The American Interest
Analysis by Walter Russell Mead & Staff
Spain: Thanks for the $125 B, Can I Have $625 B More?

Ten short days ago, the $125 Spanish bank rescue plan was being hailed, briefly, by rattled European officials as a breakthrough that would stabilize the eurozone’s fourth largest economy.

Now yields on Spanish 10 year bonds have passed 7 percent, the “magic number” that forced Greece, Ireland and Portugal to seek national bailouts, and the talk is growing that Spain is going to need another, bigger bailout: of the country, not of the banks. 7 percent is a magic number because when heavily indebted countries have to pay that kind of interest on their debt, a doom spiral sets in: the high interests rates make their debts harder to service and raises the ratio of debt to GDP. That higher risk leads investors to demand even higher interest rates, and that makes the debt even less sustainable, driving interest rates even higher.

Repeat until dead.

This is the prospect Spain now faces, and the only way out would be an EU bailout of the Spanish government. From the FT:

A full bailout would cost something close to €500bn, stretch the resources of the EU and the International Monetary Fund, and raise the possibility that Italy would also require assistance and so herald a break-up of the euro.

€500 billion is about $625 billion; even by today’s standards, that is a lot of money. It would more than wipe out the funds Europe currently has available for bailouts, and the US among others would be under intense pressure to kick in more money through the IMF.

And as the FT notes, Spain might not be the star of the show; an Italian bailout would be substantially bigger.

The establishment of the euro was clearly one of the worst policy decisions of all time, right up there with Napoleon’s invasion of Russia. A united European establishment joyfully signed an agreement that would blight the lives and crush the hopes of tens of millions of Europe’s people. Many people warned of disaster at the time, but the European leaders were so arrogant and so ignorant (that most fatal of combinations) that they pressed on regardless.

They are a bit less arrogant now, but immense damage has already been done. At almost every important historical turn since 1914, Europe has made disastrous mistakes. For the forty years of the Cold War, Europeans behaved with unwonted wisdom and discretion, building the most prosperous and peaceful system the old continent had ever known.

But ever since the end of the Cold War — when the first big decision the French and Germans took was to go for a monetary union without first doing the hard (and maybe impossible) work of building a real political union that could sustain a common currency — Europe has resolutely and repeatedly chosen the wrong road again.

It is tempting for some Americans, irritated by the smug condescension with which Europeans so often criticize America’s failures even as the United States assumes a greater portion of Europe’s defense burden, to gloat at the EU’s misfortunes. At Via Meadia we can’t do this. Europe’s peace and well being are too important.  Via Meadia hopes, indeed we pray, that Europe’s harried and flawed leaders can find a way forward now. America can manage in a world in which much of Europe is broke, weak and divided, but for us, for the Europeans and for the whole human race a successful and peaceful Europe is greatly to be preferred.

Published on June 19, 2012 7:08 am
  • Jacksonian Libertarian

    The only way forward is to dump the Euro, it was a bad idea to begin with, and trying to save it is a stupid waste of effort doomed to fail. It’s been said that, that which cannot continue won’t. But I expect that the European politicians will just keep kicking the can, until it becomes impossible. While it would be better all around if the Euro were dumped immediately while there is still some time, I don’t see any leadership in the EU willing to be responsible.

  • Wifman

    Amen!

  • Eurydice

    It’s an astonishing spectacle, isn’t it? Like watching some kind of slo-motion natural disaster – or being at the scene of a turning point in history.

    At this point, I don’t see what they can do. Abandoning the Euro is going to crush every country as the uncertainty drives all the money out of Europe – propping it up will leave Europe with years of underperformance. It’s like they have a choice between dreariness and despair.

  • Jacko

    This is a thoughtful and insightful essay by WRM. Although he and the rest of us pray that Europeans will find a way forward, it’s difficult to see how they can.

