Spanish canary in the European coal mine

January 29, 2010

The quote of the day comes from Marc Chandler, currency strategist at Brown Brothers Harriman, who has graciously offered to let me reprint a note he sent today.

While Greece gets much of the news, Chandler argues that it’s in Spain where the policy dilemma is “most stark.”

Today Spain reported that its unemployment rate in Q4 rose to 18.8% from 17.9% in Q3.  The consensus was for a rise toward 18.5%.  The unemployment rate has doubled in the past two years.  As seems to be typical in  Europe, the unemployment [rate] is especially pronounced for young people. In Spain it’s 40%…

Cyclical forces and the €8 billion public works program pushed Spain’s deficit to around 11.2% of GDP last year according to the EC.  This is almost as large as Greece’s.  One key difference between the two in this context is that Spain’s debt to GDP is considerably lower than Greece, giving it perhaps greater chance to stabilize the debt/GDP ratios before they become ruinous.

In the face of such sobering news on the labor market today, Spain officials have felt compelled to indicate that they are considering increasing their efforts to cut the budget deficit quicker.  The government is contemplating proposals that will cut another €50 billion or 5% of GDP by 2013.

Rolfe here. Victor Mallet at FT has the news: Spain unveils radical austerity budget.

This illustrates the dilemma policy makers face.  The economy does not warrant an end to fiscal support yet.  The IMF has argued this.  The EC has argued this.  But the dramatic market response to Greece has been a siren call, seemingly forcing policy makers–not just in Spain, but Portugal earlier this week and Poland earlier today too–to mitigate the wrath of the bond vigilantes.

By appeasing the vigilantes, officials risk aggravating the economic downturn, which offsets some of the fiscal austerity and spurs social tensions.   [But] if the vigilantes’ concerns are not addressed in a satisfactory fashion, capital will strike, at least partially, and interest rates will rise…also exacerbating the economic downturn.

Many developed economies have borrowed so much, they can borrow no more. While borrowers love to hate their lender, they need him desperately if they’ve levered up their lifestyle past a point supported by their income.

Governments that rely too much on the bond market for funding should expect the market to turn against them eventually.

Comments

“Governments that rely too much on the bond market for funding should expect the market to turn against them eventually.”

If that’s the case, and I have no reason to not believe it is , then the sooner the better the bond vigilantes bring this extraordinary experiment in QE and fiscal stimulus, to say nothing of structural deficits, to an end. Everyday that goes by will make the inevitable financial realignment that much more difficult as the debt mountain grows ever taller.

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