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 Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 8.

    Spain has NO hope in the Euro. Its Labour rates are higher than Germany, its economy is unproductive, it cannot devalue, it cannot print more money & its suffered from a property price collapse. Who in their right mind would invest in Spain whilst it remains in the Euro?

    The EZ is a black hole, which is consuming one state after another & it won't end here!

  • rate this

    Comment number 14.

    John, there lies the problem. If you were working in Greece or Spain would you accept a 40-50% cut in wages? No, well that is what would be required to make Spain or Greece truly attractive for investors and the only (relatively) painless way to do this is to devalue, which of course also makes a country's exports more attractive. All options that are not open thanks to the Euro straightjacket

  • rate this

    Comment number 18.

    John the reality is, Spain et al are light years behind German productivity. It's an imbalance that can only be corrected by having a lower value currency, which is what they had before they joined. If they exit the EZ, their international spending power (not domestic) will be reduced, & their own output would be cheaper. lots of pain but at least they can recover, in the EZ they can't

  • rate this

    Comment number 25.

    Could it be the markets are beginning to twig that bailouts which are loans don't fix the fundamental problems (they've been reasonably satisfied with previously) This bailout fixed one very specific problem with the balance sheets of Spanish banks that needed to be fixed. Some of the Hype (particularly from Rajoy) implying it was more important wouldn't have helped inspire market confidence

  • rate this

    Comment number 1.

    Banks MUST go bust.

    It is intellectually and economically insane to rescue banks as this PREVENTS the necessary liquidation of assets at market prices which is ESSENTIAL to a recovery and the new jobs to pay off the new loans.

    This is as true of Spain as it is of the UK.

    Even my much derided Mervyn King knows this - too big to fail is not acceptable.


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