    What’s missing from WRM’s analysis and that of so many other economic commentators (David P. Goldman excepted) is the demographic factor. WRM mentions that Europe had a good run during the Cold War. While Europe benefited from great leaders during the early Cold War (e.g. Konrad Adenauer, Alcide de Gasperi), the main factor in Europe’s success was the demographic dividend – large numbers of young people entering the workforce and stimulating significant economic growth.

    Today, following the sexual revolution and the introduction of The Pill, southern Europe is in a demographic death spiral. Southern Europe’s fertility rate has been so far below replacement for so long now that there is probably no hope of recovery.

    There is no economy that has ever been able to grow in a society experiencing demographic decline. It is thus pretty well impossible to see how Europeans will ever grow their way out of this mess. The future for Europe is bleak.

  • Kenny

    Sooner (hopefully) rather than later, something is going to snap.

    It will like be a black swan, or maybe a flock of them, landing in the middle of the EU.

    And let’s recall what a black swan is. It is the occurrence of a low probability, high impact event that, in hindsight, should have been forecasted and prepared for but wasn’t.

    Could it be the disintegration of the EU compounded by an energy crisis?

    And the after effects of a black swan are unpredictable. They could range from war to societal collapse (full or partial) to the mass expulsion of Muslims.

  • giant_bug

    Can’t I gloat just a little?

  • Otiose8

    You are putting way too much blame on the Euro for what is taking place now.

    The Euro is not the primary cause of the current predicament of the Europeans.

    The first cause is the lack of discipline regarding using debt. The second would be the co-opting of the banking system (deposit/savings) into buying even more debt.

    If they had had some sort of discipline connecting how much being produced to what was being spent and if that lack had not been turbocharged by having banks buy up all the debt thrown their way (0 capital cost made it just too attractive) the Euro itself would not now be a problem.

    Demographics would still be a cause for concern, but it was the taking on of excessive amounts of debt that is the beginning and will be the end of Europe we now know.

    California does not have a problem with the Dollar and no one talking about its problems mentions the Dollar has somehow the root cause of its problems.

  • WigWag

    “The establishment of the euro was clearly one of the worst policy decisions of all time, right up there with Napoleon’s invasion of Russia. A united European establishment joyfully signed an agreement that would blight the lives and crush the hopes of tens of millions of Europe’s people. Many people warned of disaster at the time, but the European leaders were so arrogant and so ignorant (that most fatal of combinations) that they pressed on regardless.” (Via Meadia)

    Does Professor Mead count Charles Kupchan amongst the ranks of the arrogant and the ignorant? He’s one of the public intellectuals who was just sure that European unity would pose a threat to American leadership of the world.

    In 2002 Kupchan published a book entitled, *The End of the Amerian Era: U.S. Foreign Policy and the Geopolitics of the Twenty-first Century.* See,

    http://www.amazon.com/The-End-American-Era-Twenty-first/dp/0375726594

    As it turns out, Kupchan’s thesis turned out to be as remarkably wrong as it was provocative. Kupchan suggested that the era of American dominance was coming to a close. Kupchan suggested that the true challenge to American power would not emanate from Radical Islam or from China; the new world hegemon Kupchan assured us was sure to be Western Europe.

    Here’s some of what Charles Kupchan had to say,

    “One of the reasons that America’s moment at the top will be short-lived is that history is moving much more quickly than it used to.”

    “Now it’s going to be the Federal Reserve vs. the European Central Bank. If we don’t get that relationship right, there could be very serious implications. We are so used to being alone at the top that it’s going to be hard for us to get used to that.”

    “My guess is that by 2005 and certainly by the end of the decade, the Brits will be buying their fish and chips with euros and they will be one of the engines behind European integration rather than lagging behind.”

    “The split that we’re now seeing between Europe and America reminds me of the split between Rome and Byzantium that occurred in the end of the third century and into the fourth century. You had a unitary imperial zone divided into two, and once you had two separate capitals, Rome and Constantinople, you immediately had rivalry rather than unity. The same thing is happening between Washington and Brussels.”

