The ECB cannot save Spain

Madrid’s persistent pressure for the European Central Bank (ECB) to monetise part of its debt is necessarily a self-defeating strategy. Once the Spanish government recognises that it is unable to restore the credibility of its liabilities and that the sole purchaser that can be expected to appear in a worldwide capital market is the central bank, the distrust in its debt can only increase.

On these grounds, it is not clear why the ECB should do precisely what most private investors dare not do, i.e. buy massive amounts of Spanish national debt. Naturally, it could be argued that a central bank’s role is to solve liquidity problems amidst a panic, but its role is certainly not to cure solvency problems. As no debtor can become solvent by rolling over its liabilities (much less by increasing them), there is no point in providing new and growing amounts of funding to already over-indebted agents. And for this reason, quite contrary to mistaken perceptions, the ECB is already imprudently providing too much cheap credit to the over-indebted Spanish economy: around €400 billion to the banking system and some €50 billion to the government.

That is to say, the ECB is directly lending to Spain more than 45% of its GDP (twice the amount which the Federal Reserve or the Bank of England are extending to their economies). Most of this credit is being employed to offset foreign capital outflows and thus is an attempt to stabilise the economy by avoiding much more critical scenarios.

But such stabilisation measures have proven deficient for deterring those capital outflows in recent months and there is no reason to think that it will prove different in the future. If private investors are concerned about the long-term solvency of Spain’s economy, the remedy cannot be found in lighter conditions for getting into more debt. Of course, if the expectations are that the ECB will buy more public debt over the next few months, there will certainly be some speculative front-running which will reduce temporarily interest rates. But that would be only a way of hiding Spain’s problems, not of solving them: real solutions can only come from improving Spain’s solvency by balancing the budget with deep spending cuts and by accelerating the liberalisation of the economy.

The Spanish government’s strategy seems to rest on the dangerous assumption that it has already enacted all the reforms needed to restore long-run creditworthiness and that the country just requires some extra time until those adjustments take full effect and are acknowledged by the market. Consequently, it is the mission of the ECB to step in and buy Spain that time. The problem is that remarkably few investors are accepting this highly optimistic hypothesis, basically because there are very good reasons for believing that the core problems of the Spanish economy still remain mostly unaddressed: unsustainable structural deficit levels, oversized public spending, high tax rates, rigid and overregulated markets, potential social unrest and dysfunctional governments at all levels.

In this context, what would be the purpose of a massive debt purchase by the ECB? To give Spanish politicians more time to implement new cuts and intense reforms, maybe under the European intervention umbrella? Or, more plausibly, to offer artificially cheap credit to the Spanish authorities so that they can further delay the vital adjustments needed to bring back financial soundness? In the first case, ECB credit would not be necessary for stabilising Spain’s debt crisis, since the same investors who are now fleeing Spain due to long-term risks would return once those risks were dispelled. In the second scenario, ECB credit would be insufficient to solve the underlying problems after the short-run speculative euphoria went away and private creditors were subordinated to the ECB. As the Bundesbank and even the ECB have constantly stressed, it is not the role of a central bank to fix any country’s fiscal issues.

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  1. Buén artículo, bastante conciso, pero un poco parco en detalles. Creo que dejará a muchos foraneos preguntándose por qué no se hacen esas reformas, y no se atajan los verdaderos problemas.

    En cualquier caso, deja bastante claro cual es la diferencia entre un problema de solvencia y una mera falta de liquidez, para el caso Español.

  2. The problem is politics. It appears to be that the autonomous regions are structurally to blame for a large part of the gov. deficit and simply for suboptimal government outcomes (e.g. education). How can anyone from outside (ECB, EU) ask Spain to adjust its state structure without infringing on Spain’s national sovereignty? How could a Spanish government accept a reform of its state structure in exchange for EU/IMF help? (“Esto ni se plantea”…according to Rajoy). The regions are enshrined in the Spanish constitution. Only a new referendum on a fundamental reform of the political division of the kingdom could facilitate change. But how realistic is that?

  3. Nadie puede salvar a quien gasta mas que ingresa.

    Esa es la definición de un agujero negro económico, ninguna economía por saneada que sea puede escapar si intenta el rescate, será succionada por completo antes o después.

  4. To gkmuc:

    I think the problem is not (only) in the politics, its in the minds of the Spanish people.

    In 2000 we had the same 17 small states, the public education and healthcare services we have now, but we spend nearly half the tax payer’s money per inhabitant.

    We could get back to that, even with the same 17 small states. Yes, it will be easier to disassemble those ministates, cause otherwise many things will have to change and people will have to get used to things like:

    1- Almost no public money for Unions, Corporate representatives (yes we pay those with taxpayers money here, believe it or not), Politic Parties, the Church, the renovable energy, etc.

    2- Less public (taxpayer’s) money for R&D, which in Spain just means less incentives to “pretend you are doing some R&D in order to throw taxpayers money your way”

    3- A lot less politicians in the state and the ministates, possibly even removing the senate altogether, a 260politician institution that DOES NOTHING in Spain, cause all decisions are ALWAYS taken in the Parliament, whether the Senate likes them or not. Less politicians on each ministate, on each townhall, etc.

    4- Almost zero public companies sustained by taxpayers money, and all the public workers that did not even have to pass a public exam to get in, most they just got a finger pointing at them “to get the prize”.

    But the problem on either case is that politicians can easily sell, or they even don’t need to sell it anyway, to get people against all those cuts.