Friday, 13 April 2012

When does the great Spanish bailout begin?

Over the last five months, the European Central Bank has undertaken one of the greatest financial sector bailouts in human history. Through its obscurely named LTRO facility, it has lent out over a trillion Euros to beleaguered European Banks at extremely low interests. In turn these banks have used part of those funds to buy government bonds.

Everyone seemed happy. The banks have cash, which they can use to buy higher yielding assets. The governments can continue to run large fiscal deficits, relying on the banks to provide the necessary funding. Actually, it looks a lot like a victim-less crime.

The problem is that the scam isn't actually working. Interest rates on Spanish bonds are now around 6 percent; close to the point where Ireland, Portugal and Greece got their big bailout packages. Italian interest rates are also on the rise. Even some of the northern European countries are starting to wobble. Is it so hard to imagine a moment where France joins Italy and Spain in the great 21st century bond market shut out? Actually, it looks very likely if the French elect a Socialist as President.

The European crisis is in transition. It started by testing the weakest and smallest countries in the EU. In the early days, European institutions confidentially handled the bailout when it was just Greece with their hands out looking for cash. When Ireland and Portugal sank, it exhausted all the available EU bailout money. The crisis is now looking to devour larger dishes. There is no bailout money left in the EU coffers for the big basket cases like Spain and Italy.

The Spanish Prime Minister confessed to the limited options for an EC-led bailout. He summed up the situation starkly "To talk about a bail-out for Spain at the moment makes no sense. Spain is not going to be rescued; it's not possible to rescue Spain, there's no intention to, it's not necessary and therefore it's not going to be rescued."

If Spain can no longer borrow from the market at reasonable rates, then there is only one institution that can prevent a meltdown - the ECB. When the shut out begins, Europe's central bank will have a terrible choice to make. Either it lets Spain slide into the abyss or it begins another bailout operation.

Assuming Spain is rescued then Italy will not be far behind. In order to successfully provide enough resources to fund the combined fiscal deficits of five major EU countries, the ECB will have to produce astronomical amounts of liquidity. When this happens, the ECB will have lost control of monetary policy. Its credit creation policies have become subservient to the fiscal decisions of hard pressed Southern European politicians.

Some optimistic souls think that this will all work out without any inflation. European economies are mired in recession and that there will be no pressure on prices. Oil prices seem to think otherwise. Furthermore, inflation is beginning to pick up in Europe. It is low at the moment, and superficially in seems containable.

Once the inflationary spiral kicks off, all kinds of crazy things start to happen. I know, it is hard to see it today, but monetary policy operates with a long delay. Just wait; but 2014, when inflation and recession are raging across this dying and moribund continent we will be lamenting the terrible decisions taken to save Italy and Spain during the summer of 2012.


Anonymous said...

Having been to the Spanish capital recently, I would say that any more austerity would create Greek-style riots as the economic changes are hurting. But I don't think that is your point.

Germany has a successful economy both within the EU and the Eurozone. It does have bankers like we do. It has a communist/socialist leader. So why the difference?

Answers on a Deutschmark please.

Mr Curious said...

Does Germany have bankers like we do?
One overlooked key to the country’s economic dynamism is its strong public banking system, which focuses on serving the public interest rather than on maximizing private profits.

Some people think German bankers are just naive, but...

Chief of men said...

salamanca summer (200th anniversary of last spanish bailout)

Anonymous said...

"Germany has a successful economy .."

Germany built its economy on the premise that that it will be an exporting country into the rest of Europe, which included very same Greece, Spain, Portugal, etc.

Arithmetics requires that those countries run deficits to finance their imports, which exactly what happened. In fact, some of the Greece bailout money went back to Germany and France for purchases of stuff that Greece, doesn't need, such as weapons (

In any case, now that the importing countries are collapsing the demand for German exports will go down and the Germany's economy will follow shortly. This will take some time (months), but mathematically it has to happen.

Sean said...


Are you saying Germany is a Parasite running a parasitic economy?

dearieme said...

Sell tickets for the public execution of Tony Blair. It might raise useful amounts and at least it'll make us all feel better.

Ted said...

Absolutely splendid idea even better if you could make it a double, Blair and Brown both executed simultaneously. This could be done slowly with piano wire and possibly incorporated into the opening ceremony of the summer Olympics. It would really make them special.