spotfxtrader

Sitting here watching the €uro get hammered on the Greece rumour, I was idly trawling through some of my favourite sites and re-read this piece from Gonzalo Lira written a while back [December 2010]. Seems that now the pressure is off the USD, (obviously, now Gold and Silver have had a ‘correction’), attention has turned again to the other problem currency.

☞ Possible EMU Collapse: What To Pay Attention To In 2011

After the Greek and Irish bailouts, it looks like Portugal and possibly Belgium are up next in this perverse game of musical chairs played to the tune of sovereign debt—

—but these smaller countries are dwarfed by Spain: Spain, as I argued here, is where the European game is really at.

As I pointed out, Spain is twice the size of Greece, Ireland and Portugal combined—Spain is roughly half the size of Germany—Spain has a fiscal deficit of over 11% of GDP for 2010, and a total debt of over 80% of GDP, data here (I am counting the accumulated debt of comunidades autónomas, which is so far 10.2% of GDP and steadily rising; data here)—Spain has an unemployment of over 20%—

—in short, Spain is trouble.

Not “Spain is in trouble”—that’s obvious, but that’s not my point: Spain is trouble. Trouble for the German banks that own so much of the Spanish debt. Trouble for Germany, which is propping up its insolvent banks (What, you think German politicians are any less craven than American politicians?). Spain is trouble for the European Union, for what a German banking crisis might mean for the EU as a whole and as an institution.

More than anything, Spain is trouble for the European Financial Stability Facility, because Spain is too big to be saved—and there’s really no way to finesse that hard fact.

You know what a lynchpin is? Actually, I didn’t—I had to look it up. According to the dictionary, a lynchpin is “a pin passed through the end of an axle to keep the wheel in position”. Hence the figure of speech: Without a lynchpin, the wheel comes off, and the whole vehicle crashes.

In the case of Europe, the lynchpin can come off awfully fast—think of Ireland. A few impolitic words from Angela Merkel, and suddenly the Irish bond market panics. Suddenly, Ireland is teetering on the brink of insolvency, unable to meet its funding needs. And that was Ireland—all due respect to those wonderful people, but we’re talking a GDP of a paltry $227 billion. Ben Bernanke takes a morning dump bigger than that. What’s Ireland’s $227 billion when compared to Spain’s economy of $1.5 trillion?

Spain: During 2011, Spain will be the flash-point—so you want to keep one eye on Spanish sovereign bond spreads, and one eye on Brussels:

When Spanish debt spreads over German bunds creep into the 3.5% to 4% range, you know trouble is coming. And when the Spanish spread decisively crosses 4.25% over the German 10-year, then you know trouble’s arrived—and it won’t be leaving town ‘til it’s had its chance to run riot in the streets.

How the EU and the ECB handle an eventual Spanish sovereign debt crisis will determine the very future of the European Union.

Because there will be a Spanish sovereign debt crisis—it’s inevitable. The Spanish balance sheet is not improving fast enough, even with so-called “austerity” measures, because even though the Spanish government might be cutting spending, the comunidades autónomas—roughly analogous to states or regions—are expanding their budgets in order to take up the slack, and thereby increasing the Spanish deficit. Don’t believe me? Check the figures I just cited.

So when Spain goes into crisis—which should take place no later than August 2011, and perhaps as early as this coming March—the European Union’s collective and institutional reaction to this crisis event will determine whether a smaller, healthier European Monetary Union continues to exist, or whether the whole concept of EMU is ripped to shreds by events.

If the EU and the ECB are clever, and brave, and humble in the face of failure, then they’ll expel Greece, Ireland, Portugal, Spain and Italy from the European Monetary Union. The euro will remain the currency of the stronger economies—France, Holland, Germany—while the weaker economies will go back to their original currencies, and immediately devalue so as to kickstart their economies.

If, however, the European Union and European Central Bank leadership proves to be stupid, cowardly, and arrogant—as is very likely, considering their confused, self-defeating actions and reactions to the Greek and Irish crises—then there will be some sort of European-wide convulsion, when the bond markets panic, and leave Spain locked out of any funding.

This is the key event of 2011: Whether the European Monetary Union survives. Unless Brussels gets its collective shit together and realizes it has to cut the weaker economies loose from the euro, odds are high the euro goes the way of the dodo.