It is not austerity but the threat of insolvency that is killing peripheral economies such as Spain. Since it has become clear that the European Union is not willing to completely mutualise risks and that, as a consequence, some countries may prefer to abandon the euro rather than restructuring their private and public debt, no capital seems to be safe inside any of the candidates to default and depreciate their currencies.
One just needs to take a look at some figures to realise the level of distrust which is undermining these economies. The best known case is the deposit flight which has taken place in Greece since the end of 2009. Greek banks have lost around 80 billion euros in the last two and a half years (equivalent to almost a third of Greek GDP) despite the huge transfer of funds from the European bailout plan.
However, Greece is not the only country in which investors have lost their faith. The figures for Spain are also alarming: in the last 12 months, Spanish public debt in the hand of foreigners has fallen from 52% to just 37% of the total. Furthermore, Spanish banks have greatly increased their dependence on the European Central Bank liquidity lines: Target 2 data show that (extraordinary) funding from the Eurosystem to Spanish banks has risen from 40 billion euros to 300 billion euros.
Capital is keeping out of Spain not because of too much austerity and too much internal saving, but because indebtedness is too high and is not being properly addressed by the new government. Unless Spain proves to its creditors that it can honour its liabilities, investors will not return, and without the aid of fresh entrepreneurial projects it will be difficult for an economy which relied too heavily on the housing bubble to start growing again and to absorb its six million unemployed (25% of the whole labour force).
The solution will come neither from more impoverishing debt-based public expenditure plans nor from more liquidity injections by the ECB. A solvency problem cannot be fixed by rolling-over debts; it can only be delayed at a high cost. We need larger public and private savings that allow our economic system to deleverage, to self-finance our maturing debt and to readjust our old-fashioned structure of production.
Leaving the euro and depreciating a new currency may seem like an easy and fast way to correct current imbalances. It is argued that Spain would regain competitiveness and attract foreign capital by offering assets at bargain prices. But returning to the peseta might not be such an attractive path after all: currency devaluations are equivalent to a default on external liabilities, transferring debtors’ problems to creditors; and currency devaluations increase the cost of imports and, unless they can be replaced by internal production, may have a limited impact on export competitiveness.
Moreover, let us not forget that a national currency would allow politicians to monetise much more public debt in order to fund their colossal deficits (as they are currently asking the ECB to do), thus postponing all the healthy internal adjustments and reforms that Spain so urgently needs. Given Spain’s track record with devaluation (between 1992 and 1995, the peseta was devalued a 30%, while our unemployment rate remained above the 20% up to 1998) one should not think that an implosion of the eurozone would help the Spanish and world economy to recover. Precisely the opposite seems more plausible.
In the end, however, Spain will only be able to keep the euro (a very imperfect currency but a long way better than its obvious alternative: floating national paper currencies) if reforms and austerity are enacted much faster. The new government has promised to reduce the budget deficit from 8.9% to 5.3% of GDP, but so far spending cuts have been minimal while savage tax increases threaten to further damage the economy while not providing any extra revenue in this recessionary environment. Labour market liberalisation measures still give trade union and courts too much power over contracts between workers and entrepreneurs. And financial reforms are forcing banks to raise more than 80 billion euros to cover past losses but do not specify where this money will come from (raising the likelihood of an expensive governmental bailout).
Current policies are clearly insufficient to bring the country out of a bankruptcy scenario. Time is running out yet Spain’s politicians are failing to grasp the urgent need for radical reform.
Publicado en el Institute of Economic Affairs
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