Monday, July 30, 2012

The strain in Spain goes on for ... forever and a night?

Página 12's regular Paz & Rudy cartoon feature of 07/29/2012 spoofed the IMF's program for countries with debt troubles:

Reporter: Spain is following the recipes of the IMF, but the IMF is pessimistic about Spain.
IMF Spokesman: And yes ... Have you seen a country that did what we told them and had it go well?

Spain's interest rate on its 10-years bonds was running over 7% last week, even getting close to 8%. The 7% mark is generally considered unsustainable. This presumably reflects investors' judgment that the ailing Spanish economy that is running an austerity program in this depression that postpones recovery is becoming a bigger and bigger risk for paying back its debts.

Emma Ross-Thomas gives a decent summary of the current situation in the EU crisis in Europe's Brutal Game of Dominoes Bloomberg Businessweek 07/26/2012. But her opening lines are a reminder how volatile the situation is right now: "Remember Europe’s good old days? You know, June?"

The European Central Bank (ECB) chief Mario Draghi cheered the markets up last week by making a vague statement that the ECB was ready to do whatever it takes to make the euro work. But in another indication that short-run market turns may be based on something other than hard-headed analysis, there was no concrete policy commitments behind it, as Paul Krugman explains in Here Bee Draghi 07/29/2012. Short-run purchases of sovereign debt by the periphery countries by the ECB could provide more short-run help. But without making that a permanent policy along with making the eurozone a real fiscal and trasfer union and allowing the issuance of eurobonds based on the entire eurozone's credit, even more emergency ECB debt purchases is only a stopgap. As Krugman summarizes the currency zone dilemma, which experienced:

... massive capital flows from the core to the periphery, which led to an inflationary boom in said periphery, and which therefore also allowed the German economy — which was in the doldrums in the late 1990s — to experience a big gain in competitiveness and hence a surge in its trade surplus without needing to go through painful deflation. This meant, in turn, modest inflation in the eurozone as a whole — slightly above 2 percent over 1999-2007.

To keep the thing flying, you’d need something like a reverse play along the same lines: an inflationary boom in Germany, so that the periphery can regain competitiveness without devastating deflation. And it would actually have to involve a higher rate of inflation, both because the required adjustment is bigger and because the periphery is a smaller share of euro area GDP, which by the math means that overall inflation needs to be higher to accommodate a given amount of relative adjustment.

Nothing like that is happening. Germany is arguably close to full employment, but not in an inflationary boom; expected euro area inflation appears to be less than one percent.
And Germany's Finance Minister Wolfgang Schäuble gave yet another signal that German Chancellor Angela Merkel's government still insists on pursuing a minimalist approach to the crisis. In an interview with Welt am
, "Noch nicht alle haben unsere Strategie verstanden" 29.07.2012, he sang the same old song about Greece not doing enough to implement Angie's program of impoverishing itself and wrecking its entire public sector. And he pooh-poohed the notion that Spain is under dangerous financial pressure. Things are going fine he said, it's just that the markets haven't yet realized how wonderful the austerity program is. The markets, it seems, are more in line with the thinking of Paz & Rudy than with that of Angie and Schäuble.

He practically sneers at the notion that Spain's interest rates or general financial situation might be a problem:

"Der Finanzbedarf Spaniens ist kurzfristig nicht so groß. Die hohen Zinsen sind schmerzlich, und sie schaffen eine Menge Beunruhigung - aber die Welt geht nicht unter, wenn man bei einigen Anleiheauktionen ein paar Prozent mehr zahlen muss." ("Spain's financial need is not so big in the short term. The high interest rates are painful, and they cause a lot of uneasiness - but the world isn't coming to an end if one has to pay a few percentage points by some bond auctions.") Wow!

One of the factors facing Spain is how the economic crisis and the austerity policies piled on top of them are pushing Spanish provinces to the point they need federal help to pay their provincial government debts.

Krugman has been writing a lot about how currency zones like that of the euro can create pressure for "internal devaluation", which is what Greece, Ireland, Italy, Portugal and Spain are now experiencing. In Internal Devaluation, Inflation, and the Euro (Wonkish) 07/29/2012, he writes, "The current European strategy is 'internal devaluation', which means expecting Spain to cut wages and thereby restore competitiveness. ... The trouble with this strategy is twofold: it’s really, really hard to get wage cuts, and deflation in Spain makes the problem of debt overhang worse."

As he argues, part of a real solution would be that Germany would have to accept a period of higher inflation so that relative prices within the eurozone could adjust without economically suicidal and potentially politically disastrous results in the periphery countries. But Germany is dogmatically wedded to a "hard money" policy of low inflation no matter what. Without a quick and drastic change in political leadership in Germany, the euro is unlikely to be saved. And such a change is not on the horizon, much less the horizon for 2012.

To quote Krugman yet again, in Dornbusch's Law And The Euro 07/20/2012 he provides a guideline for what to expect in the euro crisis by quoted the late economist Rudi Dornbusch with reference to a Mexican debt crisis: "The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought, and that’s sort of exactly the Mexican story. It took forever and then it took a night."

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