Spain’s Severity is Not Sustainable

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

The pain in Spain continues with the government releasing the country’s latest budget which has been described by some Spanish economists as ‘the most severe since Franco’:

Spain’s government has announced $36 billion in new budget cuts, as it attempts to reassure the European Union that it will not need a financial bailout.

The budget savings will take the form of a freezing of civil servant wages, ministerial spending cuts and new corporate taxes, announced Soraya Saenz de Santamaria, the country’s deputy prime minister, on Friday.

“The ministries will see an average reduction of 16.9 per cent … there will be adjustments of over 27 billion euros [$36 billion] through revenues and through spending,” she said, after she and her cabinet colleagues passed the draft budget at a meeting in Madrid.

“This government will not raise value added tax but is calling for an extra effort within corporate taxes,” she said. Overall, government spending cuts will amount to $22.7 billion.

The government has also decided to freeze civil servants’ salaries, but to maintain unemployment benefits and planned pension increases.

Jose Manuel Soria, the country’s industry minister, further announced that electricity bills for small consumers would also rise by seven per cent during a quarterly review due in April.

De Santamaria termed the budget proposal severely austere, but essential. The measure is to go to parliament on Tuesday, and is expected to be formally passed in June.

The aim of these cuts are to reduce the Spanish budget deficit from 5.3 per cent of its gross domestic product from 8.5 per cent last year, €27 billion is equivalent to 2.5% of GDP. As we have seen from both Greece and Portugal this sort of abrupt cut in government spending has some serious negative flow-on effects to the broader economy which tends to lead to further unemployment and lower industrial production. Those problems, however, didn’t enter the minds of the Eurocrats as they congratulated the Spanish government:

European officials praised Spain’s 2012 budget measures and urged Prime Minister Mariano Rajoy’s government to implement them without delay.

“The unambiguous commitment of the Spanish government to the target of 3 percent fiscal deficit in 2013 is indeed of paramount importance,” European Union Economic and Monetary Commissioner Olli Rehn said in Copenhagen yesterday. “I expect this will be substantiated soon by a convincing path of fiscal consolidation” along with economic reforms to put Spain on a “more sustainable growth model.”

There is nothing sustainable about this path, the Spanish have not written off any debts yet are setting themselves a path of even lower national income. Unemployment is over 20% and rising, bad debts in the banking system are still rising, bank deposits are flowing out of the country, lending to the private sector is falling all while households attempt to repair their balance-sheets as they continue to lose wealth from falling house prices.

However, with the Spanish private sector in dire straits members of the European bureaucracy want us to believe that taxing them more will somehow lead to growth. I guess I shouldn’t be too surprised by this madness, Olli Rehn has a history of making political statements that make no economic sense and inevitably turn out to be embarrassingly incorrect.

From 15th August 2010

There is no possibility that Greece will default on its debts and no reason to doubt Germany’s commitment to an EU pledge to help Greece, the European Union’s monetary chief said on Thursday.

Economic and Monetary Affairs Commissioner Olli Rehn told a conference in Brussels that Greek default was not an issue, saying: “There will be no default.”

a year later, August 29th 2011

Jean-Claude Trichet, president of the European Central Bank, said there was no shortage of liquidity in the European banking system. EU economic commissioner Olli Rehn insisted that the health of EU banks had improved over the last year.

I don’t think I need to go on, but maybe the best thing for all us is that these people resign, or at the very least just stop talking.

It seems almost inevitable now, given the budget the Spanish are about to enacted and the complete lack of debt write-downs, that the country’s economy will weaken further over the next 12 months. Excluding some unforeseen positive event I think it is very likely that the country will require external help shortly. Which brings me to the other news of Europe over the weekend.

European officials announced on Saturday that the European Financial Stability Facility (EFSF) has committed an additional €200 billion in funds to the European Stability Mechanism (ESM) which technically brings the total availability to €500 billion with an overall firewall figure of €800 billion. It all sounds very positive but, as I have explained previously, neither of these mechanism are as exciting as they seem on the surface.

If we look at what will actually be available we find that €100bn of the €800bn is money from the EFSM, a small fund set up by the EU commission, that has is already allocated to Ireland, Portugal and Greece. Another €200 billion has been counted for the EFSF, but again this has already been allocated to existing bailout programs. So there is €300bn in double counting.

The ESM is supposed to be available, but as you would have noticed in the statement the talks about accelerating the “paid-in” capital. What this means is that by the end of 2012 the ESM won’t actually have all of its funds available because the €80bn in “paid in” capital will not have actually been “paid-in”. That being the case the mechanism is likely only to be able to generate €200- 250bn in the first year. Because the ESM isn’t actually ready the summit has decided to allow the EFSF to borrow up to its €500 bn limit if need be. Whether or not this change needs to be ratified by any national parliaments is an open question, but let’s assume for now that this isn’t the case.

