World Markets Watching Spain

For a long time, market watchers have predicted that Spain might be the next economy to crumble after Greece fell apart and needed a bail-out. Don't you hate it when the doomsayers are right? It just doesn't bode well for the world economy to see all this instability in Europe, and unfortunately it's nowhere near over because Italy is next in line. The pain continues, and could leave the rest of Europe ~ and the world ~ overwhelmed.

 Ezra Klein on Rachel Maddow

. . . If you're picking one indicator to watch to see if it was going to survive or fall, you would pick Spanish bond yields because it would be bad if Greece had to leave the euro, but it would be survivable. There is no world where Spain goes down and the euro endures. If Spain goes down, the euro is going down. Spanish bond yields, the thing you need to remember is the higher a bond yield is, the higher a country has to pay when they borrow money.
Spain can't afford to borrow the money necessary to finance itself, and the Eurozone is going down. and that means our economy might be going down, too.
Well, Spanish bond yields have kept going up. This is way above the level which Spain and the euro can survive.
Tonight's Ezra Klein challenge is to explain why this happened. . . . Austerity isn't working! . . . Spain has been doing what the Eurozone has asked them to do, austerity, cutting budgets. They're trying. everybody agrees they have been a good faith actor. but that treatment is driving them deeper and deeper into recession, and these bond yields are the market . . . saying 'this is not working.'

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From MSN Money UK:

The Dow Jones Industrial Average, after falling 239 points earlier in the day, ended down 101.11 at 12,721.46. Yields for US government bonds sank to record lows as traders sought the safety of American debt.

Borrowing costs rose sharply for Spain and Italy after news that the Spanish economy contracted by 0.4% in the second quarter. Falling economic output makes it more difficult for Spain to deal with its debts. The Standard & Poor's 500 index fell 12.14 points to 1,350.52. The Nasdaq composite index dropped 35.15 points to 2,890.15.

"Increases in Spanish borrowing costs have brought back questions about the health of Europe," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia. "That's driven a flight to safety."

More Scary Stuff from Bloomberg

Now, that worst-case scenario has re-emerged. The catalyst is Greece. Over the weekend, Germany’s economy minister, Philipp Roesler, said he doubted that Greece would keep the fiscal promises it made in return for its bailout. If help for Greece is cut off, a disorderly exit from the euro becomes much more likely. For the rest of Europe and the world, that’s alarming less in its own right than because of the risk of contagion.

Spain would probably be the first to suffer, and as things stand there’s nothing to stop the situation from unraveling. With anxiety about Greece rising again, it was reported that Spain’s regional governments were seeking bailouts from Madrid, threatening to add to the central government’s debt burden. The Spanish economy is contracting, the latest figures showed last week. At the same time, Prime Minister Mariano Rajoy sparked protests when he said he would press on with further fiscal tightening, which is likely to slow growth even further.

On Monday, Spain’s 10-year bond yields rose for the first time above 7.5 percent. Rates sustained at this level are unaffordable and, in effect, make the Spanish government insolvent. Disturbingly, yields rose sharply at shorter maturities, too, and the cost of insuring against a Spanish default set a record -- both signs that confidence is evaporating.

Spain is the fourth biggest economy in the euro area. If it has to be bailed out, the EFSF and ESM will be overwhelmed. Then comes Italy, whose 10-year bond yield just climbed to a six- month high, remaining well above 6 percent. That’s no less crippling than Spain’s cost of borrowing, because Italy’s debt burden is far greater.

If Europe’s governments continue to stand aside, they will sink not only Greece, Italy and Spain, but the wider European and global economies as well. Europe’s leaders must either greatly expand the ESM and start to use it more proactively, or urge and empower the ECB to buy or somehow guarantee distressed sovereigns’ debt. One way or another, bond yields have to be capped at a supportable level.