Spain Will be Forced to Choose

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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.

For many years, thanks partly to bad policies in Spain but mainly to aggressive attempts by Germany to achieve growth by forcing a trade surplus onto its European neighbors, Spain, and many other countries in Europe, ran enormous trade deficits. It 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.

This, by the way, is exactly what John Maynard Keynes demanded that the United States do in the late 1920s if it wanted to avoid a global crisis. The United States ignored Keynes, and the crisis occurred just as he predicted. Germany, with the same uncomprehending stubbornness today that the United States displayed in the 1920s, refuses to do what is necessary to prevent a crisis.

But, and this is the key point, 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. Part of the reason Spain can then run a trade surplus is that as wages drop relative to those of Germany, Spanish goods will become more competitive in the international markets. But the real reason why Spain will run a trade surplus after many years of unemployment is that Spanish workers will simply be unable to afford to buy much.

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.

For now, Spain has chosen the option of unemployment, in the hopes that it will be able to adjust and eventually resume to normalcy. No country, after all, can bear the pain that Spain is bearing today without a serious deterioration in the social and political fabric.

But both history and common sense teach us that the idea that after one or two more years of adjustment Spain will have resolved its debt problems and can bring unemployment down is nonsense. If Spain wants to continue along its current path, it must be prepared to suffer another five to ten years of extraordinarily high unemployment, an erosion of the productive capabilities of its economy, and rising political chaos.

Or it can leave the euro.


Comments (9)

  • Muppet
    Brilliant! Where is the data supporting the arguments? What happened to the Spanish property market?
    The article is a "propaganda" piece lacking supporting data, historical context, and proof. China Daily can do better...
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  • Questionaire
    > Germany, a country that had run massive trade deficits in the 1990s.

    In the 90s there was *one* year with a slightly negative trade balance. What are you talking about?
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  • Stratico
    Not even an hypothesis. No supporting information, research sources, or bibliography. But a reasonable pub chat nonetheless. However, to think Spain will be anything as a result of intervention or political action is plain daft. Spain's government has no clue how to generate economic growth, entrepreneurship, business strategy, or integrity. So what will be will be as a result of central European pressure so, as in this article, BLAME can be positioned anywhere other than Spain's government or politicians. The PP has a BLAME CULTURE.
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  • Alex Bramwell
    There is another option. That is for Spain to reduce the cost of starting a business and being self-employed and encourage entrepreneurship. Then the Spanish will be free to generate their own trade surplus via innovation and new exports. There are millions of highly intelligent, well-educated people in Spain who are either underemployed or unemployed. It's the biggest untapped pool of talent in Europe. Given the right conditions there is no reason why they can't generate Spain's future prosperity themselves. Or, like the Spanish government, do you think they are incapable of that?
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  • Miguel Otero-Iglesias
    Hi Michael, this is Miguel. I see that you insist on the possibility of leaving the euro. Please think for a moment on what life would be like outside it. I tell you, yes, we would devalue, but that would mean going back to the 1950s. We would be 50 percent to 60 percent poorer, we would have major inflation, major political instability (do not forget that we are a very unequal society) and, of course, this would mean that the European political integration project would collapse, with all that it implies. I agree that Germany needs to reflate its economy. No question about that. But if they don´t do it, the other option is debt restructuring in Spain, which I think is unavoidable. In any case, do not forget that the euro is a political project and it is very difficult to go back, for Spain and for Germany (all sensible people in Europe agree on this). Spain does not want to be in the second division. They will want to be in the first division, and of course, this means that they will have to pay a price. The price is to modernize as a country. I believe this is easier done within the euro than outside. Going back to the peseta will bring "pan para hoy y hambre para mañana". Bread for today (by devaluing), but hunger for tomorrow by being a underdeveloped and backward country outside the decision-making tables of core Europe. This is the real choice...
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  • Alister
    This seems like a pretty fair overview, Muppet.
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  • Rik
    What you are completely missing is that Spain is simply uncompetitive (and not only in relation to Germany). Like China, it will have to move to another business model to assure growth in the next decades (but Spain is not doing that).
    A Spexit and a devaluation will be helpful but will not do the whole job, not in a country that has to import so much of its goods.
    Staying in the EZ would require a huge drop of local prices (and they simply aren't currently dropping) to compensate the drop in wages somewhat. Now in the EZ we have the situation that prices are so high that you need double the wages of China to have the same PP.
    That will simply require, as part of the within the EZ solution, substantial deflation. This in turn will mean as all PIIGS will have to do that that the EZ as a whole will experience deflation. Germans simply will not accept inflation of a magnitude that makes the whole EZ go to a 2 percent inflation level. This is simply politically unsustainable.
    Choices are much more worrying and complicated than the ones you present.
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  • Fernando Fonseca
    The view is broadly right. Except that it does not get the right answer. That is that the management (politically and technically) of the euro being in a monetary union has to change completely and requires a clear orientation from the institutions. If the author's argument holds true, which is based on the assumption that one or some countries of the euro can act in their own and exclusive interest, one could question why the others were so foolish in adopting the euro. It is obvious that everybody assumed that the play would be fair and balanced, not blocked by the egotism of some. In the early 90s, most EU countries had to bear the burden of Eastern Germany joining the EU. Yes to the EU, not only to West Germany. At a huge cost. None blocked the joining though. So let´s learn from the past and look farther ahead. Is anyone sure that in the future the so-called North will not experience rough times? Just imagine a disruption of the Asian economies or a cut of gas supplies from Siberia. So everyone in the EU has to think very seriously if the EU and the euro mean a joint effort to the ups and downs of the economy. If it is not a joint effort, then it is better to scrap the EU idea.
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  • Thiago
    Ah, but everyone's in a rut. Not to discount Spain's problem, but between America's debts, and even rising bankruptcies in Canada, and countless concerns elsewhere, its hard to say who's in the most dire straights.
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