Spain's Band-Aid on Europe's Bigger Problem

by John M. Curtis
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Copyright June 13, 2012
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             Promising to bailout Spain for 100 billion euros or $125 billion, the Eurozone kicks the common currency can down the road for only a short time, maybe long enough to satisfy Wall Street before next November.  President Barack Obama sees his fortunes tied to Wall Street, a key part of U.S. economic recovery.  Without a sustained Wall Street rally, publicly held companies don’t have the cash needed to start hiring again and driving economic recovery.  “The system . . . is the Spanish government bails out Spanish banks and Spanish banks bail out the Spanish government,” said Columbia University Nobel-winning economist Joseph I. Stiglitz, concerned that Spain’s bailout won’t fix the real problem in the Eurozone:  The lack of a common tax base.  Without a common treasury, Eurozone’s more prosperous countries, especially Germany, must revenue- share with struggling states.

            Borrowing more cash solves short-term liquidity problems in Spanish banks but pushes the all-important Debt-to-GDP ratio over the Eurozone standard of 3%.  When Greece’s Debt-to-GDP ratio topped 15%, the country was considered insolvent, threatening to take down the entire Eurozone.  Spain currently reels from a housing bubble crash, much the same as the U.S. in 2008.  Bad loans and bad derivative investments have left Spain’s biggest banks out of cash.  Frankfurt-based European Central Bank has refused to print more euros and pile up more collective debt, heaping the pressure on Eurozone’s more prosperous countries.  Resentment builds daily in Germany’s Bundestrat and Bundestag, upper and lower houses of parliament, over Germany’s expected role as the Eurozone’s bank.  German politicians don’t like bailing out Eurozone’s weaker economies.

            When the Eurozone launched in 1999, it expected to boost the prosperity of participating countries.  Going on the euro was supposed to reduce historic currency devaluations, especially among more struggling economies.  Sacrificing the ability to print currency, Eurozone countries were forced to live within their means or answer to the ECB.  It didn’t take long to less export-based economies to run in the red and out of cash.  Spain’s banking system needs an emergency cash infusion or faces defaulting on government debt.   German Chancellor Angel Merkel has urged all struggling Eurozone countries to belt-tighten, keeping Debt-to-GDP ratios around 3%, reducing state salaries and retirement benefits.  With all of Europe’s socialized programs, including health care and retirement benefits, the costs per capital are far higher, at least currently, than the United States.

            All sovereign nations need to manage budgets in a responsible manner.  When joining the common currency, each country gives up its right to print more currency to supply cash to banks or pay the hefty prices for social welfare and retirement benefits.  “It’s Voodoo economics,” said Stiglitz, referring to Spain’s banks needing cash from the government and the government needing cash from banks.  Stiglitz believes the common currency is failing because there’s no common tax base and treasury to handle today’s liquidity problems.  “It’s not going to work and it’s not working,” referring to a cash-strapped Spain’s need to continue borrowing at high interest rates.  Borrowing more and driving up the Dept-to-GDP ratio drives up interest rates and discourages bond investors from buying Spanish paper.   Merkel’s austerity measures do nothing to promote Eurozone growth.

            When recession strikes in the U.S., the government—through the U.S. Federal Reserve Bank—buys up treasury bonds, in what’s known as “quantitative easing,” and generates public works jobs to fuel the economy.  Stiglitz doesn’t see how the Eurozone plans to increase business spending, corporate expansion and jobs creation by forcing governments to cut back spending.  Stiglitz, an old fashioned Keynesian economist, believes that governments must spend their way out the recessions.  Merkel’s belt-tightening and austerity measures slow the pace of economic recovery.  Merkel believes that austerity measures lower Debt-to-GDP ratios, reduce borrowing costs and improve governments’ cash flow.  “Germany keeps saying that the strengthening is fiscal discipline but that is a totally wrong diagnosis,” said Stiglitz, urging the Eurozone to work on creating a common tax base and treasury.

            When Greeks go the polls June 21, they’ll decide whether to stay on the euro, an ominous prospect for the Eurozone, Wall Street and U.S. economy.  No one wants to see Greece become the contagion that brings down the Eurozone, decimates Wall Street and damages the U.S. economy, especially Obama.  “I think the price they will pay if the euro falls apart will be greater than the price they will pay for preserving the euro.  I hope they will come to realize that, but they may not,” said Stiglitz on the prospects of Germany pushing the Eurozone into real fiscal reform.  Before the Eurozone creates a common tax base and treasury, Germany will have to revenue share or face the end of the euro.  Merkel’s austerity measures drive the Eurozone’s struggling economies out of the common currency.  Only Germany sharing more revenue now and working toward real fiscal reform can save the euro.

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