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Mardi 30 Octobre 2012

Is Spain Following Greece?

By Keith Wade, Chief Economist, Schroders.

Following the news that Standard & Poor’s has cut Spain’s credit rating from BBB+ to BBB-, Keith Wade, Chief Economist at Schroders shares his view on the country and whether it is heading down the same path as Greece.

“What markets are waiting for now is for Spain to ask for assistance. Until Spain requests help from the European Central Bank (ECB) it won’t be able to act. Unfortunately the Spanish Prime Minister is playing a waiting game.

“Time is running out for Spain. If you look at the banking system and the level of deposits in the Spanish banks you can see that they are starting to fall and that happened earlier in the Greek economy. People in Greece began to believe that they might not be a member of the euro at some point in the future and started to take their money out of domestic banks and moved it into German or French banks, or into bunds. The same thing is now happening in Spain, where the danger is a run on their banks and potentially a Northern Rock situation in the Spanish banking system as a whole.”

The Eurozone’s hidden balance of payments crisis

“In the Eurozone you can’t depreciate your currency. If people are taking their money out of an economy, the currency doesn’t fall because it is contained within the single currency. However, what you will see at the ECB is a set of credits and debits going on and as money comes out of Spain it means that Spain is running a debit with the ECB because the ECB then transfers money to the Spanish banking system. That money means that there has to be a credit to the countries that have a surplus.

“For a long time the Target 2 system – the interbank payment system for the cross-border transfers throughout the European Union - was seen as an arcane bit of accounting that nobody was interested in. It’s now become important because the credits and debits across the system are very big and will become actual debts should a country leave the Euro. It could be described as the ‘hidden balance of payments crisis’ in the Eurozone. We know that capital is flowing out of Spain, Italy and Greece and going into the core countries, mainly Germany, which is racking up large credits whilst Spain and Italy and the other peripheral countries are racking up large debits.

“Whilst some might just see this as an accounting convention, if a country leaves the euro the Target 2 balances become an important issue as it leaves outstanding credits and debits that won’t be able to be paid. With credits now approaching €1 trillion across the Eurozone, the longer this goes on the more expensive it would be if a country were to leave. Countries such as Germany would be on the hook and therefore need to decide if they are happy to let countries leave the Eurozone and take a hit on this, or if they want to continue funding the peripheral economies.”

Where now for the euro?

“The problems in the Eurozone are likely to continue; it is not just going to go away.

“Unemployment is at frighteningly high levels in places like Spain; it is up at a quarter, 25% of the population are unemployed and youth unemployment is 50%. That to me is a failed economic policy.

“The problem as I see it is that these economies are trying to deflate their way out of a debt crisis so they keep tightening fiscal policy and trying to drive down inflation. If you drive down inflation, you make your debt problem more difficult to solve – in many ways that was the insight of John Maynard Keynes. Wages are falling in Spain and unemployment is still going up. As wages fall so does demand. Nobody wants to buy anything; there is no demand in the economy and nobody wants to create jobs. Economies can get stuck in a weak growth-high unemployment state - that was the Keynesian insight and that is what is being ignored in the Eurozone. We expect Spain to request a bailout before the end of the year.”

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