Spain: Too Big to Fail

In the past few months, we have witnessed a rise in the questioning the stability of the eurozone. Much of the focus has been on Greece and the June 17th elections (which have led to more confusion). The winner of the Greek elections, pro-euro New Democracy, has the next two days (give or take) to form a coalition government. New Democracy wants Greece to stay in the euro, but it isn't that easy. Any government that forms in Greece will face a massive debt burden (~$16 Billion due in next three months), a high unemployment rate, a contracting GDP, and a populace that is struggling to meet austerity measures. There is good reason to believe that Greece will be forced to exit the eurozone in order to deal with its debt and economy. Many fear, that when Greece exits the eurozone, problems will hit larger economies such as Portugal, Italy, and Spain.

Spain is the latest in a line of countries to receive bailout funding. The June 9 announcement of a 100 billion euro bailout of Spanish banks has done little to give investors confidence. Today, Spanish bond yields rose to over 7.1%.

In this article, The Economist argues that investor confidence in Spain is so low, the most recent bailout has already failed, before even starting.

Capital has drained from Spain at an accelerating pace in recent months, for two reasons. First, investors are worried by the vicious spiral of a weakening economy, tottering banks and worsening government finances. Second, they are losing confidence in the single currency and Spain’s place within it. This bank rescue does too little to assuage the first worry, and nothing to deal with the second. That is why it won’t work.

The article also mentions the impact Greece may have on Spain.

If it elects a government determined to rip up the conditions of its bail-out, it could be out of the euro soon. That would exacerbate concerns not just about Spain’s future, but also about Italy’s. The yields on Italian bonds shot up this week because of fears of contagion.

Despite New Democracy winning the parliamentary elections, the possibility of a Greek euro exit remains high. In the next few days, we will learn if a pro-euro/pro-bailout coalition government can be formed. It will take weeks or months before we know if any Greek government can stay in the euro.

The major player in all of this is not Greece, Spain, or Italy, it is Germany. Germany, arguably, benefits the most from a common currency. Germany also stands to lose the most if the euro crisis turns to euro-recession or euro-depression. Which is what many fear will happen if problems in Greece lead to problems in other economies.

The real source of uncertainty about the euro’s future is not what is happening in these countries, but the failure of Germany and its European partners to commit themselves to the level of integration needed to hold the single currency together. This newspaper has long argued that country-by-country rescues will not be enough. Systemic reforms will be needed, including some mutualisation of debts and a move towards a banking union, with euro-wide oversight and responsibility for banks. Spain’s bank rescue could have been a down-payment on such a solution. By injecting their funds directly into Spain’s banks, European rescuers could have taken a first step towards a banking union. Instead, they chose a mildly improved version of the old approach. It is a plaster, not a cure.

My thoughts and questions:

Spain and other European countries lack the resources they need to handle the current crisis. They face high unemployment and declining GDP. The governments have no ability to print money (like in the US and UK) and debt payments are coming due.

Can the euro stand up to a major economic collapse in Spain or Italy?

Will the EU move towards greater economic integration, like The Economist argues is necessary? Or will fragmentation and national economic crises lead to the collapse of the euro?