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Euro plunges as Spain cuts deeper

The euro sits at multi-year lows against both the pound and US dollar this week on the back of Spain's latest batch of tough austerity measures.

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Changes over one week:

GBPEUR: 1.254 to 1.267 (+1.037%) – Highest point since October 23, 2008

USDEUR: 0.807 to 0.82 (+1.161) – Highest point since June 18, 2010

Oh, Spain! As you can see above, the euro sits at multi-year lows against both the pound and US dollar this week, giving you a good opportunity if you intend to emigrate to the continent, or snap up some Eurozone goods.

Yet the reasons for the euro’s decline could be better. Spanish Prime Minister Mariano Rajoy has announced another €65 billion in spending cuts for the Iberian nation, already widely discredited as the best way to keep Spain in recession. (For instance, Jeremy Warner of telegraph.co.uk notes, “The Eurozone’s appetite for self-harm knows no bounds.”)

Rajoy announces new cutbacks 300x200 Euro plunges as Spain cuts deeper

What's to applaud? Rajoy's cutbacks are the toughest yet for Spain.

The measures include a 3.0% jump in VAT (or IVA, as the Spanish call it), a 10.0% cut in unemployment benefits after the sixth month, and a 30.0% reduction in all ministerial budgets. It’s the toughest set of cuts Spain has ever known (which is saying something given that this is the fourth round of cuts since Mr. Rajoy came to power, just seven months ago.)

Why exactly, then, are these cuts so bad for Spain, and how might they impact the euro in the future? Are cuts Spain’s only road to recovery?

The reason these cuts are bad for Spain, and have pushed the euro to its recent nadir, is summed up in a quote by Harvard University professor Richard Cooper: “I don’t know of any situation in the world where a reduction of the debt-to-GDP ratio has been achieved by reducing GDP.”

In other words, the lauded goal of these cuts is to get Spain to the 3.0% debt-to-GDP level required by the EU. Yet according to the best economic wisdom available, cutting spending, when you’re already mired in a recession in which tax revenues are falling, is the exact opposite of the way to go about it. Far from digging Spain out of its recession, these cuts are likely to prolong it.

The trouble is that Mr. Rajoy seems to be the only one focused on Spain’s situation who doesn’t see this. Announcing the cuts, he said: “That is the reality. We have to get out of this mess and we have to do it as soon as possible.” No one would dispute that. And yet, everyone outside the Spanish government feels this is the wrong way to go about it. Hence the declining euro, as the markets foresee Spain’s economic fortunes declining further.

Less about the recovery, than appeasing Europe?

On the other hand, it might be naive to say this is a simple case of the Spanish prime minister seeing his country in a hole, and doing his best to get out of it (no matter how misguided his attempts.) Because Spain is in the Eurozone, and is therefore subject to whatever conditions the bloc’s more solvent members require to remain there. This is especially the case given that Spain has just agreed a €100bn loan from the European Commission.

In other words, you could argue that these recent cuts have less to do with what’s good for Spain, than what Mr. Rajoy sees as necessary to appease Finland and Germany etc. In fact, Jeremy Warner makes just this point, commenting: “The latest austerity package is part of the conditionality attached to the Eurozone loans for banking bailouts.”

In other words, you could characterise these latest cuts as a Spanish attempt to castigate itself, in order to send a signal to the Eurozone: “Yes, we want to remain here. Yes, we’ll do what you ask to be in this club.” It’s a little like the initiation tests you get at fraternity houses, inflated to international proportions.

Is the north exploitative, or acting on moral principle?

Given this, it’s then worth asking: First, why do the solvent members of the Eurozone demand so much austerity from the south, and second, how much austerity will Spain accept?

In much of the media, German-imposed austerity is seen as a way for the north to perpetuate the cheap euro for its own gain. This is the opinion of Warner: “The euro is meant to be a symbol of European solidarity, but in practice it has become little more than a mechanism for maintaining German competitiveness at the expense of others.” In this sense, the euro is (or has become) a trick, in which Spaniards suffer for German advantage, and it’s in Germany’s best interest to keep the game going as long as possible, with as little cost to itself.

Yet I believe this characterises the solvent members of the euro as much more Machiavellian than is probably the case. I imagine euro solidarity is real, but that the Finns and Germans simply wish to hold Spain etc. to the same standards as themselves.

This idea is reflected in a recent study by EVA, a Helsinki think-tank. In this study (on European feeling in Finland), Ilkka Haavisto found that,“The Finns feel they sorted out their own banking mess [in the 1990s] through hard work and austerity, not handouts. This has led to a feeling that being too lenient with bailouts and other measures is not just a bad idea from them but somehow morally wrong.”

In short, demanding austerity of Spain isn’t a negotiating tactic, but a desire to hold the indebted euro nations to a moral principle. There’s no exploitation of the south involved. For people who feel that Mr. Rajoy is being led up the garden path by accepting more cuts, that might be reassuring.

But of course, even if the north’s intentions are honourable, that doesn’t address the question: how much more can Spain take? With these latest cuts, Spanish prime minister Mariano Rajoy has put a real dent in his credibility, given that, first, he promised not to increase VAT before his election, and second, his measures are so patently not helping Spain. There have already been instances of social unrest in the Iberian nation, in protest to the cuts. But with more on the way now, anti-euro feeling could soon be on the rise in a big way in Spain.

That could keep the euro at its current lows.

This is intended as a guide to the latest changes in the exchange rate, as well as Europe’s economy, to help put you in the best position the next time you need to change currencies.

Get in touch: If you have any questions about changing currencies or transferring money abroad in the meantime, please don’t hesitate to leave a reply in the box below. I’d be delighted to provide an in-depth personal answer to your enquiry, free of charge.





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Peter Lavelle is an economist at foreign exchange broker Pure FX. For a free no-obligation quote regarding changing currencies, get in touch at foreign exchange specialist Pure FX.
Website: http://www.purefx.co.uk/landing-page-iberosphere/

Copyright: Peter Lavelle, Pure FX
Category: Expats, Iberoblog
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1 Comment for “Euro plunges as Spain cuts deeper”

  1. Yet according to the best economic wisdom available, cutting spending, when you’re already mired in a recession in which tax revenues are falling, is the exact opposite of the way to go about it………This is more than a Spain/Euro issue. It is the basic difference between right of centre v left of centre solutions to recession ending. History favours the left of centre solution but apart from France most big EU governments are right of centre. Pain for everyone lies ahead.

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