The vicious euro circle keeps turning

 

It's no good bailing out the banks if you can't bail out the economy. That, in a nutshell, is the judgement that financial markets seem to have been making about Spain in the past few days.

For weeks, all we heard from financial analysts was that Spain's banks needed rescuing, and the Spanish government didn't have enough money to do it. Finally, this weekend, the prime minister swallowed his pride and asked for that support. But the market relief has been short-lived, even by the standards of past eurozone "bailouts".

At one point today the interest rate on a 10-year Spanish government bond had risen to 6.8% - the highest since the euro began. The gap between Spanish and German long-term borrowing rates also reached a record high, as did the cost of insuring against a Spanish sovereign default.

Why are investors still so gloomy about Spain?

One part of the explanation is probably our old friend, political uncertainty. The Greek election looms large on the horizon, and the agenda for the European summit at the end of next month looks painfully ambitious.

No-one knows, yet, what Chancellor Merkel will be willing to sign up to at that meeting - if, indeed, she is ready to sign up to anything at all. As Robert Peston has succinctly reminded us, she has good reason to be wary of the talk of a European "banking union" now coming out of Brussels. And so has the Bundesbank.

But the core of the problem for Spain - reflected very clearly in the market movements of the past few days - is economic growth. In Italy, too - worries about the state of the economy helped push up the Italian government's cost of borrowing at the start of the week.

It's largely the grim prospects for the Spanish economy that has led Fitch and other ratings agencies to downgrade so many Spanish banks in recent days. Emergency lending is helpful. But it can't make the recession go away, and it can't take away the need for many more years of fiscal austerity.

An extended period of economic depression and fiscal austerity can trash the balance sheet of the healthiest bank. As the IMF pointed out so helpfully in their recent assessment of Spain's financial sector, Spain does not have the healthiest banks. And, by raising Spain's national debt by up to 10 percentage points, the new 100bn-euro ($125bn; £80bn) European loan could actually make the clean-up job for the public finances last even longer.

We've seen, throughout this crisis, how different countries have been hit by the close, mutually destructive relationship between banks and their sovereign governments. In Spain, as in Ireland, it is the debts of the banks that have fundamentally weakened the government's balance sheet. In Greece, Portugal and to some extent Italy, the debt problems have largely spread in the other direction - from the government to the banks. Either way, it's been a toxic mix.

Now Spain's enfeebled banks are being made even weaker, by the broader economic consequences of tackling the government's debt problem - a problem created, in no small part, by the banks themselves. In that sense, the vicious circle is complete. And not just in Spain.

 
Stephanie Flanders, Economics editor Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this
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    Comment number 263.

    262 There isn't time for that.Markets will decide when the time is up.Even if the MEPs and others running Euroland decided it was doomed it would take them years to agree to a plan.Instead, in the coming months or year or so the Euro may just fall off a cliff.If they don't have a plan already prepared in their back pocket (I don't think they have because they don't believe it) chaos will ensue.

  • rate this
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    Comment number 262.

    A good idea for the next summit would be an announcement that the EU is beginning a multi year plan to dissolve the single currency, and give the markets some confidence that this absurd idea will end?

  • rate this
    0

    Comment number 261.

    "The vicious euro circle keeps turning"

    It's not a euro circle, it's a euro garrote

  • rate this
    0

    Comment number 260.

    256.John_from_Hendon; I did not impose the failed, flawed and disastrous single currency on any one.
    The inability now to deal with the deficiency of the euro is down to its architects, political dogma over ruled good practice......the euro by any shape of the imagination is finished.
    It is a failed, shambolic and retarded project......lets move on?

  • rate this
    0

    Comment number 259.

    The only growth we will get is if we work our way out of it rather than speculate our way out. Confidence & growth is unlikey to happen quickly left in the hands of Eurozone leaders who created one currency for different mismatched economies that are now knitted together in the EU countries not just the Eurozone. Sterling is in the Eurozone we just call them pounds!!

 

Comments 5 of 263

 

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