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The Pain in Spain
New York: March 01, 2010
By John Stephenson

While all eyes have been on the Greek tragedy that is playing out in Europe, Spain could prove to be the spoiler of whether or not the 16-nation currency stands or falls. Spain , with the fourth-largest euro zone economy, is grappling with big debts, a yawning budget deficit and a deflating housing bubble.

A potent combination of too much spending and too little saving and investment have put Spain between a rock and a hard place. As part of the European monetary union, Spain can't devalue its currency to make its exports more attractive or its beach resorts cheaper since the value of euro is largely driven by the much-larger German economy.

But unlike Greece , which experienced runaway government spending, Spain 's government had been running surpluses until the last few years. But in Spain it was the private sector that went on a debt-fuelled bender that has hobbled the economy and left Madrid with few options out of the crisis.

Because of the massive spending by the private sector, Spain now faces a total debt of $4.9 trillion, or around 342 percent of GDP. This is a higher percentage of total debt than that faced by the U.S. or most other major economies. The only major economies with higher total debt burdens are Britain and Japan.

At the center of the crisis are millions of unemployed Spaniards and a deflating housing bubble. The unemployment rate is 19% and among young people it is running close to 45 percent. In the last two years, one in nine working Spaniards have lost their jobs.

Full employment in Spain has proved illusive. Even in good times, unemployment never got below about 8 percent. The Spanish employment market is deeply flawed. Wages are set through a complicated system of negotiating in this highly unionized country where wage increases are often foisted on companies whether or not they can afford them. Many workers are hired on so-called indefinite contracts and are entitled to 45 days of severance per year of service. This has led to labor market rigidity that will likely act as a drag on future economic growth.

Spanish house prices more than doubled from 1998 to 2008. And at the peak, Spain , a country with just 45 million people, was building more houses than Germany , Italy and France combined. Already, house prices are off more than 15 percent from their highs and there are more than 1.3 million homes unsold.

The Spanish government is left with three unpalatable choices forward. They could choose to do nothing and wade through years of debt defaults and shy-high unemployment. They could slash spending and try to overhaul the badly flawed labor market or they could withdraw from the common currency and try and devalue the Spanish peseta.

The problem with abandoning the euro is that this is a very costly route. The minute the Spanish government even hinted at leaving the monetary union, a likely run on Spanish banks and an effective default of every euro financial contract in that country would occur.

Already, the market is betting that Spain will continue to face tough times. The cost of insuring against a Spanish default has begun to rise. Just three years ago, you could insure €10 million in Spanish bonds for a five year period for just €2,350. Today, that same insure will cost €125,000 or more—a fifty-threefold increase.

Investors, worried about a possible collapse of the euro zone, should avoid European investments for the time being. Instead, there are better investment opportunities in the resource-rich economies of Canada and Australia , whose growth is tied to global growth.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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