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PORTSIDE  April 2011, Week 4

PORTSIDE April 2011, Week 4

Subject:

Europe's Crisis & the Pain In Spain

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Dispatches from the Edge

Europe's Crisis & the Pain In Spain

By Conn Hallinan

April 26, 2011

Submitted to portside by the author

When the current economic crisis hit Europe in 2008, small
countries on the periphery were its first victims: Iceland,
Ireland, and Latvia. Within a year it had spread to Greece
and Portugal, though the GDP of both nations-respectively
11th and 12th in the European Union (EU)-are hardly central
to the continent's economic engine.

But now the contagion threatens to strike at the center of
Europe. Spain, the fifth largest economy in the EU and 13th
largest in the world, is staggering under a combination of
debt and growth-killing austerity, and the balance books in
Italy, the Union's fourth largest economy, don't look much
better. Indeed, Italy's national debt is higher than that of
Greece, Ireland or Portugal, three countries that have been
forced to apply for bailouts.

Spain is a victim of the same real estate bubble that tanked
the Irish economy. In fact, house prices in both countries
rose at almost exactly the same rate: 500 percent over the
decade. A feeding frenzy of speculation, fueled by generous
banks and accommodating governments, saw tens of thousands of
housing units built that were never inhabited. There are
currently 50,000 unsold units in Madrid alone and, according
to the web site Pisosembargados, Spanish banks are on track
to eventually repossess upwards of 300,000 units.

Bailing out Ireland, Portugal and Greece has strained the
financial resources of the EU and the International Monetary
Fund (IMF), but rescuing Spain would be considerably more
expensive. If Italy goes-with an economy a third larger than
Spain's and more than twice as big as that of the EU's three
current basket cases-it is not clear the Union or its
currency, the Euro, could survive.

Given the current tack being taken by EU and the IMF, that
might not be the worst outcome for the distressed countries
involved. The current formula for "saving" economies in
Ireland and Greece consists of severely depressing economic
activity that is likely to lock those countries into a
downward spiral of poverty and unemployment that will last at
least a decade.

First, it is important to understand that the so- called
"bailouts" of Greece and Ireland, and the one proposed for
Portugal, will not "save" those countries' economies. As
Simon Tilford, chief economist for Center for European
Reform, points out, the money is being borrowed-at a high
interest rate-to bail out speculators in Germany, France and
Britain. It is German, French, British, and Dutch banks that
will profit from these "packages," not the citizens of
Ireland, Greece, or Portugal.

Indeed, Portugal was forced to ask for a bailout, not because
its economy is in particularly bad shape, but because
speculators in other EU countries drove up borrowing rates to
a level that the government could no longer afford. Rather
than intervening to nip off the speculators, the European
Central Bank sat on its hands until the damage was done, the
government fell, and Portugal was essentially forced to sue
for peace. The price for that will be steep: severe
austerity, brutal cutbacks, rising unemployment, and a
stagnant economy.

Spain and Italy are vulnerable to the same forces that forced
Portugal to its knees, only they are far bigger countries
whose economic distress will have global effects.

The current blueprint for reducing debt is to cut spending
and privatize.  But in a recession, cutbacks increase
unemployment, which reduces tax revenues. That requires
governments to borrow money, which increases debt and leads
to yet more cutbacks. Once an economy is caught in this "debt
trap," it is very difficult to break out. And when economies
do improve, cutbacks to education, health care, housing and
transportation put those countries at a competitive
disadvantage.

For instance, Spain has drastically cut its education budget,
resulting in a wave of "early leaving" students-at a rate
that is double that of the EU as a whole-and a drop in
reading, math and science skills. Those figures hardly bode
well for an economy in the information age.

The "cuts to solve debt" theory is being played out in real
time these days.

When the Conservative-Liberal alliance took over in Britain,
it cut spending $128 billion over five years, on the theory
that attacking the deficit would secure the "trust" of the
financial community, thus lowering interest rates to fuel
economic growth. But retail sales fell 3.5 percent in March,
household income is predicted to fall 2 percent, and
projections for growth have been downgraded from 2.4 percent
to 1.7 percent. In terms of British people's incomes, this is
the worst performance since the Great Depression of the
1930s. "In my view, we are in serious danger of a double-dip
recession," says London Business School economist Richard
Portes.

