Fasten your safety belts Australia. The euro is in danger of collapse via its banking system – a banking system that Australian banks depend on for a significant portion of their deposits and which funds much of our mining investment boom.
The usual caveat applies. Predicting the European end game is tough, if not impossible, but last night’s events multiplied the risks so, in my view, we are now much closer to the end of the euro, as we now know it, although the sorry saga could drag on for an extended period.
And any collapse will not come via Greece but via Spain because Spanish banks are in deep trouble and it has now become very difficult, if not impossible, to save them.
Spain is not Greece. It’s more like Australia without a mining boom. In the last decade Spain had a low budget deficit and government debt was not a problem. But the low interest rates that came with the euro saw Spanish consumers triple their household debt to buy houses, which skyrocketed in price.
A volley of European investors seeking a second home in Spain joined the locals to push house prices even higher. Then after the global financial crisis the market turned down and Spain responded with the dreaded austerity to balance the budget.
Spanish home prices have fallen by at least by 30%, with more falls likely. Two million homes in Spain are vacant and more are coming onto the market – 20% of residential mortgage holders have negative equity.
Spain’s unemployment rate at around 25% is the highest in Europe, and among young people it is over 40%. As an economic indicator, toll road revenues are down 28% and some toll roads are now bankrupted causing big bank losses. Others are on the edge of bankruptcy. The same applies to many once secure businesses. All these forces add up to huge bad debts for the banks.
The cash strapped banks are tightening their lending so worsening the situation and all the indicators are headed south. Whereas when faced with a similar crisis in sub prime, the US moved quickly to stabilise the banking system, neither Europe nor Spain appears to have the mechanism or the willingness to inject large amounts of equity in to the Spanish banking system.
And the money printing exercises that were so successful in the US can’t or are not being duplicated in Europe. The Europeans, via the central bank, tried lending the Spanish banks money and encouraged them to buy Spanish bonds, which then promptly fell in price making the banking loss situation far worse. It was a dumb idea which indicates that the politicians and central bankers have neither the powers nor the talent to solve the problem given a common currency,.
Remember that many other European banks have balance sheets that do not bare close examination because they have also lost their capital. In France, for example, toll road revenue is down 12% and, given the unemployment, French banks must be in deep trouble. But no one owns up.
Maybe someone will come up with a brilliant idea or the Germans will use their wealth to save the euro. But the Germans do not look like doing that and given the Spanish mess it may be beyond them. It will be incredibly painful, but if Spain leaves the euro it can start the long process of restoring its economy by taking the pain on the currency rather than via the jobs of the people.
But for bankers this is a complete disaster. And for the world it means that the biggest funder of global trade – the European banking system – will be deeply wounded for an extended period. The Spanish crisis is not only much more serious than the Greek fiasco but it takes Portugal with it.
This article first appeared on Business Spectator.