    “Part of it stems from looking at what I would say are the wrong indicators. They look at the GDP and the military capability of the United States vs. other countries. If you do that, it doesn’t look like anybody is going to come close for many decades. I agree with that. But Europe is no longer a group of sovereign countries; it’s coming together just like [the United States] did [in the 18th century]. That’s why you have to talk about Europe as a collective entity and its ability to serve as a counterweight to the United States.”

    “…there are three ideological camps: the neoconservatives, who are unilateralists; the moderate centrists, who are essentially liberal internationalists of the sort that I advocate such as Father Bush, Brent Scowcroft, Henry Kissinger; and this new, young ascendant wing of the Republican Party represented by President Bush. That’s the heartland wing — the agrarian South and the mountain West. It’s populous and its inclinations are neo-isolationist.”

    “The E.U. takes the lead and says, “You want to drive SUVs and drill wells in the Alaska wilderness? Well, we’re going to go ahead with the Kyoto Protocol without you. You don’t like the International Criminal Court? We’ll do it without you.” Does it hurt the ICC that we’re not there? Yes. But does it also start building a world where you have these other countries coming together with major steps forward and we’re not there? Yes.”

    “We ought to say: Europe is rising, Europe wants voice, influence, and we’re going to make room. I don’t think that we’ve been doing that. We’re still in the mode of “How dare you challenge us?”

    “I spent less time on China in the book because most people exaggerate China’s importance. China is still a relatively small country economically with an economy smaller than California’s. Ten years from now China will be an Italy with nuclear weapons. Once you get into the second quarter of the century, 2025 and beyond, then China starts to begin to take its place as one of the top-ranking countries. Then, you might spend a lot more time worrying about China.”

    For more on Kupchan’s predictions go here,

    http://www.salon.com/2002/12/02/kupchan/singleton/

    Those tempted to see just how lame Kupchan can be should read his book “How Enemies Become Friends” or his incredibly absurd articles in “Foreign Affairs” on Kosovo.

  • http://nationaldebtprimerplan.blogspot.com/ GC

    I agree with Otiose8: the excessive use of debt by consumers and governments is a primary cause of today’s problems.

    Also, WRM writes in his excellent analysis:
    “A united European establishment joyfully signed an agreement that would blight the lives and crush the hopes of tens of millions of Europe’s people. Many people warned of disaster at the time, but the European leaders were so arrogant and so ignorant (that most fatal of combinations) that they pressed on regardless.”

    Do you have a little list of the arrogant and of those who opposed the Euro? If so, please share it.

  • Kris

    “Spain: Thanks for the $125 B, Can I Have $625 B More?”

    MOAR?!

  • Eurydice

    The excessive use of debt is actually a symptom of the Euro. The structure of the Euro and the misconceptions surrounding it caused a mispricing of risk. The discipline comes from the market. If the rates are too high, you can’t borrow as much.

  • Jim.

    A successful and prosperous Europe is greatly to be preferred, of course, but that success and prosperity will not exist without intelligent and sustainable decision-making.

    That means, no more debt.

    That means, recognizing what their means really are anymore and living within them. (Hint: they’re not as high as they were back when the world bowed to Europe, nor are they as high as the Socialists promise for all.)

  • Kris

    ???:

    The deadline for a group of auditors to present full reports on the capital needs of Spain’s financial sector has been delayed to September from July 31, a Spanish central bank source said Tuesday. The move has been agreed with Spain’s government, the International Monetary Fund and the European Central Bank, as well as the auditing firms — Deloitte, KPMG, PwC and Ernst & Young — themselves, this person added. The delay seeks to provide the auditors with more time to complete their evaluation of the banks’ books and also responds to the fact that many Spanish companies and government institutions are only thinly staffed in August, a traditional holiday month when the cabinet and parliament rarely meet, this person said.

  • Otiose

    Eurydice, I’m not sure I understand how excessive use of debt is a ‘symptom’ of the Euro – a unit of account.

    Governments via various means took steps to ensure funds would get sidetracked from private investment into financing government deficits or in other words they took steps to ensure market discipline was reduced or removed.

