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Spain's Economic Crisis Shows the Eurozone Can't Escape its Debt Trap

By , Associate Editor, Money Morning • @DavidGZeiler •

Fresh evidence of Spain's deepening economic crisis has revived fears about that nation's ability to dig out of its sovereign debt problems, and illustrates why the Eurozone debt crisis is likely to drag on for years.

Spain's gross domestic product (GDP) was flat in the third quarter, the country's central bank said yesterday (Monday). That follows anemic growth of 0.4% in the first quarter and 0.2% in the second quarter.

Even more troubling is the nation's unemployment rate, which rose to 22.6% in September - the highest in the Eurozone.

As one of the PIIGS (Portugal, Ireland, Italy, Greece and Spain), Spain has been trying to wrestle down its high sovereign debt with austerity measures. Unfortunately, those measures are driving the Spanish economy toward recession, which is making it impossible for the government to hit its budget deficit reduction targets.

"It will be very difficult to meet the deficit goals without additional austerity, which might push the economy back into recession," Ben May, a European economist atCapital EconomicsinLondon, told Bloomberg News. May thinks Spanish unemployment could go as high as 25%.

Each of the PIIGS faces the same cycle of futility - economy-killing austerity measures that erode the nations' ability to cope with their debt issues, necessitating even deeper austerity measures.

But without the economic growth to create the wealth to cope with the budget deficits, the Eurozone debt crisis will gobble the PIIGS up one by one.

Like Greece

In Greece's case, its faltering economy led to a series of bailouts from the European Commission (EC), the International Monetary Fund (IMF) and the European Central Bank (ECB), to avoid default.

But the Greek economy is among the Eurozone's smallest. If the other PIIGS, particularly Italy and Spain, descend to where Greece has fallen, there won't be enough money to rescue them.

"Unless European economies outgrow their deficits, the chance of rolling bailouts working is slim to none," said Money Morning Capital Wave Strategist Shah Gilani.

Just last week European Union (EU) leaders developed a rescue plan to contain the Greek debt crisis and prevent similar problems in Spain and the other PIIGS. They agreed to increase the EU bailout fund to $1.4 trillion (1 trillion euros), step up efforts to recapitalize banks and write down Greek debt by 50%.

But not only will the plan fail to help the economies of any of the PIIGS, it's little more than a Band-Aid fix.

"The chance of the plan to save Europe actually working is exactly zero," said Gilani, pointing out that the bailout money simply isn't there and will need to be borrowed. Even then it will only be enough to "save Greece from defaulting for about three minutes, and enough to recapitalize all Europe's teetering banks for about four minutes, and enough to prop up Italy's bond market, for about six minutes. Oh, and when the seventh minute starts, they'll need more money all over again."

Spain's Conundrum

Spain had set a target of 1.3% GDP growth for 2011, which after yesterday's news is expected to fall to about 0.8%. That will push the debt to 67% of GDP, which is less than half of that of Greece but still double 2007 levels.

Hitting that growth target was supposed to reduce Spain's budget deficit from 9.2% of GDP last year to 6% of GDP in 2011. The target for 2012 is 4.4%, which looks increasingly unlikely.

"They will never make it," Ludovic Subran, chief economist at credit insurer Euler Hermes SA in Paris, told Bloomberg Businessweek. "Our September forecast sees Spain's deficit at 7%."

Moody's Investor's Service (NYSE: MCO), which two weeks ago cut Spain's credit rating for the third time in two years, said it expects Spain's deficit for 2011 to be 6.5% and fall only to 5.2% for 2012.

Not making its deficit-reduction targets will make it harder for Spain to borrow more money.

"Missing the deficit target would destroy private-sector demand for your bonds," Harvinder Sian, an interest-rate strategist at Royal Bank of Scotland in London, told Bloomberg Businessweek. "If you start seeing big figures like 7%, then it's very problematic."

Spain's economy also is suffering from a hangover from a burst housing bubble even more severe than the crisis in the United States. Real estate losses are still rising in Spain, adding to the risk it will fall further and further behind in meeting its deficit targets, which will push the country ever closer to a full-blown Greek-style crisis.

All of the uncertainty is eroding investor confidence in Spain's ability to solve its debt woes - which could end up lighting the fuse to the financial meltdown everyone fears.

At a recent seminar in Helsinki, noted economist Nouriel Roubini warned of just such an outcome, saying that both Spain and Italy would need a "bazooka" to "have a fighting chance to avoid insolvency."

"Once you have lost the market confidence, and the market doesn't know how much fiscal effort you're going to do, how much reform you're going to do, who's going to be your government, they put pressure on your spreads," Roubini said. "You look insolvent."

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