Spain’s Unpleasant Choice: Accept Lower Wages and Still Higher Unemployment, Leave the Euro and Default
On the near 100% probability that Germany will not voluntarily give money to Spain, nor will Germany voluntarily modify its trade policies, the choices facing Spain are quite bleak.
Michael Pettis, writing for Carnegie Europe describes Spain’s unpleasant choices in Spain Will be Forced to Choose.
In the great debate over the economy we sometimes forget the simple arithmetic of economic rebalancing. This arithmetic, like it or not, severely limits the options open to Spain.
t is easy and popular to blame the greed of the Spanish and the stupidity of the government for the mess in which Spain has found itself, but the policies Germany put into place in the late 1990s guaranteed that Germany, a country that had run massive trade deficits in the 1990s, would run equally massive trade surpluses in the subsequent decade.
Because once they joined the euro the rest of Europe had no control over the value of their currencies and the level of their interest rates. It was inevitable that European countries that had joined the euro with a higher-than-average level of inflation would be forced to respond to German trade surpluses either by forcing up unemployment or by running the large trade deficits that corresponded to Germany’s trade surplus. No other choice was possible.
These deficits, as a matter of economic necessity, had to be financed with loans from Germany, leaving Spain with an enormous debt burden. Just as Spain could not run a trade deficit without borrowing from abroad, Spain can only repay its debt if it runs a trade surplus. What is more, since rich Spaniards are taking enormous amounts of money out of the country in order to protect themselves from the debt crisis they know is coming, the Spanish trade surplus must be large enough to accommodate both flight capital and debt repayments.
In practice there are only three ways Spain can achieve a sufficiently large trade surplus. The first way requires that Berlin reverse those policies that forced a German trade surplus at the expense of its European neighbors. Berlin must cut taxes and increase spending so much that Germany runs a trade deficit large enough to allow Spain to run the opposite surplus, which it must do if it hopes to repay the debt.
If Germany does not move quickly to reverse its trade surplus, Spain only has two other ways of creating a trade surplus in spite of German recalcitrance. One way requires that Spanish wages are forced down by many years of high unemployment. This will allow Spain to run a sufficiently large trade surplus.
Spain’s second option is to leave the euro and devalue. This will immediately force down prices and wages relative to Germany.
Neither option will be easy, but it is important that we realize that if Germany doesn’t adjust, Madrid has no choice but to pick one or the other. Both options will cause debt to soar in real terms, and will probably force Spanish businesses, and even the government into default. But in both cases Spain will begin running large trade surpluses.
As much as leaders in Madrid, Brussels, and Berlin hate to admit it, these are the only three options open to Spain. Any policy proposed by policymakers that is not consistent with one of these three ways will be impossible to achieve.
The only good options from Spain’s point of view are for Germany (or Germany and France) to bail out Spain with free money (not a loan) or for Germany to go on a massive sustained spending spree (no doubt accompanied by higher inflation), such that Germany’s trade surplus turns into a deficit.
However, those are not options Spain can choose. Those are options that only Germany can choose. The odds Germany voluntarily selects those options are roughly zero percent.
Spain gets to decide between these two choices
- Lower Wages Coupled With Still Higher Unemployment
- Leave the Euro and Default
For now, Spain has selected choice number one. How long can it last?
Yesterday I wrote Looking Ahead, Spain Worse Than Greece; Only One Realistic Solution.
The realistic solution of course is to “leave the euro and simultaneously undertake structural reforms” but in spite of 25.8% unemployment, Spain still sees things differently (for now).
The nannycrats in Brussels are starting to get worried because following massive protests in Spain, Portugal, Italy, Greece, and Belgium, the nannycrats decided Spain will not need further austerity measures in 2013.
However, a one year suspension in austerity is not going to do a thing for Spain in the long run.
Greece has missed budget target after target (see Greece Allegedly Gets Time, Not Money; Mish Says Time Is Money) and Spain is following smack down the same path.
Eventually Spanish citizens will have had enough and will force a change. The only question is how much pain Spanish citizens can take before that happens.
Mike “Mish” Shedlock