The Euro Zone’s Latest Weakest Link -- Spain


A currency union is as strong as its weakest link, and, for a while now, the working assumption has been that the euro zone’s weakest link has been Italy, and not without reason.

As I noted in a Corner post back in May:

Writing two days ago for Bloomberg, Alessandra Migliaccio, Luca Casiraghi, and Viktoria Dendrinou provide a useful summary of some of the issues that are coming to a head, even if they do not address the underlying causes of Italy’s woes: It cheated its way into a currency union for which it was clearly always unsuited, and was always going to be unsuited. The result has been to place its economy into a straitjacket from which it has been unable to escape. Italy has been in and out of recession since 2000 and now its weakened, heavily indebted economy has to deal with the consequences of COVID-19 and the economic destruction caused by the effort to contain it.

Bloomberg (in May):

The European Commission sees [Italy’s] gross domestic product shrinking 9.5% this year, after a 4.7% decline in the first quarter, the worst drop since the series started in 1995. That could swell its already massive debt to well over 150% of GDP.

By September, Fitch was forecasting a full year fall in Italian GDP of 10 percent. So far as year-end debt/GDP is concerned, other forecasters still are expecting a number north of 150 percent, some suggesting that it could go quite a bit of the way to 160 percent.

However, assuming that the “one-off” (?) COVID-19 rescue package approved in Brussels in July receives its final sign-offs, then Italy should be fine (for now), even if the structural problems it faces as a result of having a currency (the euro) for which it is fundamentally unsuited are not going away.

So how about Spain?


It used to be Italy that was seen as the bigger risk. But now officials in Germany, the region’s economic motor and the one paying the most money toward the European Union’s Covid-19 recovery fund, are worried by just how badly Spain is coping with the pandemic.

The resurgence in infections since the end of the summer has exposed the country’s vicious partisan divisions, with officials from the center-right regional administration in Madrid bitterly challenging new restrictions imposed by the Socialist national leadership. The result is a spiraling health crisis.

“It’s a political war and politicians are campaigning instead of acting united against the pandemic,” said Manuel de Castro, a doctor at Madrid’s 12 de Octubre hospital and a union leader. “We’re lacking leadership and a clear chain of command.”

For years, officials in the rest of Europe have been able to turn a blind eye to the acrimony and dysfunction in Spain as the economy kept humming along. But after the euro’s fourth-biggest economy plunged into Europe’s worst recession yet, they are being forced to take a closer look…

Once the virus hit, public administrations worldwide were put to the test. Spain and Italy were early epicenters of the pandemic in Europe. While Italy seems to have a handle on the second wave, Spain does not.

Spain has not had a stable government since 2015. But there was a degree of complacency about its ability to cope given that the economy had been barreling along on autopilot thanks to robust consumer spending and record tourist numbers.

But August saw a 76 percent drop in the figure of foreign tourists visiting Spain and a 79 percent decrease in spending by foreign tourists. In July the fall was 75 percent, and those are typically two of the strongest months for tourism in Spain. With rising rates of COVID-19, any autumnal revival seems unlikely.

The Wall Street Journal:

Tourism directly accounts for 12% of Spanish gross domestic product—more than any other member of the Organization for Economic Cooperation and Development—and employs 14% of the population.

Official figures suggest that half of the one million jobs lost during the depths of the outbreak have already been recovered. But there are an additional 735,000 being propped up by subsidized furlough programs. Many are tourism-related roles that will probably disappear as soon as support ceases. The real unemployment rate is likely well above 20%, rather than the official 15%.


The International Monetary Fund warned that Spain’s revival is under threat and that risks are “tilted strongly to the downside.” The Spanish central bank forecasts the economy could shrink as much as 12.6% this year.

Spain’s debt/GDP ratio may well exceed 115 percent by year-end.

As with Italy, the prospect of EU rescue funds (even if they take longer to arrive than once hoped) together with support by the European Central Bank in the debt markets, should ensure that a financing crisis will be avoided this winter.

But as with Italy, Spain’s underlying problem is that it is trapped in a currency union in which, quite obviously, it does not belong. To repeat myself repeating myself (this time from May):

Splitting the euro into ‘northern’ and ‘southern’ units has long been the least bad way to fix the mess created by the belief that a ‘one size fits all’ currency would work for such a wildly disparate group of economies.

But, sadly and madly, the necessary support for that idea is simply not there.

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