Darkening
skies over Europe
The
euro zone may be forced to make a difficult choice soon.
1
August, 2012
You
can’t spell Spain without “pain,” and you can’t spell euro
zone without nearly breaking down in tears as you contemplate the
latest unraveling of the continent.
On
some level, it is hard to make room in your mind for how badly the
financial condition of Spain has unwound in the past two months, but
you need to do that because it is as serious as Greece, but with
bigger consequences.
Don’t
get tired of all the bad news. You still need to pay attention even
though policy makers are trying to cobble together another in a
series of rickety, short-term fixes this week with twine and chewing
gum. There is a controlled explosion rippling across the continent,
and just because it is summer, does not mean it’s not real.
Despite
the efforts made toward the 100-billion-euro bailout of its banking
system last month, Spain has not yet evaded a banking crisis at all.
And it has not evaded its sovereign debt crisis. And its fiscal
situation is worsening because the Spanish people are freaking out
about the fourth in a series of harsh austerity measures. The
regional government system in Spain is also getting worse, with
Valencia needing a bailout now and Catalan soon to follow.
And
all this time, the euro zone paymasters in Germany are sick and tired
of people asking for more money. They’re ready to dump their Greece
project, and will try to drop the hammer on Spain as well — the
heck with euro zone unity. Which can only lead to one thing, and that
is a social and political crisis, as the Spanish and Greek people
take to the streets to protest, stepping out on their jobs, cutting
output, and, in turn, reducing the taxes that can be collected to
solve the fiscal crisis.
The
drain in Spain is a classic deflationary spiral lifted out of the
history textbooks and dropped into a modern, beautiful country full
of hard-working and lovely people with iPhones and vacation house and
some of the best food in the world.
The
latest plan by the Spanish government to generate more funds calls
for an increase in the consumption tax, which is similar to a sales
tax (or a VAT) to 21% — up from the already super-high 18%. Policy
makers are also demanding a cut in unemployment benefits, an increase
in wage cuts, and layoffs of more state workers. The way analyst
Gregory Weldon counts it up, it looks like 110 billion euros in
austerity measures have been launched at the Spanish people over the
next three years. This in a country where youth unemployment is
already 52%.
Where
has all the money gone? A lot of bad real estate investments that did
not pan out, all across the country. Tens of thousands of kids
dropped out of school so they could build houses that now sit empty,
and the youths have few higher-education skills. Last week, the
Spanish government was forced to spend 18 billion euros to create an
emergency financing facility for regional governments, who are
saddled with their own debt, a great deal of which matures at the end
of this year.
Valencia
is more than just sunlight and oranges. The semiautonomous region is
deeply in hock, with a debt-to-GDP ratio nearly three times that of
Italy, according to Weldon data, pegged at 21%.
There
is not enough money in the central government to bail out Valencia
and Catalan, and there is not enough in the euro zone to bail out
Spain. German lawmakers have taken the unexpected step of blocking
the recapitalization of Spanish banks directly — an agreement that
was the centerpiece of the euro zone summit last month — putting
the onus of all new funding on the back of the sovereign.
I
hate to sound negative, but this is not going to turn out well unless
ECB chief Mario Draghi attacks the crisis with all guns blazing, with
German lawmakers staunchly behind him.
Also
making investors run a fever lately is the revived specter of a Greek
exit from the euro zone. Germany and the IMF were quoted over the
weekend stating that the Athens government isn’t moving quickly
enough to complete austerity measures required before the next
tranche of bailout money will be released.
It’s
looking like the IMF and Germany both want out of Greece, where they
have already dropped tens of billions. So what are the odds they are
going to be willing to drop more on Spain, following the
100-billion-euro bank bailout? You can probably ignore the apparent
haste of the announcement last week. Nothing happens too fast in
Europe, especially in the summer, but at least you know the direction
the financial winds are headed. Skies are darkening.
*
* *
Against
this backdrop in Spain, the stock market news in the rest of Europe
is not much better. Italy introduced a ban on the short-selling of
bank and insurance stocks. The measure is to remain in effect through
the end of the month.
Meanwhile,
Spain banned the creation of negative bets on equities through
shares, derivatives and over-the-counter instruments for three
months. These efforts never work — and in fact, make matters worse
because they prevent legitimate hedging. They are demagoguery and
lead to worse financial conditions.
The
political instability in Italy is growing to be more of a concern, as
Italian President Monti tries to hold his technocratic government
together. There was a report in late July that Monti was considering
calling early elections for the fall to shore up his support. If he
loses a vote of confidence, the already very weak investor confidence
could be shot, and just at the worst time.
The
problem in Italy is the same as elsewhere on the continent: Cities
are under increasing financial strain. The newspaper La Stampa
reported that there is a “black list” of 10 major Italian cities
with more than 50,000 people at risk of near-term financial problems.
Naples and Palermo top the list. This follows last week’s worry
that the autonomous region of Sicily was nearing default on its debt.
To
top it all off, in Europe came a report over the weekend that the
International Monetary Fund could end support for Greece as early as
September. Der Spiegel reported that senior officials at the IMF have
informed the EU that the fund is no longer willing to fund Greece.
Greece’s creditors seem unwilling to be flexible on bailout program
terms, as the next tranche is expected to amount to 50 billion euros.
Switching
to China, the news doesn’t get much better. The latest independent
data shows that China’s growth could slow further. The region’s
equities were lower today after a respected professor stated that
economic growth for this quarter could be 7.4%. This is in comparison
to consensus of 7.8% and last quarter’s 7.6%. You may recall that
Premier Wen Jiabao lowered the country’s economic growth target to
7.5% from in 8.0% in March. Stocks have retreated to their lowest
level in three years.
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