Spain’s Paradise Lost

Spain’s Paradise Lost

A political system so corrupt many believe it can’t be fixed, perhaps the weakest credit system in the world and the some of the worst macroeconomic indicators in the developed world. After last week’s insight into Cyprus, I now welcome you to Spain. A review of a country whose people once did not know how high they could climb, and now can only wonder how far they will fall.

“Something more will have to be cut”

As the introduction above suggests, the current situation in Spain demands attention, and the issues can be broadly split into three facets: politics, banking and macro-economic indicators. The range of political scandals currently emerging is literally too great to cover here, but the most prominent include an ex-mayor being accused of taking money from Russian mafia, the wife of a different ex-mayor suspected of money laundering and last, but not least, the prime minister being accused of taking mystery large ‘envelope’ payments from a £17.5m Swiss bank account set up by a former treasurer. At a time of crisis, accusations of elite corruption levelled at the prime minister are unwanted, particularly if that individual is already known for having all the creativity, charisma and leadership of a grapefruit. As the result of the actions of a few unscrupulous individuals, the public has now lost faith in the credibility of the entire political system, let alone their ability to get anything useful done (what else is new). Even the monarchy has not escaped the public anger and demand for truth, as the King’s daughter is a suspect in an upcoming fraud case.

Going back to root causes, it is clear that some banks simply lent far too recklessly. As seems to usually be the case, the banking implosion was matched by the collapse of the property bubble (in four years from 2004, property prices rose by nearly 50%). This has led to the usual spiel of loans, based on woefully inaccurate property valuations and given to people who could not afford them, having no value on the banks balance sheets, and suddenly no-one has any money. To make matters worse, the dramatic increase in unemployment has caused a huge drop in disposable income. Even a school-level economics student could tell you that this invariably leads to less demand, less goods sold and therefore businesses go bust as they can not afford to repay their loans. From October to December 2012, company bankruptcies were up 40% and once again, like a vicious circle, this leads back to more trouble for the banks. You don’t have to go very far back (a few years, in fact) to discover a time where Spain was seen as a potential global leader in multiple sectors, but it is clear now that a great deal of this promise was based on irresponsible lending and unrealistic property valuations.

The aforementioned collapse of the properly bubble also led to a complete halt in the construction sector. Not only did existing houses dramatically drop in value (most houses in Spain are now not undervalued, they’re just valued realistically and accurately, as they should have been in the first place), but also houses in the process of being built have been put on hold indefinitely. Due to various environmental conditions such as extreme heat and humidity, combined with the high wood content in many houses, Spain will actually have a massive task in knocking all these half-built places down, as they will rot without maintenance after a few years. Near where I live in Murcia, locals tell me as cost-benefit analysis goes, it makes more sense for people to illegally live in empty homes and risk being caught, than to live on the streets. There are huge areas of land where pavements, roads and the first bricks have been laid years ago, only for the whole thing to be fenced off, and left. The situation would be laughable if it was not so severe: so many people have lost their homes and so many homes have been abandoned prior to completing development, that homeless people can easily find places to stay, simply because the government and local police can not keep track of all these empty domiciles.

However the issues pertaining to property valuation, incomplete construction and the homeless don’t hold a candle to that of another: construction (un)employment. For a period of a several years in the property boom, to fulfil the tourism demand for holiday homes among other things, the construction sector experienced sensational wage inflation. It became common knowledge that leaving school at 16 to work on construction sites could often result in a salary equal to, or even greater than, the pay of a 22 year old university graduate working in another profession. This was fine, as long as the boom continued at the same rate, and for long enough to give the workers a life long career. Obviously, this was never going to happen, at some time point demand was always going to plateau, and result in an excess supply of construction workers. However, because it has dropped so suddenly, there are literally thousands of young construction workers with no other skills or experience, no academic diploma, no construction work available, no disposable income, no assets and no real prospects

Solutions to Spain’s problems only spawn further ones

When a country with a population of 47 million people has unemployment of 26% and youth unemployment (21-25) of over 50%, millions of lives are ruined beyond repair and an entire generation is lost. Longer term, it also will cause a further increase in difference between classes. Ironically, Europe was united by the Euro to relieve poverty and isolation, but the people of Spain are going to feel alone for a while now. Conditions, consisting of the middle class essentially being trapped without purpose, through no fault of their own, are ripe for rioting. The rise of last years protest group Los Indignados (who stand for social responsibility) illustrates this. The doomsday scenario of greater riots on a national, united and synchronised level, are now well within the realms of possibility.

Once again, the strict approach taken by Germany, by demanding Spain cut their budget deficit very quickly, comes under scrutiny as there are legitimate concerns that austerity measures could worsen the recession (although the situation is better, there is a similar debate going on in the UK, and I intent to cover this next week). However, it is fair to say that if you put almost any country in Germany’s position of superiority, they would take the same stance. As Spain is significantly larger than say Ireland, Portugal or Greece, the impacts of its failures are obviously greater for Europe. Regardless of what your parameters may be as an economist – there is no denying, and this is not over-dramatic, that Spain could quite conceivably split, collapse or destroy itself.

There are two main conclusions to take away from this – firstly that the combination of a wide range of issues coming to prominence simultaneously has lead to an unprecedented meltdown in Spain, resulting in the almost certain loss of at least one entire generation (and possibly another). The second concerns the implications for wider Europe. Spain’s current predicament is causing considerable unrest among investors, and the country is only one of a long list of European countries with a highly uncertain future.  In the next round of communications between Spain, the ECM and the IMF, one can only imagine a repeat of the conversation in Wall Street: Money Never Sleeps between Lou Zabel and Jake Moore, as one Spanish politician asks “Are we going under?”, and an EU representative replies “You are asking the wrong question. You should be asking who isn’t”.

Categories: Economics, Europe

About Author

Matthias Vermeulen

Matthias has extensive experience in equity & financial research and has worked in brokerage houses in London and Brussels. His specializes in the political risks, macro-economy & financial systems of both the UK and Europe. Matthias graduated with Upper Second Class Honours in BSc Accounting, Business Finance & Management at the University of York. He also graduated with a MSc Behavioural & Economic Science from the University of Warwick.