Spain and the EU face a serious dilemma. Several analysts have gone so far as to state that the euro will be made or lost in Spain. And while the markets seemed to welcome leaks of an imminent Spanish bailout, it might be one of those “be careful what you wish for” moments. Spain – it’s sovereign, banks, regional governments, corporations and economy – today suffers a market crisis of confidence. Estimates place (guess) the banking system’s capital shortfall in the wide range of between 40bn to 250bn euros. A full-scale Spain IMF/EU bailout program could tally in the hundreds of billions. The chatter is of some “bailout light” strategy that would tide Spain over – at least through the Greek election and its immediate aftermath. Do too little and the plan lacks credibility; promise too much and the markets will question where the money is to come from.
The Telegraph’s Ambrose Evans-Pritchard (“Spain too big for EU rescue fund as China recoils”) reminded readers of potential problems associated with the EU’s “firewall” facilities. The EFSF, for example, is backed by euro zone member/creditors. But once a country taps emergency funds it can longer back EFSF borrowings. So the firewall shrinks or the additional liabilities accrue to the other member states. There is also the issue of prospective market appetite for EFSF/ESM debt. Mr. Evans-Pritchard’s article noted that China’s sovereign wealth fund is backing away from European debt. Quoting the chairman of China Investment Corporation: “The risk is too big, and the return too low.”
I have written previously that Europe’s “firewall” was created with the hope/intention that it would never be deployed – a big bazooka that sits there with everyone just kind of assuming it’s loaded and operational. Well, it’s likely to be called upon in a big way and in a hurry. And when the headline crosses that Spain has requested aid, it might very well be seen as good news (“resolves uncertainty”) in the marketplace. I don’t expect it to be long, however, before serious questions arise as to the credibility of the bailout structure. Is the bazooka legit? Will global investors be willing to buy hundreds of billions of euros of EFSF/ESM debt in an environment where the marketplace surely will have serious questions as to the sustainability of the euro currency regime? Can bailout bond and the euro credibility persevere through the failure of a “core” euro zone country?
There were reports that Greek government revenues during May were down 20 to 25% y-o-y. No matter the outcome of the Greek election – or even whether Greece stays or exits the euro – there is little to suggest that this deeply troubled little economy will anytime soon end its status as a quite formidable financial “blackhole”. This post-Bubble dynamic makes one really fear for Spain – and the euro. I’ve believed that a preferred strategy – and perhaps the only hope for salvaging the euro - would have been to push the Greeks out of the euro to ensure that the full weight of policymaker attention and European resources could be deployed to “ring-fence” the euro zone’s vulnerable “core.” Over the coming days and weeks we’ll instead be faced with the spectacle of a failed periphery (Greece) and a failing core (Spain) perhaps working in concert to pull the fabric of the euro apart at the seams.
The view that this week provided only the opening policy response salvo is anything but unjustified. If things proceed in Europe (and globally) as I fear, we can expect the ECB to cut rates and implement additional liquidity measures, as the Fed moves forward with additional quantitative easing. The Chinese, Indians, Brazilians and others will stimulate in hope of sustaining faltering booms. And I expect all of these measures to have little, if any, constructive impact on deepening global Credit and economic crises. At the same time, the impact on financial markets is less clear. Even NYC taxi drivers are confident that policy measures are sure to bolster the markets. To what extent will the sophisticated operators now use generous market accommodation to head for the exits? It’s traditionally been referred to as “distribution.” Think Facebook IPO.