greatest part of the damage from the euro has already been done, as AEP has outlined. And the damage is to Germany as well as to Club Med. All that wealth Germans thought they had in loans made to Club Med no longer exists. Its loss has just not yet been formally acknowledged. Aside from the parasitic politicians and EUcrats, there are no winners from the euro, just losers. But every loser thinks someone else was a winner at their expense, a perfect foundation for pervasive intra-European hostility. The rot is deep. Politicians keep trying to hide it so they don't take the blame but can milk the carcass a bit longer. They are like a doctor who misdiagnosed an incipient cancer when a cure would have been possible and now it is past that stage, says don't worry, you are really OK, just take some asprin and eat more greens.

The main reason that the Euro crisis was allowed to evolve was to deflate the Euro. We have now entered into the competitive currency devaluation era, where the theme is “devalue or die trying to”, for nations are going to do whatever it takes to keep their products competitive in the global market. Germany was knocked out of the top place and replaced by China as the world’s largest exporter and that must have hurt. Thus by allowing the crisis to progress, the EU could, in fact, devalue the Euro without actually issuing new currency. And then when things started to look really bad, they could pretend to help by approving a huge package, but this package would now devalue the euro even more.

pumpernickel,joe griffin,ediehooper May 30 After a nervous start the FTSE will end positive on Tuesday. The Dow is not ready to fall just yet and will lead. The big drop will come around Thursday with all markets falling through their February lows.

Ambrose, in Britain inflation is running at 5%, whereas wages are not going to increase. In fact they are being cut in BA now, and the public sector might follow suit in the emergency budget to be put forward soon. Point being, people understand that they are worse off than before. People understand their real wage is being cut. You seem to think it's possible to make people think they are not worse off by keeping nominal wages stable. I don't think you can credibly argue from economic history that wage deflation in the mediterranean countries will work worse than the inflation driven loss of wealth going on in the UK. The med. countries simply need to slash prices on their vacation offers. That's what we're seeing, and that's healthy for their economies. I don't see how you can think how these countries would be better off by scrapping the euro and introducing hyper-inflated and weak local currencies. It seems obvious they would be a lot worse off then compared with a little belt-tightening now.

Ambrose E-P You write ..."Mr Lellouche ...by boasting that Europe's politicians had created an EU debt union on the sly. "It is expressly forbidden in the treaties. De facto, we have changed the treaty," he told the Financial Times...." You mean the EU has driven a horse and coaches through the Rule Book, and around it. Isn't that always like politicians? Take Gordon Brown who wrapped his bank bailouts in secrecy (Terrorism Laws) such as the Icelandic Banks. Then like a bull-in-a-chine-shop blasted aside the Competition Laws (and Commission) bribing Lloyds to take over HBOS to make a mega-giant bank. Then threw some more taxpayer largesse at Lloyds when the deal he brokered went bust. Is this not anarchy? Are the people that make the Laws not the biggest rule breakers? Are the people (politicians) not wagging their finger at us for dirty business not the most rotten, and bankrupt, players of all? This is the sham that is Govt. The regulators that regulate us, but nobody appears to regulate them. And this constant drip, drip 'water torture' on the public trust is another factor in the coming Great Depression. When politicians systemically trash confidence/trust in public institutions (Govt, banks etc) and public value systems (ie. the currency) the entire fabric of our economy is dismantled. The EU is doomed because the Eurocrats are trashing wealth for political purposes

eddiehopper: "Don't worry chaps. I can assure you that the FTSE will be unchanged tomorrow." Nice one!

If the euro was set up to punish the Germans for WW2 it is succeeding very well. First the country gets bombed into rubble and now the children and grandchildren are being pauperised with a vengence.

"If Ambrose is right about the Euro and countries like Greece and Spain, then why are the economies of both Britain and America in the same perverse spiral?" They aren't. The economies of the PIIGS are in the process of contracting, while those of the UK and US are in the process of expanding.

Anders: "I think you should stop writing about the mess in the Euro area, they have the money and means to deal with it..the real mess is the UK with some 450% public and private debt...with no way to repay it...that's the disaster in the making... " Anyone can pick a number out of the air. The number you are quoting looks to me to be *gross* debt, not net debt. Many people can't tell the difference. Or perhaps you are comparing public + private debt in the UK with public only elsewhere. Since you don't say, I can only guess. If you compare public debt only, the UK still has less than France and far less than the PIIGS - or Belgium for that matter. One thing we do know is that UK - and US - debt is in such demand that yields on ten-year debt have been driven down from 4.5% to just over 3.5% in about a month. Unless you think markets are crazy, that says UK debt levels are not particularly serious, and no disaster is indicated.

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