Too many factors of risk

For some time now, the fragmentation of the euro zone has ceased to be an impossible scenario. In Greece and outside it, the country’s exit from the single currency is seen as an increasingly likely denouement to the current situation. The German authorities and the ECB itself consider it possible, in view of the present difficulties in achieving the necessary political stability in the country. The effects such an outcome would have on the whole of the euro area are not easy to predict.

And this uncertainty, together with the perception that neither the EU authorities nor those of the most important national economies have the capacity to cope with such an outcome, produces severe market attacks on the public bonds of the most vulnerable economies, as well as on all variable-interest European bonds, and most especially on bank shares. What happened on Monday in these markets, as well as the turbulence affecting the euro, expresses a growing pessimism. This cloud hung over the meeting of the finance ministers of the Eurogroup in which, together with the Greek threats, attention was focused on the forecasts for the process of fiscal consolidation in Spain, and on the recent banking reform. Both aspects are now intimately related.

The deteriorating solvency of the Spanish banks, linked to the ever-more eroded value of their real estate assets and, in general, to the recessive panorama of the Spanish economy, constitutes the most serious threat to restoring Spain’s public finances back to health. In the absence of growth it will no longer be the heavy financial liabilities of the residential construction and development sectors alone that continue to deteriorate the capital of Spanish banks, reducing the forecast effects of the increase in provisions decided on at last week’s Cabinet meeting.

The necessary outlays of public money will rise, at the same time as tax revenue goes on falling, in spite of the hike in tax rates. Private debt, the original sin at the heart of the Spanish economy, will go on being converted apace into public debt, at a rate greater than predicted. And this is reflected in the risk premium on Spanish public debt, which hit its record high for the year on Monday.

In the absence of forceful reactions by the EU institutions, the specter of euro-zone fragmentation will take on greater probabilities, thereby aggravating the already severe damage done to these institutions. The preservation of the interior market itself is hard to conceive, were the single currency to be abandoned by some of the countries now most exposed.

The ECB needs to take exceptional action, purchasing public debt and increasing bank liquidity. Simultaneously, solutions must found for rapid stimulus measures for growth, to reduce the likelihood of recession and further shrinkage of employment. Otherwise not only the moral authority of the European Union, but its very existence, will be in jeopardy.