As bad as things are in Britain, they are considerable worse
in those countries that bought into the "bail out." Ireland's
growth rate has been downgraded from an anemic 2.3 to a
virtual flat line 1 percent, personal income has declined 20
percent, and unemployment is at 14 percent. Greece is, if
anything, worse, with a 30 percent jobless rate among the
young, an economy that is projected to fall 4 percent this
year, and between 2 and 3 percent the next.

If Portugal-with an unemployment rate of 14 percent-takes the
$116 billion bailout, it will torpedo what is left of that
nation's economy.

Even the managing director of the IMF seems to be taking a
second look at this approach. Dominique Strauss-Kahn recently
quoted John Maynard Keyes about the need for full employment
and a more equal distribution of wealth and income. He also
warned that bailing out the financial sector and focusing
just on debt at the expense of the economy is a dead end
strategy: ".the lesson is clear: the biggest threat to fiscal
sustainability is low growth."

Is this a serious change of heart by the organization, or
does one needs to take the IMF director's recent comments
with a grain of salt? He is rumored to be resigning this
summer to run for president of France as a Socialist. Hard-
nosed market fundamentalism is not exactly the path toward
heading up that particular ticket. And while Strauss-Kahn
says one thing, the IMF's board of directors-largely
dominated by the U.S. Treasury Department-has yet to signal a
change in course.

However, the director's comments may reflect a growing
recognition that "bailouts" that protect banks and their
investors, while locking countries into a decade of falling
growth and rising poverty, are not only politically
unsustainable, they makes little economic sense.

The next step is debt restructuring, which means investors
will have to take some losses-a "haircut," interest rates
will be lowered, and payments stretched out over a longer
period of time. So far, Greece and Portugal are refusing to
consider restructuring because it will affect their credit
status, but in the end they may have no choice in the matter.

"The basic reality is that we cannot service our debt," Greek
economist Theodore Pelagid told the New York Times, "We don't
need another bailout, we need creditors to take a hit."

Of course, there is always the Argentine approach: default.
Faced with an astronomical debt burden, a stalled economy,
and growing poverty, Buenos Aires tossed in the towel and
walked away from the debt in 2001. "The economy shrank for
just one quarter," writes Mark Weisbrot of the Guardian
(UK),"and then grew 63 percent over the next six years,
recovering its pre- crisis level of GDP in just three years."

So far there is no talk of defaulting by the financially
stressed European countries, but the subject is sure to come
up, particularly given the growing anger of the populace at
the current austerity programs. Hundreds of thousands of
people have poured into the streets of Athens, Lisbon and
London to challenge the austerity-debt mantra, demonstrations
that are likely to grow in the coming months as the full
impact of the cutbacks hit home.

Iceland recently voted to reject a 30-year plan to pay
British and Dutch banks $5.8 billion to cover their
depositors who speculated on Iceland's high interests rates.
Britain and the Netherlands are threatening to block
Iceland's EU membership bid if it doesn't pay up, but these
days, threats like that might be treated more with relief
than chagrin in Reykjavik.

The bailouts have had a devastating impact on European
politics. Governments have fallen in Ireland and Portugal,
and the Greek government is deeply unpopular. In essence, the
demands of banks and bondholders are unbalancing democratic
institutions across the continent.

Spain's unemployment rate is 20 percent, the highest in
Europe. If the EU and the IMF sells it a "bailout" similar to
the ones Ireland, Greece and Portugal accepted, Spain's
"pain" will be long lasting and brutal.

And Italy-with its decade-long 1 percent growth rate-waits in
the wings.

If Italy goes, the EU will be split between northern haves
and southern have-nots. Can a house so divided long endure?

Conn Hallinan is a Foreign Policy in Focus columnist. He also
writes the blog Dispatches from the Edge.
http://dispatchesfromtheedgeblog.wordpress.com/2011/04/06/libya-and-the-law-of-unintended-consequences/

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