The Bane of Europe
“Thou hast seen nothing yet.” – Miguel de Cervantes, Don Quixote
In the late 15th century, fortune smiled upon Spain as it captured the Emirate of Granada in 1492, effectively completing the Reconquista of the Iberian Peninsula and ending Islamic rule that had lasted for 781 years. In the same year, Christopher Columbus, sponsored by Queen Isabella, stumbled upon the New World.
This moment marked the emergence of Spain as the first global powerhouse.
For the next two centuries, Spanish treasure ships ferried an immense wealth of gold, silver, spices, tobacco, and agricultural products from the Americas to Spain. The Spanish monarchy regarded this fortune as an everlasting bounty. Yet, this windfall came with significant repercussions.
Over time, Spain’s continuous influx of wealth became a sense of entitlement. The riches proved to be more of a burden than a blessing. Much like careless heirs or unprepared lottery winners, Spain mismanaged its fortunes through a series of costly blunders.
Wars of succession, the repercussions of Habsburg inbreeding resulting in the infamous Habsburg jaw, Napoleonic domination, the Spanish-American War, a Civil War, and many other events drained Spain’s resources and ultimately dismantled its empire. By the late 17th century, Spain’s decline was irreversible, relegating it to the role of Europe’s bane for the next 250 years.
A Golden Opportunity for Destruction
As the new millennium dawned, fortune appeared to favor Spain once more. On January 1, 2002, Spaniards replaced their pesetas with euros, and within no time, Spanish bonds began trading at rates comparable to German bunds, igniting a new economic boom.
The Iberian Peninsula basked in images of limitless prosperity reminiscent of the days when Spanish galleons laden with gold filled the harbor of Cadiz. Indeed, it had been ages since Hernan Cortes had brought such immense opportunity for ruin to the Spaniards.
Like many nations during the early 21st century, Spain became engulfed in a fervent property bubble. Property prices soared, and foreign trade deficits ballooned. Strangely, after years of economic ups and downs, Spain failed to recognize the dangers posed by easy credit and rampant speculation.
All was well in Spain until it suddenly wasn’t. In 2008, a devastating recession driven by the real estate market hit the nation hard. Unemployment skyrocketed from 7.6 percent in October 2006 to an alarming 22.8 percent by the end of 2011. Yet this was just the beginning…
With the economy contracting and debt levels rising, anxiety has begun to mount among Spain’s creditors.
Spain to ECB: Inflate or Die
Just last week, the yields on 10-year Spanish bonds surged to 5.84 percent, marking their highest rate since the European Central Bank initiated a liquidity injection into Europe’s financial system last December. Despite the higher yields, Spain managed to sell only 2.59 billion euros of debt, falling short of its maximum target of 3.5 billion euros.
Much like Greece, Spain is facing financial difficulties. However, unlike Greece, the sheer size of Spain’s economy makes it too significant for the ECB to bail out without jeopardizing the euro itself.
Spain’s GDP, based on 2010 figures, stands at $1.4 trillion, nearly double the combined GDP of Greece, Ireland, and Portugal. Furthermore, Spain contributes 8.6 percent to the overall GDP of the Eurozone. A bailout at this scale could create serious repercussions for the euro. Yet, what choice does the ECB have?
Spain’s situation suggests that the ECB’s existing Long Term Refinancing Operation (LTRO) may not suffice to stabilize the European financial landscape. Following Spain’s underwhelming bond auction, ECB President Mario Draghi acknowledged that the full impact of the LTRO would take time to materialize. However, rising yields could indicate that the anticipated effects may have already passed.
So, what lies ahead?
Much like the U.S. Federal Reserve’s quantitative easing, the ECB may find that creating money is much easier than stopping it. Spain is dependent on it, as are Greece, Italy, Portugal, and the entire EU. In other words, the ECB has reached a critical juncture: inflate or risk calamity.
Sincerely,
MN Gordon
for Economic Prism