Since the beginning of the debt crisis in Europe more than two years ago, defenders of the euro currency union have stuck to a basic argument: if the euro zone’s weaker economies would only keep pursuing policies of austerity, even as growth collapsed and job losses mounted, they would be rewarded by investors more willing to buy their bonds.
Yes, the social cost would be high, but over the long term economies would benefit from the lower interest rates that can come with the seal of approval from global bond investors. Or so goes the argument.
That approach, though, has failed in Greece, Ireland and Portugal. And now it is being severely tested in Spain, where the more the government promises to cut its budget deficit, the more foreigners are unloading their Spanish bond holdings.
Late Thursday, when Standard & Poor’s jumped into the fray by slapping Spanish bonds with a two-notch downgrade, it gave public voice to what investors have been sensing for months now — that it will be nearly impossible for Spain to meet its current deficit-lowering target amid one of the most severe recessions in the euro zone.
Yet another batch of grim job figures from Spain on Friday seemed to underscore this contention. Spain’s unemployment rate is now 24.4 percent, the highest in Europe and an especially stark figure given that the Madrid government has not yet begun to lay off public sector servants in any significant number.
None of this comes as news to foreign bond investors, the lenders who are supposed to help Spain stay in business. And it is not news to the growing number of economists and analysts who predict Spain might soon need to bail out its banking system, which could force it to seek European aid that might end up far larger than the bailouts of Greece, Portugal and Ireland.
Over the last year, close to 100 billion euros ($132 billion) has fled Spain, according to Iñigo Vega, a bank analyst at Crédit Agricole Cheuvreux in Madrid. Most of the outflow has come from insurance companies and pension and sovereign wealth funds reducing their holdings of Spanish bonds.
Those distress sales have picked up speed in the last few months. Many foreigners have been selling to local Spanish banks temporarily flush with cash from the European Central Bank’s cheap lending program, even though Spain’s banks have an impending wave of real estate loans at risk of going into default.
With investor expectations already at rock-bottom levels for Spain, its benchmark 10-year bond yield held fairly steady on Friday, ending the day at 5.9 percent. That is just below the 6 percent that has been considered the threshold of danger. But the fact that the yield, or interest rate, did not spike higher was further indication that the downgrade by S.& P. provided little new information to the market.
On Thursday, S.& P. lowered Spain’s bond rating by two rungs, to BBB+ from A, leaving it two notches away from losing investment-grade status.
If history is a guide, the other two main ratings agencies, Moody’s and Fitch, may soon follow S.& P.’s lead. So far the two are rating Spain at the A level, but with a negative outlook.
In January, when Spain and many other euro zone countries were downgraded, S.& P.’s two-notch reduction was shortly followed by a similar downgrade for Spain by Moody’s.
Driving the investor exodus from Spain is a view that Europe’s current policy of forcing countries to improve their competitiveness by cutting spending and lowering wages will not result in a growth payoff — whether in Greece or Italy or Spain.