A Crisis in Full Flight

For a while, it looked as if the ECB’s €1 trillion credit program to pump liquidity into Europe’s banking system had calmed global financial markets. But now, with interest rates on Spanish and Italian bonds rising again, it has become clear that the ECB's policy has merely made a bad problem worse.

MUNICH – For a while, it looked as if the European Central Bank’s €1 trillion credit program to pump liquidity into Europe’s banking system had calmed global financial markets. But now interest rates for Italian and Spanish government bonds are on the rise again, closing in on about 6%.

Of course, this may not be the breaking point beyond which the debt burden becomes unsustainable. After all, interest rates in Southern Europe were well above 10% in the decade before the euro was introduced. Even Germany at that time had to pay bondholders more than 6%. Nevertheless, the markets are clearly signaling growing doubt about whether Spain and Italy will be willing to bear their debt burden.

The main problem is Spain, where private and public-sector foreign debt is larger than that of Greece, Portugal, Ireland, and Italy combined, and, as in Greece, is in the neighborhood of 100% of GDP (93% to be precise). A quarter of the labor force and half of Spain’s youth are unemployed, reflecting the country’s loss of competitiveness in the wake of the real-estate bubble inflated by cheap euro credit in the pre-crisis period. The current-account deficit remains at 3.5% of GDP, despite the recession-induced decline in imports, while economic contraction will cause Spain to miss its budget-deficit target again.

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