A couple weeks ago the Italian Prime Minister Mario Monti announced that the Eurozone crisis was "almost over". He specifically said that Spain's financial problems were not a concern.
The very next day Spain was rocked by a general strike against austerity measures that shut down over 70% of the economy. In response, Jorge Fernandez Diaz, the Spanish interior minister, announced new draconian laws that would target online protest organizers.
The measures will make it "an offence to breach authority using mass active or passive resistance against security forces and to include as a crime of assault any threatening or intimidating behaviour," he said in Congress.
Spain is in a depression. Not that the media will tell you about it. They are still talking about the "danger of recession", despite the fact that the unemployment rate is north of 23%, and the youth unemployment rate is over 50%. Spain's GDP has been shrinking at an annual rate of -1% a year for going on 5 straight years.
It is in this depression that the government and international creditors are demanding extreme austerity. Support for the new rightist government is already collapsing. One has to wonder what the political limits of austerity will be. 30% or 35% unemployment? 70% unemployment in youth?
Spain is not Greece. It is Ireland
Greece arrived at the point of collapse because of unsustainable public debts. A problem that has only been kicked down the road by the recent bailouts.
Spain, like Ireland, had much lower levels of public debt when the 2008 crisis hit. Like Ireland and America, Spain's problem is enormous levels of private debt caused by a huge real estate bubble.
Spain's public debt may have ended 2011 at a relatively manageable 68.5% of GDP, but the Spanish private sector is awash in debt -- to the tune of 300% of GDP. And as the Irish debt crisis shows, if a country winds up turning unsustainable private debt into public debt, the deterioration of public finances can be stunningly fast.It is this scenerio that is causing investors to flee Spanish government bonds and driving up interest rates, thus pricing the Spanish government out of the market and making a bailout a forgone conclusion.
In 2007, Irish public debt was a low 25% of GDP. The country finished 2011 with a public debt-to-GDP ratio of 112%. And it's forecast to hit 120% when it peaks in 2013.
What happened? An Irish housing boom turned into a housing bust that turned into a financial crisis at the banks that issued the mortgages. And when the Irish government stepped in to rescue the banks, the private debt became a public burden.
But before we jump ahead to Spain having to bail out its banks, its the condition of Spain's banks we must look at.
Spain's banks are fast joining the ranks of the most unloved in Europe just as many need to raise capital urgently, deserted by investors who believe the country is on the brink of a recession that many lenders will not survive.Because investors are afraid of Spain's banks going under, those banks have been forced to turn to Europe's bailout fund, accounting for 63% of the borrowing.
Compounding the problem is what the Spanish banks did with those ultra-cheap loans from the ECB.
Andrew Roberts, credit chief at RBS, said Spanish banks used ECB funds to purchase five-year Spanish bonds at yields near 3.5pc in February and 4.5pc in December. The same bonds were trading at 4.77pc on Wednesday, implying a large loss on the capital value of the bonds.With the banks owning more and more of the government's debt, it becomes more and more unlikely that the Spanish government will allow the banks to fail.
It's a self-reinforcing negative cycle, as long as foreign investors believe that the balance sheets of the banks are going to get worse. Why would they believe that? Because Spain's property bubble continues to deflate.
Analysts at Citigroup suggest Spanish house prices could fall a further 20-25 percent before hitting a floor. This will eat further into the value of the 300-plus billion euros' worth of property assets on banks' balance sheets - 176 billion euros of which is already classed as "troubled" by the Bank of Spain.Unlike the American housing bust, where things are still getting worse but at a slower rate, Spain's housing bust is still picking up speed with an annual fall in prices of 11.2% last year.
Typical loan-to-deposit ratios, a measure of financial strength, show Spanish banks are already lending more cash than they have on deposit and the ratio is set to widen even further as unemployed Spaniards plunder their savings.
At this point it seems almost inevitable that Spain will be need to be bailed out. The problem is that Spain's economy is the 4th largest in Europe, thus making a bailout almost impossible given the current Euro structure.
On top of that, the current political reaction is for greater and greater austerity in the midst of a depression. Without some relief for the voters, it seems unavoidable that the current government will become more and more unpopular until it eventually collapses.
What will voters turn to? The socialists, because of their embrace of unpopular austerity, are even more unpopular. That leaves the door wide open for a far-right or far-left political party. Given Spain's history, either is just as likely.
Europe's leadership was able to protect the status quo because Greece and Ireland are so small. They don't have the luxury with Spain.
The status quo is between a rock and a hard place. It either learns to be more flexible or it will fail.