Friday, January 21, 2011

The Pain in Spain

has been bad enough these past three years without the curse of being associated with Portugal. The Spanish may have floated their economy on a credit-fuelled real estate boom during the last decade, but they have managed to fulfil the budget criteria for EMU membership for most of that time. Whereas Italy, Greece and Portugal only managed to enter the single currency with what was generously depicted as creative accounting, Spain demonstrated the steel and determination to bring down inflation, reduce unemployment and keep public finances on an even keel.You can read more about it here, in my book. It's only problem was moving too quickly to be sustainable.

Spain's principal problem is that international investors and European politicians don't distinguish between Spain and Portugal. When the original list of member states was being drawn up in 1998, Spain almost didn't make the cut despite doing its homework because of Portuguese problems rather than questions of its own merit. And the same problem is happening today. No one is entirely sure what toxic ooze lurks within the depths of Spain's mammoth banks, but there are good reasons to view Spain and Portugal differently. The most important is the political will and capacity of the Spanish to sort out inflation and public finances.

Today, late on a Friday evening, the Spanish government contacted me directly to let me know about a new statistical website they are setting up to inform people about their performance. The fact that there is a Portuguese election on Sunday is no accident in my estimation, and the Spanish are reacting appropriately. No matter what happens, election results have a way of unmasking the true face of public opinion and public demands. Portugal is going through the most unpleasant period of its young democratic history, and the resentment and frustration against discipline that contributes to Portugal's status as the poorer of the Iberian sisters is likely to be confirmed. That will typically lead to investor sell-offs and capital flight.

Spain's legitimate interest now is to convince investors as best it can that Spain is not Portugal. That is not only a good thing for Spain, but a good thing for Europe if it succeeds. That message needs reinforcement from other European governments, who must make a clear distinction between Spain and its western neighbour and underline that it's based on facts and a reputation for discipline. Spain will fight the good fight, but it will need help to deter an attack.

Or the first run on a major euro zone country will not be far off.

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