This post is adapted from a piece that originally appeared at my Strategic Planning Group. I've been doing a lot of work over there—hence the scarce postings over here. Sorry! GL
In the LiraSPG Scenario “When The Euro Breaks”, I discussed what would happen to the euro and the eurozone when those countries—unable to continue under their massive debt burdens—began exiting the European monetary union.
One of the assumptions I made was that one of the smaller nations of the eurozone would leave the monetary union first, thereby encouraging one of the bigger nations to follow their example and leave as well. I postulated that the small country would likely be Greece, and that the large country would probably be Spain.
From this exodus, I analyzed what would happen to the euro vis-à-vis gold and the rest of the world’s currencies—namely, that the euro would suffer a staggered loss of value against commodities and other currencies: An initial drop-and-recovery when the smaller nation exited the eurozone, followed by a sustained drop when the big nation exited the monetary union.
The Scenario was written and published on the LiraSPG site in May 2011.
Since then, I have changed my mind: I no longer think that a small country will exit the eurozone first, followed by one of the bigger countries.
I now think that Spain will exit the eurozone first—precipitously and without warning—and that the impact on the euro will be much more sudden and dramatic than I had earlier thought.
In this SPG Supplement, I will explain my thinking. First I will discuss the general European situation; then the Greek debacle, and how the European leadership has lost sight of what salvaging Greece was supposed to be about; then the current Spanish situation, how it is unsustainable, and how the new Rajoy government’s only escape—politically and economically—is to default and then exit the eurozone.
Plus Ça Change, Plus C’est La Même Chose
There has nominally been major changes in the European political situation since the Global Financial Crisis of 2008—which in fact have proven to be minor: To wit, the Italian, Spanish, Irish, Portuguese and Greek governments have been replaced by the opposition, and the French government of Nicolas Sarkozy looks like it will fall in this coming May’s elections. Of the replacement governments, the Italian, Greek and Portuguese are dominated by “technocrats”—that is, austerity hawks that will genuflect to Brussels’ and Frankfurt’s desire for the debtor countries to pay every last pfennig back to the bond holders.
Excuse me, did I say “pfennig”? I meant “euro cent”.
I can prove quite easily that the political “change” has been totally cosmetic because the economic prescriptions remain the same: On the one hand, austerity for the smaller countries (Greece, Portugal, Ireland), coupled with surreptitious bank bailouts by the European Central Bank (ECB) via Long Term Refinancing Operations (LTRO).
Keep on doing’ the same thing, you’re gonna get the same results: Since May 2011, Europe-wide unemployment has increased, to 10.8% across the eurozone; sovereign debt levels have increased both nominally, to €14.8 trillion ($18.35 trillion), and as a percentage of gross domestic product, to 113% of GDP; growth has slowed to a crawl in the big economies of the zone, with France projected to grow 0.7% in 2012 and Germany projected to grow 0.8%; while the economies of the smaller countries have been and will continue to shrink, with Italy projected to be flat in 2012 and Spain to shrink by 1.5% to 2.5%.
Why Greece Used To Matter
Everyone has been paying attention to Greece for so long—and all the European bureacrats have been trying to save Greece from sovereign insolvency for so long—that everyone has forgotten why Greece mattered.
But as I said in the Scenario, saving Greece does not matter in and of itself: After all, it’s tiny—less than 2% of the total GDP of the eurozone.
Saving Greece mattered—past tense—as a sign to the rest of the eurozone and to the financial markets that the European bureacrats—namely the ECB, the European Commission (EC) and the International Monetary Fund (IMF)—were willing and able to guarantee the sovereign debt of all the members of the Eurozone.
The European monetary union never explicitly stated that all the eurozone nations would back up the sovereign debt of any of the member nations. This collective guarantee was tacitly assumed—but never explicitly agreed upon.
When Greece got into trouble with its sovereign debt, the idea was to salvage it not because Greece was a large piece of the eurozone, but as a sign that the eurocrats would honor the tacit promise.
In other words, saving Greece was never an end in itself—it was just a symbol.
Saving Greece was also supposed to scare away the bond vigilantes and anyone else who might think that the sovereign debt of any of the eurozone members was vulnerable to financial rape and pillage.
We saw how that all worked out: The failure of the ECB-EC-IMF Troika to “fix” Greece between 2010 and 2012 wasn’t just a political embarrassment. It undermined the markets’ belief that the eurocrats knew what they’re doing. They quite obviously don’t.
It doesn’t matter that—finally, at the last second—the Troika sort-of saved Greece: The impression remains that they’re the Gang That Can’t Salvage Straight. And the impression is accurate: If they did know what they were doing, they would have solved Greece back in May of 2010—completely and definitively—and we wouldn’t still be talking about Greece.
But we are. Which means that now, we’re also talking about other, bigger countries—
Spain’s in Trouble
Spain’s GDP in 2011 was €1.05 trillion (US$1.33 trillion). In 2012, as previously mentioned, the general consensus is that it will shrink by between 1.5% and perhaps as much as 2.5%; a figure of –1.75% seems reasonable.
|Protests in Spain.|
Total government debt is projected to be 79.8% of GDP in 2012—that is, €800 billion. Much more troublingly, the debt last year was “only” €680 billion—but that was still 21% higher than in 2010. So at this rate—assuming the status quo remains unchanged, and without factoring in the contraction of GDP—in 2013 the projected Spanish government debt could well rise to 90% of GDP.
(Throughout this Supplement, when discussing “government debt”, I am referring both to Madrid’s and to the autonomous regions’ consolidated debt situation.)
Private debt is an additional 75% of GDP—and let’s not even start talking about the delinquency rates—while the banks have a capital shortfall estimated at a mere €78 billion.