What you will have noticed is that although the headline figure is €800 billion at no time will Europe have given itself access to greater than €500bn in new funds. Whether it can actually raise them is another question, which presents a new set of problems.

Firstly there is the existing programs. We have already seen admissions from the Greeks that they will probably need an additional bailout and it is becoming increasingly likely that something extra will need to be done about Portugal. Also, as you may have realised by now, and I have spoken about before, the ESM doesn’t actually have all the money. At best they are aiming for a 15% capital injection from member states that will be used as an insurance against default for additional funds borrowed by the program. The ESM is backed by all contributing nations, which means at the time of a default the 15% buffer will be used first, but any additional losses will be worn by the countries themselves.

At present Spain is a contributing country but, as I stated above, it is reasonable to assume that this will soon not be the case. In fact I think it is credible to believe that this will occur before they have actually paid in any capital themselves. Spain is supposed to be the 4th largest contributor to the ESM and the country has combined private and public sector debts that dwarf the €500bn in new funds, even if they were available. If Spain becomes a user of the fund then the burden will fall on Germany, France and Italy to take up the slack which is both politically and economically unsustainable.

I think that is the real reason you are seeing Eurocrats like Olli Rehn making such odd statements about Spain. He desperately wants the world to believe that the EuroZone actually has a credible plan because Spain is such an unmanageable problem. But the EuroZone has never had one, and still doesn’t. Releasing media statements with such obvious rubbery figures certainly isn’t going to help the union’s credibility.

Once again it appears, at least to me, that the European financial elite are their own worst enemies.

EuroGroup EFSF ESM Statement

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12 comments

  1. R Foreman

    That’s so funny, these creditors keep loaning this money that will never get paid back. That would be the definition of insanity as the saying goes, and the more times passes, the more money they lose by continuing to make the loans. So funny.

    1. Gil

      “Once you have finished your grave and are ready to lie in it, it is best to stop digging.”

      Unattributed

    2. Gerard Pierce

      What’s funny about it? The technocrats making these loans are not using their own money. I doubt very much that their pension plans are invested in Greek and Spanish bonds. The same rules apply as in United States finance: IBG YBG.

      They are perfectly sane. It’s the rest of us who are nuts for letting them continue playing the game.

    3. Glen

      Always remember bankers get massive bonuses for loaning out money they don’t have which cannot possibly get paid back. But the bonuses are quite real.

      “The pain in Spain”, toast the technocrats with champagne!

  2. jake chase

    The idea isn’t to get the money paid back. The money is nothing but electrons to the guys dishing it out, and the electrons don’t belong to them. The idea is to crush the working and middle classes and keep them hopping for the benefit of the kleptocrats well into the next century. The idea is to reduce wages in the public sector and release workers to desperation in the private sector.

    1. Nathanael

      But this is exceedingly stupid, given that the unemployed are marching in the streets and the employed are calling general strikes.

      Short of literally enslaving people, they aren’t going to get the results they want.

  3. Hugh

    Kleptocrats don’t do solutions. They do can kicking because this allows time for more and greater looting. The Euro elites, just like the elites in this country, are in on the deal. They are not their own worst enemies. They are ours.

    1. Nathanael

      Oh, they still are their own worst enemies; remember that can-kicking leads inevitably to revolution, which is NOT good for elites. (Unless you’re as clever at switching sides as Talleyrand was.)

  4. Jim

    Technocrats don’t do solutions, either. At least the ones in Brussels.

    Any person who has taken Economics 101 knows GDP=C+I+G+X-M. Given that, Spain can’t grow, not with an overvalued currency.

    The solution is obvious: Leave the Euro and Reintroduce the Peseta.

    Yet, even among the so-called progressives who supposedly look out for the working class, how many of them have argued for Spain and Italy to leave the Eurozone?

    Instead, they throw in with the political class of southern Europe, kleptocrats who are more concerned with how the Brussels-bunch perceives them than how their own constituents do so.

  5. Nathanael

    The only question is when Spain will have a revolution. They’ve now had two “warning” style general strikes; estimates were that 30% of the working population joined these strikes. They also have 20% unemployment, and practically all of the unemployed are joining the “indignados”.

    Add this up, and you’re about 6% of the population short of an outright majority willing to go to the streets. When an outright majority goes to the streets, your government does NOT survive. It may be replaced with something worse, but it does NOT survive.

  6. Nathanael

    Of course, we here all know that printing money, handing it to Spain, and having Spain hand it to its people, would work to fix the economic problems. But the elites are psychopathic kleptocrats, and *just won’t do it*.

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