Capital Flight may sound like the name of a new budget airline – in fact it’s what happens when a country loses trust in itself. In the first three months of the year, Spaniards exported a total of e100 billion to London, Frankfurt, Paris – anywhere. The biggest flight of funds since records began. Citizens, firms and banks are hedging against the likelihood that Spain will depart the eurozone, crushed by the burden of its sovereign debts. The respected former Spanish premier Felipe Gonzales said last week that “Spain is in a situation of total emergency, the worst crisis we have ever lived through”.
Where did this come from? It was supposed to be Greece that was on the point of departure. Only last week we were all worrying about contagion from a “Grexit” spreading to other Mediterrannean countries. But the contagion seems to be happening before the disease. In fact, there’s a possibility the patient may die even before it is infected, because the collapse of Spain – an economy four times the size of Greece – would be curtains for Europe, and probably for the world economy. It’s not just too big to fail; it’s too big to bail.
What is happening to Spain is similar to what happened to Lehman Brothers in autumn 2008, except on an epic scale. That was just a run on a Wall Street investment bank; this is a run on a trillion euro economy, the fourth largest in Europe. When entire countries go bust the reverberations are felt across the planet.. If Spain restores the peseta – and this is actually being talked about – then it would default on the huge debts owed by its private sector to international banks. They would go bust as a result, causing credit to cease overnight and international trade grind to a halt. There would be runs on nearly all European banks, not just the Spanish ones. Cash machines would close. It’s as serious as that.
So, another lazy, corrupt, Club Med country that’s spent more than earns? Not a bit of it. Spain is a model of fiscal rectitude. People pay their taxes and work very hard. The Spanish state has not been living beyond its means, in the way the UK or Greece has been. In the years up till 2008 it was running a balanced budget with a zero deficit. Yes, zero. Spain’s government debt ratio even now, is smaller than Germany’s.
So, what has gone wrong? Well – the European Union’s deranged and deflationary austerity programme is the short answer. But there is of course more to it than that. As anyone who has holidayed in Spain will know, the country has been a construction site for the last decade or so. It has experienced the greatest property price bubble in Europe – even eclipsing Ireland’s housing madness. Everyone thought they could get rich quick by throwing up blocks of cheap flats and selling them to foreigners – mostly British and Germans.
As late as 2007 Spain was building 800,000 houses a year, seven times as many as Britain. That’s all over. As a result unemployment has leapt to 24% and more than half of Spanish young people are without work. It all happened so fast that even the militant left has had difficulty keeping abreast of the crisis. There have been street demonstrations from the so-called “Indignados” but the Left has largely been marginalised. In the recent elections the Spanish socialist workers party was thrown from office and the conservative Premier Mariano Rajoy installed on a promise to balance the books and restore growth.
All that has happened is that cost of Spanish debt has rocketed to nearly 7% – the unsustainable level that should trigger an EU/ECB bailout. But that isn’t going to happen because no one knows how much is owed by the bankrupt Spanish banking sector – estimates range from e100bn to e180bn. Senor Rajoy has been appealing in vain for help from the so called “Troika” the European Union, the European Central Bank and the International Monetary Fund to come up with some big money. He wanted the ECB to lend directly to bankrupt Spanish banks. But this is against the rules of the ECB, so Europe has been sitting on its hands waiting for something else to turn up. But it won’t. Italy is in a similarly desperate situation with a run on its sovereign debt. If Spain, Greece, Portugal, Ireland and Italy all go together – and that seems increasingly likely – the EU coffers could be emptied within the click of a computer mouse.
The EU is paralysed, unable to mobilise the political will to create a rescue that would be large enough to meet the scale of the disaster. The European Stability Mechanism has around e700 billion to draw on, but no one believes that will be nearly enough. The danger is that piecemeal bailouts waste hundreds of billions of taxpayer wealth without solving the underlying problem. As Mario Draghi the boss of the European Central Bank said last week, the euorzone is now “unsustainable” without dramatic action from national governments. The danger is that we have all been living with this crisis for so long that when the fat lady finally opens her mouth, no one hears it.
What must happen is this: there needs to be a European wide bank deposit guarantee to stop capital flight and bank runs from playing havoc across Europe. There needs to be direct recapitalisation of national banks by collective European financial institutions – national governments no longer have the fiscal fire-power to do this. This may be creating moral hazard, but that is better than risking another credit crunch which is what widespread bank closures would cause right now.
Government debt of all European countries must be combined into one big debt pool and bonds issued to finance it, backed by the entire economic and fiscal resources of the EU. This would end the absurd situation where a prudent country like Spain finds itself, overnight, saddled with a massive deficit simply because of the excessive interest it has to pay on its government debt. The cost of all debt in Europe should be the same. Europe must collectivise risk.
Like wildebeest pursued by jackals, Europe needs to unite in a big, bad ass herd to see off the predators. Right now, the wiledbeest-in-cheif, Germany, is unwilling to go along with this fearing that it might be landed with the bill. But I suspect it will see sense very soon. There really is no alternative, as manufacturing slumps across Europe and unemployment rises to a record 11%. Germany itself will soon become a victim of its own fiscal monomania.
But this will mean a lot of changes to the European Union, not least to the treaties, which could cause problems down the line if national electorates don’t like this pooling of European risk. It will raise all manner of questions about democratic legitimacy since this would be tantmount to setting up a European federal state without there being a federal democracy. And, it would in a very real sense create a bankers’ Europe. But the single currency has made this essential, and it will have to happen. The referendum in Ireland suggests that even the most sceptical electorates realise that there is no alternative but to stay in the eurozone.
And where stands the United Kingdom in all this? Well, sitting pretty for the moment, since a lot of the money flying out of Spain, Greece, Italy is ending up in the London property market. We are a safe haven in every sense of the word. The cost of British government borrowing is almost as low as in Germany. However, there is no way we can remain aloof for long. If the eurozone disintegrates, and that looks like a 50/50 call this weekend, there will be a depression and competitive devaluations across Europe.
Government debt in Britain is vastly higher than in poor maligned Spain, but because we can still print money and devalue, we have avoided a sovereign debt crisis so far. However, there is no room for complacency. And confidence in the UK economy could soon evaporate if the Coalition government doesn’t get its act together. Last week’s catalogue of budget u-turns on pasty taxes, caravan taxes, charities etc suggests that our economic management is a few shillings short of the full pound.
The best estimate now is that if Europe doesn’t get its act together in the next fortnight, the combination of the new Greek elections, and a botched bail out in Spain, could bring the entire European project to an end as countries re-invent their old currencies, retreat inwards and try to erect currency barriers to international trade. The politicians now in charge of Europe have a choice: they can act with wisdom, imagination and energy now to move Europe to a new level. Or they can face the condemnation of history for plunging the continent into chaos.