June 7, 2012
SPAIN is trying to call Gemany’s bluff. Yesterday, the Spanish finance minister made a direct appeal to the rest of Europe to bail out Spanish banks or at least to put together a fund to recapitalise the Spanish banks. This is exactly what Germany didn’t want but may have to ultimately accept. If it wants to keep the euro, Germany will have to pay through the nose for the pleasure. By opening up another front, the Spaniards have rammed home the point that Europe’s problems are not about fiscal deficits as the Germans maintain, but about the consequences of hyper-borrowing and lending in the boom.
The banking crisis in Spain is not destroying wealth but merely reflecting the extent to which Spanish and European wealth has already been destroyed via too much borrowing and lending to stupid investments which have now gone sour.
This leaves Spain in the same bind as Ireland: the banks are facing mass defaults as the price of property keeps falling. Independent estimates suggest that Spanish house prices could fall by another 35pc if they mirror similar crashes from peak to trough in the sunbelt states of the US. This obviously has an impact on the extent to which the loans go bad. At the moment, Spanish banks have made provision for 2.5pc of loans going bad, yet we know from Irish experience that this can rise very quickly.
Let’s say, given the collapse of Spanish demand and the credit crunch that stems from bank crises, that Spanish defaults rise to 10pc, then we have a huge problem. On top of the banking losses, if we add all the various hidden debts in Spain — from the various regional and local government debts to the total central government debt — we can see that the debt to GDP ratio rises rapidly. Finally, Spain’s unit labour costs have to fall by 30pc to get down to German levels.
The country is chronically uncompetitive and that loss in competitiveness happened when Spain joined the euro. Huge inflows of cash made everyone feel richer. They rewarded each other with higher wages without productivity gains and thus dragged up the cost base and dragged down the bottom line.
As the construction sector collapsed, the budget deficit increased on top of what we already know, in total this year, is â‚¬180bn of bonds that Spain has to refinance.
Is it any wonder that the Spanish have thrown in the towel and looked for assistance?
Now for the tricky bit. The Spanish move begs three questions. If Spain gets the EU to bail out its banks using the ESM, will there be enough money in the ESM to do it? Second, if the Spaniards get the ESM to take their bank debt, don’t we have a good case for retrospective treatment? Third, what if Germany says no?
Although not in place yet, the ESM is touted as being as big as â‚¬900bn. But this includes contributions from Ireland, Portugal and even Greece — all bust countries. And the German contribution to the new ESM is going to go up from â‚¬211bn to â‚¬401bn. This has yet to be passed by the Bundestag.
If Spanish losses in the banks were as high as the â‚¬200bn that analysts suggest, on top of its refinancing demands of â‚¬180bn and its current deficit which is north of â‚¬80bn, Spain alone could absorb nearly half of the total fund. And, of course, we know that if Spain is asking for funds, it means it is now as good as in the clutches of the troika. This also signals that Italy will not be far behind.
In terms of our own narrow interests, if Spain were to persuade the ESM to take its bank debts, that would leave the rope for us to transfer our bank debts from the Irish citizen to the EU citizen. But then again, the EU citizen would be right to ask the bank creditors to just take their losses without asking us to bail them out.
Perhaps the most interesting issue raised by Spain’s move is whether the Germans have the stomach for much more of this.
I am not too sure that the central assumption of Irish establishment conventional wisdom, which is that ultimately the Germans will pay, is entirely right. We know all the arguments about why they like the euro and it subsidises their industry etc, but deep down there is a schism within the power brokers in Germany. It is clear that the Bundesbank is getting very hot under the collar about the ECB and what the Bundesbank sees as the ECB’s cavalier attitude to money in its printing cash and bailing out of governments. Many Germans feel the same way.
They know that the ECB’s and Germany’s only hope to keep the euro intact is through breaking the rules about lending to government and banks. There’s a conflict between those who say the rules are sancrosanct and others who believe rules must be broken to keep the whole show on the road.
Many Germans are philosophically in the first camp. Rule-breaking contradicts their moral code. However, the rest of Europe — and those in command at the ECB — see the rules as fungible. This loose grouping takes the view that the end justifies the means. This is hard to take for many German people; it goes against everything they hold to be morally right.
IN a sense, there is a moral dilemma playing out in the heads of Germans. If we extend this moral view of the world to money, the two sides can be broken down into simpler forms. Those like me and many other economists who see money as a “tool” used to push economies in certain directions, and the Germanic view, seeing money as a “common good”, protected by treaties and laws. In this second, moral worldview, the economy adapts to money — not the other way around.
Maybe these Germans might wake up one day and say they’ve had enough. Then the euro unravels quickly. If that happens, you can rest assured that the day this moral revolt started in Germany was the day Spain tried to call Germany’s bluff.
Come to a discussion on financial markets in our everyday world, June 17 with David McWilliams and novelist Aifric Campbell at www.dalkeybookfestival.org