MAKING SENSE -- July 23, 2012 at 11:10 AM ET
Spain's Death Spiral
The interior of the Madrid Stock Exchange, or Bolsa y Mercado, on Monday, July 23, 2012. Spanish bonds slumped, with 10-year yields climbing to a euro-era high, after the Spainish newspaper El Pais said six regions may ask the central government for financial assistance, increasing concern the nation will need additional aid. Photo by Angel Navarrete/Bloomberg via Getty Images.
Last week Spain broke the supposedly magic 7 percent barrier, its rate to borrow money for ten years rising to 7.18 percent on Friday, 7.4 Monday morning. By contrast, Germany can borrow money at 1.17 percent as I write this; Switzerland, .46 percent; even the downgraded, living-beyond-its-means, politically paralyzed U.S., 1.41 percent, the lowest rate we've had to pay for a 10-year loan in our entire history.
By way of comparison, when Spain adopted the euro as its currency back in 1999, it was paying just under 4 percent to borrow for ten years, the same interest rate Germany had to pay back then. And the identity of Spanish and German interest rates held steady for almost a decade. Same for Greek interest rates, which tells you the basic story: investors thought that any country borrowing in euro was as safe a credit as any other.
Thus the standard of living rose in the poorer euro countries: wages increased; new projects abounded. Boom time. Germany, meanwhile, practiced relative austerity, was able to lend and sell to the boomers.
It was after the Crash of '08 that investors turned forensic. Not all euro borrowers were the same, they discovered. And so rates began to diverge; lenders simply began to demand a higher yield to compensate them for the added risk they had been taking.
Predictably, the poorer countries in the Eurozone -- mainly the "Club Med" members of the Southern and historically non-Protestant tier -- couldn't afford higher rates. The more they would have had to pay in interest, the greater their budget deficits. The greater the deficits, the greater the risk of default. The greater the default risk, the more investors would demand for that risk. And thus: the death spiral.
Greece was the case in point. Poor Greece now has to pay nearly 25 percent to borrow for 10 years were it not for the solvent members of the Eurozone -- led, most conspicuously, by Germany -- lending them money at low, non-market rates to save the system and Europe's own banks, which loaned to Greece at low rates in the salad days. In return, of course, Greece has had to cut its expenses to slash its deficit. More cuts have been promised Monday morning. How else could it ever pay back its creditors?
Sadly, however -- but also predictably -- the more Greece cuts, the more its economy shrinks, meaning that its tax base shrivels, meaning the greater its deficit, meaning the greater the risk of default. Death spiral (see above).
One way out: default on your debts, quit the eurozone and start over in your own currency. That's what many of our Making Sen$e Greece experts have predicted for a few years. There's been little talk of it with regard to Spain. Until now.
That's because a Spanish default and/or euro exit would be dangerously momentous events. Spain is the world's 12th largest economy. Greece, by contrast is 38th, just two notches above Vietnam. If a Greek default is a big deal because banks that hold Greek debt would lose so much money, think of the havoc that a Spanish default represents.
And yet -- Spain is on the ropes. Periodically, we check in with our informal correspondents there. (In Spain, a Disturbing Lack of Confidence, The Pain in Spain: How Hard Is the Rain Gonna Fall on the Plains?, A 'Lord's Prayer' for Spain's Economic Troubles) Today's dispatch comes from British economist and journalist Ed Hugh, who lives in Barcelona, where he and producer Isabel Andrés-Porti served as our tour guides two summers ago. Ed begins the post, which he sent a few days ago, with an update on Isabel.
"Isabel is happy but broke. She has just done a successful TV documentary that was nominated for two prizes in Asia. So she has kudos, and cultural capital, but no work.
Maybe this sums Spain up at the moment. There is a lot of national pride for recent sporting achievements, but no work. In the summer this is more or less supportable, since you can go to the beach (or whatever) without spending much money, but as autumn draws in...
A lot of things can be summed up by what I see in my village here. In attachment you will find a photo of me, with a Canadian Business News journalist who came to visit. This is taken in the restaurant on the edge of the village (Darkness on the Edge of Town). As you will see, there is a lovely waterfall and grotto. The place is a traditional one for visits, and Salvador Dali used to come there in his day, even bringing people like Man Ray, and Marcel Duchamp. The food in the restaurant is excellent, and not especially expensive. The owner hasn't raised prices since 2008.
Yet few customers arrive, and of those that do hardly any are Spanish or Catalan. In fact there is hardly traffic on the road going past. People living in Figueres (the nearest large town) just don't have the money to spend on the gas to drive around as they used to (petrol consumption as a national aggregate has been falling all through the crisis, there are now no traffic jams on the way to Barcelona airport, etc). It is a place where young lovers used to come to either eat, or take a beer. Nowadays none of them come to eat, a few come to take a Coke or a coffee (we even have a growing band of Moroccan gays who do this, since the atmosphere is more discrete than in town), and the majority come to simply look and spend a brief moment (even bringing their own refreshments, much to the chagrin of my friend the chef).
Meanwhile I have been appointed onto the board of one of the rescued cajas [regional banks] in an attempt to get things sorted out, and have a liveable income from this, which enables me to work from home, and go down to the restaurant to eat on an almost daily basis. I even play a round of dominoes with the cook, his wife, and an 84 year old female pensioner who comes down every day just to keep active. She actually walked here from Murcia (way in the South) in the 1950s living as best she could on the way. She tells me things are nothing like so bad today as they were back then, but again, who would expect them to be?
I am even drinking my way through an excellent cellar of wine at knock down prices.
So in this crisis there are winners and losers. It doesn't make me especially happy to feel I am one of the winners, and especially not when I see how others are living.
The atmosphere in Spain has changed since the Bankia scandal. Now there is a judicial investigation into Rodrigo Rato and 32 other board members. People want "blood", and I don't think this will go away.
The situation has the feeling of being on a runaway train without a driver. The current government is thoroughly mediocre, and is already far worse than the last one. Popular perceptions are also moving in this direction. The latest attitude survey poll found that a majority of those interviewed felt things would be worse next year than this.
That more or less sums it up.
As for Miquel [Baro] the property developer, plus ça change. He is still waiting for the banks finally to accept all his unsellable property. He has moved down several categories in terms of the car he drives. Otherwise he lives from one day to the next, watching and waiting. No long term plans, and this is the worst part of what has happened, so many lives frozen in time.
Mikel [Abasalo], my "Woody Allen type" investor friend in Madrid is also well, and as neurotic as ever. He can't believe things haven't gone off a cliff yet, and feels forced to look every day to see whether and when it all finally gets to happen.