Don’t believe the reports that a new Lehman-style financial crash is in the offing. What’s going to happen is much less dramatic. In 2008 no-one knew how to value Wall Street’s liabilities (for example, AIG’s famous guarantees on subprime securities). Now the full extent of the problem is known to everyone. It’s just a negotiation now over who gets knackered. And the answer, by one means or another, is the southern Europeans.
Spain The worst possible thing would be to pour more public money into corrupt and inefficient economies and subsidize their failures, as President Obama proposed at last week’s Group of Eight summit. Reforms would help. Some of my conservative colleagues seem to think that if you sprinkle supply-side fairy dust on the Club Med economies they will roar back to growth. In fact, labor market reforms would work wonders in Italy, which has very low private debt, lots of public assets, and many pockets of strength. In general, though, these economies deserve the nasty wake-up call they are going to get. The trouble with the southern Europeans is that they insist on combining familial amoralism with state dependency: everyone views the state as an enemy when it comes to paying taxes, but insists on handouts and protection from the state. In the case of Spain, you can’t get there from here, as the Maine farmer told the tourist. (Portugal is an exception. The stoic Portuguese work had and pay their taxes, which gives that small country a better shot than Spain.)
Spain should serve as Schreckensbeispiel (a horrible example) to Americans. If we do not give Americans the opportunity to realize their dreams, be the best in the world, hit the ball out of the park, go for the gold, we will fail as a nation. In a winner-take-all world the devil takes the hindmost. If we penalize the winners, we guarantee that all of us will fail. Spain shows how quickly a seemingly prosperous country can come apart when its entrepreneurial engine stalls. If we don’t eject the most anti-business president in American history, we will look not like Europe, but like Spain.
Ultimately, you will have to sacrifice Spain. That will compromise the French banks, which in turn will require German support. Spain is unsalvageable. It is better to take the pain early and deliberately, rather than later and chaotically. Dealing expeditiously with Spain, moreover, should convince Italy to adopt the reforms which can prevent it from following Spain and Greece into de facto national bankruptcy.