Could it be Spain rather than Greece that comes out of the euro first? There is an established queue of potential exits, led by Greece in the next year or so and followed by Ireland, Portugal and Spain. This would follow the sequence of applicants for bailouts, though Spain has yet to make its approach for eurozone support. That has rather been my own expectation of the outcome, which would take place over several years, but with the possible exception of Ireland, which may have cut its costs enough to stay in.
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But I have just been looking at a paper by Matthew Lynn at Strategy Economics, which suggests that Spain may leave first. Whether it proves right or wrong it deserves attention. Given the mis-steps that Spain is making in trying to refinance its banks and the sharp jump in yields on long-term Spanish debt, it will probably get it.
The thesis runs like this. The eurozone can afford to bail out Greece. For any country to leave would lead to short-term damage to the eurozone economies. So the cost of keeping Greece on board and hence the eurozone intact is worth it. Assuming Greece goes through the motions of trying to comply with any conditions imposed on it and assuming the Greek people want to keep the euro, it could be drip-fed with enough cash to keep it going as a member.
Spain is different and the paper gives six reasons why. First, it is too big to save, for even if the Greeks reject the present austerity programme, pumping 10 per cent of GDP into the country would cost only €23bn (£18bn), whereas for Spain the equivalent subsidy would be €110bn.
Second, Spain has tired of austerity before it has really taken hold: its first riots were a year ago.
Third, it has successful export industries, including the motor industry, and so has less fear about life outside the euro. Its problem was the property bubble brought about by too low interest rates, not a fundamental weakness of the economy.
Fourth, it is politically secure, with the self-confidence that comes from that. Greece wants to stay in the euro because it locks it into Europe, Ireland because it separates it from Britain, Germany because Europe represents a break with its troubled past, France because the euro boosts its prestige in the world. Spain has none of those issues and can leave if the euro is not working for it.
Fifth, it has bigger horizons as it is able to look outwards to booming Latin America for markets rather than look inwards to flagging Europe. Finally, Mr Lynn argues, the debate has already begun with several mainstream economists arguing that the country's principal problem is the euro and the country will only recover when it gets the peseta back. "The taboo has been broken."
Well that is the case for divorce. The key element here seems to me to be that Spain does have a strong intellectual case for blaming eurozone monetary policy on many of its ills. The flood of cheap money was the main cause of its problems, not an overly lax fiscal policy, at least at a central government level. You could say that better bank regulation might have trimmed the boom but higher interest rates – even rates at UK levels – would have helped restrict it too.
Besides, the level of austerity that Spain will have to sustain looks very difficult to achieve. At the moment the country is losing ground. As you can see from the top graph, in the first four months of this year the fiscal deficit amounts to more than 2 per cent of GDP, higher than the previous year. The absolute level of the deficit is lower than that of Ireland and Greece, but unlike Ireland (and like Greece) things are moving in the wrong direction. The green bars are higher than the red ones. You can see the running central government deficit in the bottom left-hand graph, with this year's out-turn materially worse than last year's. Estimates of last year's deficit have deteriorated too, with the target originally 6 per cent of GDP and the outcome now looking to turn out at 8.9 per cent (bottom right). Commenting on this slippage, Capital Economics notes that "the upward revision was described as a 'one off' caused by the inclusion of unpaid bills by regional governments over previous years". But even if it is a one-off, that does not explain the slippage at the moment, and of course once flaws in public accounts are revealed you wonder how much more stuff there is to come out. Oh dear.
Coming out of the euro would not help Spain tackle the structural problems within the economy: rigid employment rules, which protect those in jobs at the expense of the unemployed, and so on. But if Spain could devalue by, say, 30 per cent, that would give a big boost to demand and it might start clearing the property market too. Tourism in particular responds quickly to changes in exchange rates. The difficulty is how to do it without provoking capital flight. Why keep your money in Spanish euros when you can keep it in German euros?
Actually there is mounting evidence that capital flight is already happening. A note from Royal Bank of Canada's capital markets division yesterday concluded that funds were being shifted from soft eurozone countries to hard ones on a more general basis. The bank notes too that what is happening on the exchanges suggests that funds were being cleared out of the eurozone altogether and into dollars and sterling.
My instinct is the European Central Bank can hold the line for a while, recycling the cash being put into Germany and sending it back to banks in the southern European fringe. So expect another bout of action from the ECB, pumping more liquidity into the banking system. But this tackles the liquidity problems, not the solvency ones, and the Spanish banking system has plenty of those that need to be tackled fast.