Monetary integration was meant to stabilise the European economy. It has instead spread contagion. It has also removed from indebted economies the ability to manage the exchange rate as a means of restoring equilibrium. Greece is the most pressing victim. Its weaknesses are now being replicated in Spain, which faces a lethal combination of recession and a banking crisis.
The immediate problem for Spanish policymakers is how to support Bankia, the country’s fourth-largest bank. Bankia is a conglomerate that was established in 2010 to rescue the operations of several regional savings banks. It has asked the Government for an injection of €19 billion to repair its balance sheet, in addition to €4.5 billion that has already been committed.
The Spanish Government does not have the money to rescue the country’s stricken banks. International investors know this. Spanish equity prices have fallen sharply this week. The interest rate payable on Spanish government bonds has risen to around 6.7 per cent. This is not far from the level where the country’s borrowing costs become unsustainable. Felipe González, the former Prime Minister, describes Spain’s position as “a state of total emergency”. That is no hyperbole.
Southern European states are engulfed in a financial crisis. In the years immediately preceding the creation of the euro 13 years ago, they enjoyed a one-off fall in borrowing costs. Average short-term interest rates in Spain fell by an extraordinary 10 percentage points between 1992 and 1999.
The predictable consequence, in the long boom of the early years of this century, was an expansion in credit, in which the newly liberalised banking sector acted as intermediary. It took the form of an almighty boom and bust in the property market. Spanish banks have huge exposure to the bad debts arising from this bubble.
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Bankia was intended to be part of the resolution of the problem. It has instead magnified it. The banking crisis has overwhelmed Spain’s public finances. The country had a budget surplus of 1.9 per cent of GDP in 2007. Within two years that budgetary position had been transformed into a deficit of 11.1 per cent. Uncertainty over how to deal with Bankia is prompting a flight of capital from Spain, intensifying the crisis still further.
On current policy, Spain is locked into decline. The country has fallen into a double-dip recession, which the Bank of Spain predicts will last at least another quarter. The unemployment rate stands at 24.4 per cent. Meanwhile, the need to recapitalise the banks is draining support from the Government of Mariano Rajoy in its commendable efforts to instil budgetary discipline.
European policymakers must face the implications of their misbegotten currency union. A common monetary policy was created without acknowledging that monetary union cannot work without fiscal union and enforceable constraints on borrowing. The entire scheme was an economic mistake that is now having severe political consequences, in the rise of extremism in Europe.
The only practical remedy, to restore confidence and allow indebted economies to make needed structural reforms, is for debt obligations to be shared, with the creation of eurobonds. It also entails that banks be regulated at a European rather than national level. None of this is palatable. But for Spain the choice is tighter eurozone integration, or the full break-up of the euro.