On Thursday the European Central Bank’s
Mario Draghi was moved to defend the euro, after
Spain’s government bond yields rose dramatically through the 7% level.
And when Valencia asked the central government for a bailout, followed by
indications that other cities and regions have similar problems, it became
clear that Spain is in deep trouble. We have got used to the concept of
too-big-to-fail; now we have too-big-to-rescue.
We normally talk about Spain and also Italy in
terms of government debt and budget deficits, forgetting they are only part
of the problem. To these must be added regional and local governments, nationalised and subsidised
industries, and off-balance sheet guarantees for other entities. Forget, for
the moment, future health and welfare costs, which statistically dwarf
everything: they are not the immediate problem. This still leaves us with
rescues, without even considering commercial banks, amounting to perhaps
between two and four times the headline government debt. People think Spain
can be rescued, but when you take everything into account, including the
prospect of a policy-induced slump from macro-economic mistakes, it is simply
The failure to face up to financial reality is
essentially political. Spain’s President of the Government, Mariano Rajoy, was elected with a clear majority last November,
and has failed to cut spending. Instead of reducing the burden of the public
sector on the economy, he has chosen to penalise
the productive private sector through extra taxation. If anyone had an
opportunity to face up to reality with an electoral mandate it was Rajoy, but he failed to do so either because he deemed it
politically impossible because he is simply too weak.
Perhaps it is political reality: this is
certainly echoed in all the other crisis-hit states. France’s
electorate has cut out any argument by electing a socialist president intent
on increasing both public spending and taxes at the same time. The result is
that Europe faces economic collapse sooner than it might otherwise,
escalating the burden principally on Germany of bailing out impecunious
Germany is becoming isolated, and no longer is
Chancellor Merkel able to pretend that, deo volente, it will come right in the end. Instead Germany
faces a crippling bill, now recognised by the
rating agencies. In a GoldMoney podcast released
last Wednesday, Philipp Bagus estimated the total cost to Germany to be four
times her total tax revenues. That implies personal taxes of over 100% of
private sector income. How do you carry your electorate along with you,
simply to keep the euro project alive, with that sort of cost?
You cannot. Bagus
sees no alternative to money-printing, and that is effectively what Draghi now says he is prepared to do; but unlike other
fiat currencies, the euro has no single government backing it. Therefore the
effect on the euro of Draghi’s money printing
could be catastrophic.
It would be quite an event. We have not seen a
major fiat currency collapse in recent decades, though there are those in
Germany who remember the misery it brings. The speed at which the euro
weakens could be very surprising indeed.