Spanish Economy in Dire Straits

By George Leong for Investment Contrarians | Aug 7, 2012

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Markets were disappointed following the decision of both the Federal Reserve and European Central Bank (ECB) to inject monetary stimulus into their respective economies. And like the Fed, the ECB will look to the bond market for help as it considers another bond-buying program for Spain in hopes of driving down yields with the country facing a financial crisis.

Yet the problem is that Spain needs help now, as the 10-year Spanish bond traded at an unsustainable yield of 7.2% on Friday, which could force the country to seek a bailout to avoid a worsening of the financial crisis. Spain says it doesn’t need a bailout but a loan.

ECB chief Mario Draghi said the central bank would help Spain once it formally requests a bailout. Spain has already received about $130 billion to avert a financial crisis in its fragile banking system. My view is the ECB wants to see Spain put together a tough austerity program in exchange for a bailout, but Spain is trying to avoid this.

A tough austerity program would bind Spain’s spending (but isn’t this needed?). The country is declining in its economic strength. Its economy has fallen to 12th in the world in 2011, according to the International Monetary Fund (IMF). Previously, Spain’s economy was the ninth largest, but with its financial crisis it has since been surpassed by Russia, Canada, and India. Regardless, a collapse in Spain would be devastating.

The thought of tough austerity measures in Spain is causing civil unrest. Just like Greece, the country is facing a financial crisis, a second recession, and an unemployment rate of 25%. The youth unemployment rate is a staggering 51%. So you think the U.S. jobs market is weak?

Take a look at the steady rise in the unemployment rate since 2006.

For Spain, fewer jobs translate into less spending. Retail sales in Spain plummeted 9.8% in April, followed by a further 4.3% in May and 5.2% in June, according to the National Statistics Institute. The decline represented 24 straight months of contraction. And since 2008, Spain has recorded positive retail sales growth in only three of the 54 months!

The massive reduction in spending means stagnant economic growth, which in turn, translates into less tax revenue for the government at a time when the national debt is estimated to rise to nearly 840 billion euros or about US$1.0 trillion by 2012, as reported by the IMF.

The Spaniards need to deal with this financial crisis and muted growth, but compared to the situation in the U.S., it doesn’t look all that bad. The U.S. has nearly $16.0 trillion in national debt. We all recognize the financial crisis the U.S. is in, but then that’s another story.

The reality is that Spain is critical to the eurozone in terms of its size and importance in the region’s economic engine. If Spain’s financial crisis worsens, as was the case with Greece, the aftershocks will likely be significant to not only the eurozone, but also the global economies, including China, which is Spain’s sixth largest trading partner since relations started in 1973.

I expect the situation in Spain and the eurozone will unfold over the next several quarters, but I do not see a clear-cut solution.

Tags: bond market, Federal Reserve, financial crisis, monetary stimulus, national debt, retail sales, unemployment rate