Why the pain in Spain is threatening another Eurozone crisis

Next week the Eurozone is publishing a plan to stimulate growth. About time. Photo: Reuters

Here we go again.

It’s been a quiet couple of months in the Eurozone, quiet enough for some to think the two-year long crisis had blown over.

Not so much.

A trillion Euros of almost free money from the European Central Bank has had a narcotic effect on the continent’s financial markets, but it seems that even a trillion doesn’t buy you much peace and quiet these days; just a couple of months before the vultures are back saying all that free money was delicious, but it hasn’t solved any of the underlying problems that had us circling in the first place.

Old problems in Greece and Italy are rearing their heads again, but it’s the new(ish) ones in Spain that have the continent’s Cassandras talking about bailouts once again.

Spain is in pretty bad shape, and the markets are beginning to notice.

The economy is shrinking (probably by 1.7% this year), industrial production is collapsing (down a spectacular 5.1% in February compared to a year ago), unemployment is the highest in Europe, and at the very moment you would expect the Government to be stimulating the economy, Prime Minister Mariano Rajoy has had to announce €27bn in cuts under orders from Brussels, with more of the same required next year.

Spain has the highest unemployment in Europe and faces massive austerity cuts. Credit: REUTERS/Paul Hanna

If the Spanish Government asked you to lend it some money, wouldn't you be a little bit concerned? Concerned enough to expect quite a lot more in interest to make up for the risk you are taking?

That’s exactly what the financial markets think, now demanding 6% a year to lend money to Spain for 10 years.

If an economy is shrinking by almost 2%, and yet must pay interest of 6% on the money it’s borrowing, it is easy to see how interest payments may quickly begin to overwhelm the Spanish budget.

It’s the same debt spiral we have seen in Greece, but the difference with Greece, as with Ireland and Portugal, is that the rest of Europe could step in and lend them money instead of relying on the money markets.

But the Spanish economy is double the size of Greece, Ireland and Portugal combined. There simply isn’t enough bailout cash around.

In a sign of growing panic in Madrid, the Government has demanded even more cut backs in response, now telling the regions to spend €10bn less on health and welfare in the next 12 months.

That seems improbable, not least because a country that has had to deal with the seperatist tendencies of the Basques and the Catalans has a strong tradition of local autonomy. Add to that the growing anger at austerity that is seen as being imposed from abroad, putting it bluntly, from Germany, and the chances of Spain getting its finances in order anytime soon recede even further.

The markets are demanding 6% interest on Spanish loans. Not good when your economy is shrinking by 2% Credit: Press Association

Italy’s Prime Minister Mario Monti is now blaming Spain for market jitters there, but the reality is that his honeymoon is well and truly over.

He believes the route back to growth is through untangling Italy’s byzantine labour laws, but his reform programme has already been watered down under union pressure, and getting even this weaker programme through Parliament is proving a challenge.

The last two Italian ministers who tried to reform the country’s labour practices were both assassinated, just in case you were wondering how serious the Italians are about this.

Greece has been out of the news for a while since tortuous negotiations over the second bailout package ended, but the technocratic government of Lucas Papedemos only has a few weeks left in office.

A general election is expected to be called this afternoon for May 6th, an election the polls suggest will produce no clear winner. Which would expose a major flaw in the Eurozone’s plans for dealing with Greece.

Greece had to sign written pledges in return for the Eurozone bailout. What happens if the parties who signed are voted out? Credit: REUTERS/Tony Gentile

Before the Greeks got more money in March the major parties were made to sign written pledges to stick to the ‘reform’ programme.

But what happens if a major party doesn’t then win the election? What happens if the Greek people use what few democratic rights they have left to elect MPs who are committed to rejecting the austerity programme and all the foreigners who now live in Athens supervising it? It certainly could be interesting.

No one in Brussels wants to rock the boat at this particular moment, with voting in France just weeks away and President Sarkozy running on his record of having ‘solved’ the Euro crisis.

But next week they are going to publish a plan on how to bring economic growth back to the Eurozone.

It’s quite a change from two years of demanding ever greater austerity, but - given where the Club Med countries are heading right now - no less welcome for that.