Thoughts on Spain
By Arnold Kling
1. The Washington Post pushes the “austerity” narrative.
The economic debate consuming Europe comes down to the question of whether struggling countries should choose austerity by clamping down on government spending to rein in unsustainable deficits or pursue growth stimulated by more spending.
From that perspective, who would cut government spending? Ever?
one of the major reasons the banking system is in trouble has to do with an unparalleled bubble that existed (and to some extent still does) in Spain’s real estate markets. Spanish banks continued to fund developers to a much higher extent than other nations that also experienced a housing bust, namely Ireland and the US – even after 2009.
Pointer from Tyler Cowen. I can recall (no specific link, but you can Google Spain countercyclical capital requirements banks) that Spain was once thought to be a good example, because its bank capital requirements were counter-cyclical. Thus, capital requirements go up when times are good, which should be a source of restraint. There were economists proposing such a scheme for the U.S. My guess is that you won’t hear much about that now.
3. John Mauldin writes,
the cajas, or Spanish regional banks, are worse than bankrupt. US banks are shut down when their nonperforming loans are at 5% of their capital. Spanish banks are at 20% and rising rapidly…This week the Spanish government basically nationalized Bankia, the nation’s 4th largest bank, which had been cobbled together from seven failed cajas and given a large government guarantee and a €3 billion public-offering equity infusion. Only roughly half of its real estate loans are generating returns, and that is the number for public consumption.
Read the whole thing (requires free registration).
Mauldin’s claim is that we are in what he calls the “endgame,” meaning that the Keynesian option of increasing government borrowing is no longer available to European countries. The only willing lenders are banks, which in turn need to be propped up, and ultimately they can only be propped up by printing money.
My take-away from Mauldin is that, contra the mainstream media narrative, the real dilemma in Europe is not fiscal–deciding whether to maintain government spending or not. The real dilemma is financial–whether to recognize losses and absorb defaults (by both governments and banks) or turn loose the monetary printing presses.
What will happen to inflation under the faster-printing scenario?
a) nothing. High unemployment will hold down inflation no matter what. Monetary theories of inflation will be shown to be wrong.
b) miracle cure. Yes, there will be inflation, but it will solve all of Europe’s problems. Real wages will fall, and full employment will ensue. Debt will be inflated away, restoring solvency to governments.
c) disaster. Inflation will rise without restoring full employment. Debt will be inflated away, but by the same token household savings will be inflated away. Europeans who see their wealth and incomes eroded will be bitter and resentful. Politics will turn really ugly. It will be less violent than in Germany circa 1930 only because the population has a much lower proportion of people under thirty.
Wouldn’t you say that (c) has at least as high a probability as (a) or (b)?
Mauldin has another piece (link may or may not take you to the correct article–look for “Clash of Generations”) where he quotes from Scott Burns, who co-wrote a book with Laurence Kotlikoff. He gives a fictional disaster scenario.
A major U.S. oil company had publicly called it quits on the greenback.
America’s economic death was quick and painful.
In short order, the dollar plunged. Interest rates soared. Bond and stock markets vaporized. Towns, cities, states, and businesses–large and small–started declaring bankruptcy.
Can you go from stagnation to hyperinflation that quickly? I have a hard time envisioning it. I guess if Greece goes off the euro, we’ll be able to see.
And then there’s this:
The U.S. fiscal gap now stands at fourteen times U.S. GDP. For Greece, this figure is roughly twelve times GDP. Compare the two numbers and you see the naked emperor: on a fiscal gap basis, the United States is in worse fiscal shape than Greece even though its ratio of official debt to GDP is roughly half that of Greece.
Have a nice day.