On top of all this—as if “all this” weren’t bad enough—is the issue of the outstanding Spanish debt—
—the nub of the problem.
Spain has redemptions totalling €149 billion in 2012. It will issue a total of €186, with an eye to extend the maturity of the outstanding debt. But even with these concerted efforts, in 2012, the maturity of Spanish debt will in fact shrink from 6.4 years to 6.2 years. Add to that, in 2011, interest payments totaled €28.8 billion—up from €22.1 billion the year before. Why? Because of rising bond yields: Spain is considered riskier—due to the Troika’s inability to finally “fix” Greece and Spain’s own obvious domestic financial issues—and thus Spain has to pay more to borrow money.
In other words, Spain has fallen into the classic “borrowed-short-but-my-income-is-long-and-on-top-of-that-my-loans-are-getting-more-expensive” trap.
Last week, April 4, Spain’s Treasury held a bond auction—and fuck-all was it nasty: Of the expected €2.5 to €3.6 billion, Spain barely managed to get bids for €2.6 billion—and the yield on the 10-year spiked to 5.85%, before settling at a still-way-high 5.75%.
Worldwide markets all got down on this auction—
—but here’s the thing: Spain has a lot more of these auctions coming up—on average one every two weeks.
They have to raise €186 billion in 2012.
And of the first of these, they had a quasi-failed auction.
One hundred eighty-six billion euros—in less than a year.
They’re not going to raise that kind of money—simple as that. The April 4 auction was not an outlier—it’s what’s in the post for all of the next 17 auctions.
And the Germans—being the passive-aggressive dicks that they are (my maternal grandmother is German-Danish—so I know whereof I speak)—will not allow the ECB to open the money spigot to Spain. Just like they did with Greece, Germany will dither, while all the while blocking money to Spain until it’s too late.
Germany is thinking—in its passive-aggressive way—that it can string Spain along (just like it did Greece), and then save Spain at the last minute (just like Greece was sort-of saved).
But there’s one difference: Spain is bigger—much bigger—than Greece. You can’t pull an all-nighter and save Spain like they did Greece. You want to save Spain, you best be starting now.
Of course, they’re not.
So This Is What Will Happen
The new Spanish government of Mariano Rajoy, who took office this past December, has entrusted the running of the country’s finances to a so-called “technocrat”, Luís de Guindos.
De Guindos is a technocrat—and he is doing everything in his power to keep Spain steady, like a good technocrat would. He has presented a budget that will shrink Spanish government social spending by 4.3%; he is moving aggressively to stabilize the Spanish banking sector, decreeing that all banks with assets of less than €80 billion under management will be “encouraged” to merge, in order to foster stability through size.
You know: Some German austerity coupled with some Geithnerite Too-Big-To-Fail-ism, like you’d expect a good technocrat would.
But de Guindos is not a europhile-technocrat-insider à la Mario Monti or Mario Draghi or Lucas Papademos or Cristine Lagarde: De Guindos is a private sector nationalist. He is Spanish—not European. Look at his résumé: The guy’s worked only in Spanish institutions when he’s done a public sector gig, and though his private sector jobs were with Lehman and PricewaterhouseCoopers—high-echelon international gigs—in both cases it was with their Spanish offices.
Coupled to that the fact that, ever since Franco’s time, Spain has never been fully accepted as “European” by the rest of the continent.
Now, de Guindos isn’t stupid. Rajoy isn’t stupid. An unemployment of 24%—and rising—coupled with a shrinking GDP is a recipe for political turmoil. That’s polite-speak for “political shit-storm in the making”.
There have been massive demonstrations in all the major cities in Spain—and there will be more, without question.
Rajoy and his Partido Popular currently enjoy absolute dominance in the Congress (186 of 350 seats), the Senate (165 of 266 seats), and the regional governments (13 of 19). But Rajoy knows the score: He ran in 2004 and 2008, losing both time. He’s under no illusions that the Partido Popular didn’t so much win in 2011: Rather, the Rodríguez Zapatero’s PSOE lost, because of popular discontent with the economy.
If there are another couple of failed auctions of Spanish bonds, and the message from the Troika is clearly that they won’t turn on the printing presses to save Spain—or worse, if the Troika telegraphs the message that Spain is going to have to get down on bended knee and beg and plead, while simultaneously squeezing its population ’til they scream—then rather than continue to cut services and social spending and appeasing the Troika, Mariano Rajoy will exit the euro.
“Don’t blame it on me! Blame it on the euro!” will be Rajoy’s slogan—and his people will believe him. In fact they will get fully behind him, regardless of the short-term (12-18 month) pain.
Why will Spain exit the eurozone? Because you can’t squeeze blood from a stone. With a 24% unemployment rate that is rising, and over half of the young people unemployed, no politician in his right mind—especially a nationalist—will decide that even more austerity is the cure for the disease. One thing is cutting off the fat—it’s quite another to be cutting to the bone.
For Rajoy and de Guindos, it will be simpler to exit the eurozone, go back to the peseta, and devalue by 20% to 30% right off.
It is always easier for a politician to cut expenditures via devaluation than via nominal spending cuts. Since the Eurocrats won’t allow a 20-30% devaluation of the euro, and since Spain cannot really cut any more or find any more money in the bond markets, then the only thing left for it to do is devalue a currency that it controls:
The New Peseta: Coming to Spain before the end of the year.
And The Effect On The Eurozone Will Be . . .
The effect on the eurozone will be quite something. In next week’s SPG Supplement, I will outline what will be the immediate effects of Spain exiting the European monetary union—and what would be some smart bets and ideas to keep in mind, in anticipation of that event.
If you’re interested, check out the Strategic Planning Group’s preview page to see what it’s all about.