It was only two weeks ago that Eurozone leaders were telling us that the crisis which has plagued the group of 17 member countries since late 2009 was all but over.
Speaking in Tokyo 28 March, Italian Prime Minister Mario Monti said that “The Eurozone has gone through a huge crisis, but I believe that this crisis is now almost over.” His bullish words were echoed by those of German Chancellor Angela Merkel who said that the crisis is ebbing and her country’s borrowing costs will probably rise as its status as a safe haven wanes.
Despite these pronouncements however, the pantomime that is the Eurozone debt crisis is back in the news, only this time the country front and centre is Spain.
Last week the nation attempted to sell €3.5 billion in medium-term debt, but investors brought just €2.6 billion. This lack of appetite for Spanish bonds shouldn’t come as any great surprise given the 75% haircut the EU recently imposed on holders of Greek debt.
The poor auction turnout quickly sent the Spanish ten-year bond yield to a high on 10 April of 5.98%. At the beginning of March the rate was below 4.9%.
Spanish bonds are now trading closer to the levels that forced Greece, Ireland and Portugal to seek their bailouts, and it’s a sign that Spanish banks have exhausted their LTRO money and can no longer prop up the nation’s public debt burden through back-door funding.
The European debt crisis will be with us for many years to come…
As I’ve written about before, the process of debt repayment (know as deleveraging) is a long a painful one. On average it takes 6 to 7 years for a nation to reduce its debt to GDP ratio by just 25%, and only three of the ten largest developed economies have begun the process of debt repayment. The rest have actually increased their debt burden, three of them, i.e. Japan, Spain and France, quite significantly.
Eurozone leaders would like us to believe that they are close to resolving the crisis, the truth however is that they are making it worse. Their plan, as far as I can work out, is this:
- Print money and give it to whoever needs it to prevent a systemic collapse or breakup of the Eurozone.
- Impose austerity measures on those nations most at risk of immediate default. (The hope is that these spending cuts will be enough to gradually reduce these nation’s budget deficits. For example it is hoped that by 2020 Greece’s debt-to-GDP ratio will be 120%.)
- Erode the debt burden through high and sustained inflation.
The problem with this plan is this:
- You don’t solve a debt crisis by going further into debt. You solve it by reducing spending. However…
- Austerity measures alone, without the necessary policy reforms won’t bring about a new wave of prosperity. Instead they create an environment of high unemployment (the unemployment rate in Spain is now 23.6%), which leads to lower tax receipts and higher welfare costs which inhibits the repayment of debt, and necessitates even more cuts.
- Inflation also destroys the value of savings, and without savings you cannot have investment, and it’s investment in new businesses, research, technologies, etc. that brings about the creation of wealth. Part of the problem is that for the past 20+ years we came to believe that wealth was created by borrowing and spending.
- The reality is that the debt crisis isn’t restricted to Europe. In fact, I believe that the next country to experience a serious debt crisis will be Japan.