    If Basel I, which took effect in the early 90′s, had the capital costs for banks holding sovereign debt set at least equal to private loans (instead of 0), then the market would have had higher interest rates across the board as there would have been much less savings/deposits funneled into purchasing government debt. Less demand equals higher interest rates means much less would/could have been borrowed by governments.

    There is also a somewhat overemphasis on the total amount of capital in banks when a higher priority should be placed on how it’s calculated in general.

    For example, Bank A buys an insurance derivative from Bank B to cover its exposure to some asset with the cost of the insurance much less than the cost of the capital would have been. This reduces the total capital Bank A is required to carry because it has transferred the risk to Bank B.

    Bank B can do the same for its assets buying insurance from Bank C.

    And of course Bank C can buy the same insurance from Bank A.

    The total risk carried by the three banks is unchanged, but the total capital they are required to maintain has been nearly reduced to nothing.

    If a system wide disruption occurs all three banks may have all the capital that the regulators require and no where near enough to cover their exposures as each bank cannot collect on the insurance.

    An added twist in Europe over the last few years is that the hundreds of banks that got caught with far to much exposure to other countries sovereign debt have been reducing their exposures, which is good. But while the banks have been reducing exposures to other sovereign debt they have been increasing exposure to their own national debt.

    This is the unraveling of the pan European bank dream when over the last 20 years all the banks rushed to buy subsidiaries/set up operations across Europe.

    As home country politicians/regulators push each bank’s management to buy ever more home country debt, bank managements tried to pull cash from remote subsidiaries, but that in effect is withdrawing deposits from other countries, which those other country’s taxpayers would have to replace (assuming that they’re guaranteed). Those other countries rightly step in and halt such transfers. The result has been a crumbling of the internal funding networks of all the European banks as each country hoards its cash/resources to forestall facing the inevitable cuts to government entitlements and the size of government in general.

    In effect the banks have entered a death spiral with their national governments.

    The differing productivity rates between countries and cultures are hardly anything new.

    I believe that there were many other factors involved in the excessive growth in debt in the last ten (or twenty) years than just the adoption of the same unit of account across boundaries.

    Just one example factor that I suspect was much more important would be the globalization of the credit (high savings moving easily to low savings areas) that made itself felt worldwide manifesting in various ways. In the US easy and cheap (low interest rates) contributed to the excessive accumulation of debt – e.g. rise of consumer debt – and was a major factor making the housing bubble possible (along with many others).

    In Europe, many countries found the easy borrowing and low interest rates (across the board) irresistible and merrily financed entitlement redistribution schemes that Krugman admires so much about Europe co-opting their banks to ramp up the borrowing to unsustainable levels.

    Blaming the euro is just misdirection following a bright shiny object.

  • FDominicus

    Consider looking at your own debts. It may give you an idea that the USA is at least as bankrupt as either Greece, or Spain or the others you mentioned.

  • Otiose8

    I agree FDominicus. The US has its own version, but the end result – high debt and everything that entails – will be the same.

  • Eurydice

    @Otiose – I should have been more precise in my language – the excessive use of debt is a symptom of the imposition of the Euro. A country that can print its own currency will always be able to pay the debts denominated in its own currency (the worth of that currency is another issue). The rate a country will pay on that debt is determined by how lenders feel about the economic condition of the country and how that affect the currency. So, drachma-based debt would have been priced a relatively high rate that would discourage too much borrowing.

    With the switch to a common currency, each country should have been evaluated on its ability to earn Euros (not print them) and that’s a whole different way of evaluating risk. Technically, Germany’s credit rating should have gone down (or borrowing cost gone up), as the odds of being able to earn Euros were less than it being able to print Deutsche marks. But Germany’s borrowing cost stayed the same and all the others went down towards it. This was a misperception by the market and encouraged by the Eurozone countries. In effect, lenders were offering prime rates to bad credit – and borrowers took advantage of it.