The inevitable death of the euro
Monday, 30 July 2012
On Thursday the European Central Bankâ€™s Mario Draghi was moved to defend the euro, after Spainâ€™s government bond yields rose dramatically through the 7% level. And when Valencia asked the central government for a bailout, followed by indications that other cities and regions have similar problems, it became clear that Spain is in deep trouble. We have got used to the concept of too-big-to-fail; now we have too-big-to-rescue.
We normally talk about Spain and also Italy in terms of government debt and budget deficits, forgetting they are only part of the problem. To these must be added regional and local governments, nationalised and subsidised industries, and off-balance sheet guarantees for other entities. Forget, for the moment, future health and welfare costs, which statistically dwarf everything: they are not the immediate problem. This still leaves us with rescues, without even considering commercial banks, amounting to perhaps between two and four times the headline government debt. People think Spain can be rescued, but when you take everything into account, including the prospect of a policy-induced slump from macro-economic mistakes, it is simply too big.
The failure to face up to financial reality is essentially political. Spainâ€™s President of the Government, Mariano Rajoy, was elected with a clear majority last November, and has failed to cut spending. Instead of reducing the burden of the public sector on the economy, he has chosen to penalise the productive private sector through extra taxation. If anyone had an opportunity to face up to reality with an electoral mandate it was Rajoy, but he failed to do so either because he deemed it politically impossible because he is simply too weak.
Perhaps it is political reality: this is certainly echoed in all the other crisis-hit states. Franceâ€™s electorate has cut out any argument by electing a socialist president intent on increasing both public spending and taxes at the same time. The result is that Europe faces economic collapse sooner than it might otherwise, escalating the burden principally on Germany of bailing out impecunious states.
Germany is becoming isolated, and no longer is Chancellor Merkel able to pretend that, deo volente, it will come right in the end. Instead Germany faces a crippling bill, now recognised by the rating agencies. In a GoldMoney podcast released last Wednesday, Philipp Bagus estimated the total cost to Germany to be four times her total tax revenues. That implies personal taxes of over 100% of private sector income. How do you carry your electorate along with you, simply to keep the euro project alive, with that sort of cost?