Anheuser-Busch Briefing Center, U.S. Chamber of Commerce
1615 H St NW, Washington, D.C.
Registration and Breakfast: 8:00 a.m.-8:30 a.m.
Over this past week, markets across the world were caught in turmoil. One major source of this upheaval was found, once again, in Europe. More specifically, Spain. Spain's bonds have reached interest rates once deemed unsustainable (over 6%), which in turn not only makes it harder for business to finance their work, but also undermines the ability of Spain to continue funding its deficits. For a country with over 23% of its workforce unemployed and an economy desperately in need of growth, this hurts. Spain's impact on world markets matters to businesses and investors elsewhere too. "Contagion" is the one word that should strike fear in the hearts of even American businesses, for no amount of EU aid can paper over a Spanish default on its over £700 billion in debt.
How are we to make sense of this and its impact on business? Matthew O'Brian of The Atlantic explains everything you need to know about the Euro crisis in 3 paragraphs:
Most explanations of the Euro debt crisis are about government spending. That's not accurate. The real story is all about capital flows within Europe. During the boom years, money poured into "southern" Europe. Sometimes governments borrowed it. Sometimes the private sector did. It didn't much matter which did. The result was the same: soaring wages and unsustainable growth. Once Lehman failed, though, the money spigot turned off. Southern Europe's economies promptly collapsed. So too did tax revenue. That left them with swelling deficits and uncompetitive labor forces due to too-high wages.
There's usually an escape valve for economies facing what economists call a "sudden stop": a cheaper currency. That lets them swiftly cut real wages and export their way back to health. But euro membership makes this impossible. That's left Europe's weak countries with no plausible path back to growth. At best, it takes years to get workers to accept nominal pay cuts. Prolonged stagnation from such an "internal devaluation" -- that is, pushing wages down and unemployment up -- has created the very real possibility that these countries might literally run out of euros. After all, they can't print euros themselves. Only the ECB can do that. And that has produced self-fulfilling fears. Investors worry that other investors are worried, and dump sovereign bonds. Borrowing costs surge. That pushes governments to cut even more spending, which kneecaps growth, which worries investors even more. And so on, and so on.
The final piece of this doomsday puzzle is Europe's banks. They hold huge amounts of sovereign debt. As bonds sell off, that makes banks look riskier. The riskier banks look, the more likely it is that they'll need to be bailed out. And the more likely that they need to be bailed out, the riskier Europe's sovereigns look. It's a negative feedback loop only a Eurocrat could dream up.
The surprising fact for Spain is that its national debt only totals some 70% of GDP (compared to America at over 100%), though a broader picture of real federal debt puts its ratio closer to 90% of GDP. Deficits are the real challenge for Spain. This year's budget will add another £60 billion to what Spain owes, and that's after large budget cuts were supposed to lower that number. As the budget cuts kicked in, economic growth took a nose-dive in reply, thus cutting into tax revenues. Once you figure in the banking liabilities and transportation funding issues facing Spain, the country is caught between a rock and a hard place.
We'll see on Thursday whether Spain can muster enough interest in its two-year and ten-year bond auctions. If not, and if yields continue their seemingly inexorable climb to 7%, Spain will face a funding crunch that will ripple throughout Europe and beyond. Something to keep an eye on this week.