Rolfe Winkler

The Euro’s final battleground: Spain (Fidler, WSJ) The folks at Variant Perception warned the world about the impending disaster in Spain last August. Here’s a copy of their report, which they’ve graciously allowed me to share. (Though they’re famous for that one, they do write about more than Spain.) Anyway, Spain’s economic problems are prompting mainstream discussion that the euro could actually collapse. Greece is small enough that it can be rescued by Germany and France. Spain not so much.

What Greece tells us about Europe (Defterios, CNN) “It is not often discussed, but many [striking] government workers enjoy preferential tax rates, can retire at the age of 54 (in some cases earlier) and enjoy 14 months of pay for 12 months worked.”

Detroit Mayor emphasizes need to shrink city (MacDonald, Detroit News) Detroit is at the forefront of dealing with economic decline. The U.S. economy is overgrown and collapsing under its own weight. More to the point, we don’t have the resources to support all of our commitments. Some mode of shrinkage is necessary. Doing it proactively, as Mayor Bing seeks to do in Detroit, is better than the alternative….

Cash-strapped L.A. goes after unlicensed dogs (AP)

Madoff whistleblower Markopolos says he thought about killing Madoff in new book (Baram, HuffPo)

Idol winners: not just fame but big bucks (Wyatt, NYT) And you don’t have to win Idol to cash in….you just need to finish near the top.

Henderson back at GM, for $3,000 an hour (Taylor, Fortune)

Stand up while you read this (Judson, Opinionator) “Your chair is your enemy.”

Cringeworthy video resume…(more examples at Gawker)…be sure to check out the Michael Cera parody at the bottom. Disappointed that Gawker forgot the most infamous video resume of all time.

Funny how the market is just waking up to the Euro debt problem. Many have argued that debt levels are unsustainable, yet the IMF has adopted the neo-Keynesian line that governments can spend with impunity so long as unemployment is high. If there are unemployed workers in the economy, then conventional wage-push inflation — i.e. workers negotiating higher wages, which in turn drives up consumer prices — can’t happen. Or so the argument goes.

But this ignores bond market realities. The PIIGS on Europe’s periphery — Portugal, Ireland, Italy, Greece and Spain — have huge budget deficits as a percent of GDP, but don’t have the power to print money to pay it back. So bond markets are bidding up the cost to insure their debt:

Readers should offer their own view, but seems to me there are three options here, two bad and one nuclear.

1) The PIIGS cut their budgets to pay back debt. Such austerity programs are typically very difficult to get done in democracies. Deficit spending stays high long past the point that it’s possible to work off debt over any reasonable period. To successfully dig out of the hole requires cuts so deep, voters never agree to them.

2) Europe bails them out, which is the easiest solution in the short-run. Richer European countries certainly have the wherewithal to bail out a small country like Greece or Portugal. But it’s a dangerous precedent to set. What about Spain? It’s 14% of the Euro economy compared to 6% for Portugal/Ireland/Greece combined. If economies keep spending with an eye towards a bailout from the ECB, eventually you get #3.

3) The monetary union breaks apart. The customary way out of a debt crisis is to devalue one’s currency, see Argentina in 2001. It couldn’t maintain it’s dollar peg and still service its debt, so it devalued its currency and defaulted on debt. But this locked the country out of the international capital markets and drove them into a deep, though brief, Depression. For Greece to devalue, it would have to pull out of the Euro, pass a law that it’s debts are payable in new local currency and then devalue.

Some combination of #2 and #1 is probably the only sustainable solution. And that’s what the market appears to expect, what with Greek 5-yr CDS falling back to $389,000 from $425,000 yesterday.

But any help must come with tough conditions. Cuts must be deep enough that further rounds of bailouts won’t be needed.

UPDATE: Nick Gogerty points out that the IMF is another potential source of rescue funds. But whether bailout cash originates from the Germans or the IMF doesn’t change the fundamental problem, which is that Greek state is living well beyond its means…

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.