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Monday, 20 June 2011

My answer to Edward Harrison: “it was a wise decision to let Spain, Portugal and Greece into the Euro-zone”. Why one also should consider the political component behind the Euro zone.

The last few weeks there have been numerous tweets containing a text like:
·    Greece should never have entered the Euro-zone
·    Portugal should have stayed out of the Euro-zone
·    Spain should never have been allowed into the Euro-zone.

Especially the last tweet pointed to a very good article of Edward Harrison: Spain is the perfect example of a country that never should have joined the Euro.

The figures in his article speak volumes, as Edward Harrison proves that is was not fiscal recklessness, a bad regulatory regime from the Banco de España, or surplus government spending during the last years, that made Spain one of the underdogs in Europe. Here are some snips:
The harmonisation never came to pass. Instead what we got was an unbalanced Euroland in which Germany and the Netherlands exported and Spain, Portugal and Greece imported, running up enormous current account imbalances in the process.
These imbalances are a direct result of a monetary policy that was geared to slow-growth core Europe. The result was an enormous property bubble in Spain and Ireland in particular.  It's not as if a robust regulatory environment could have overridden these forces either; the  Banco de España, Spain's central bank, is widely credited as having run one of the more solid regulatory regimes in Euroland.  Yet, this did not stop a runaway property bubble from forming and imploding.
Moreover, what these two charts also point out is that, in Spain and Ireland, enormous property busts turned what were fairly large government budget surpluses in 2006 – the largest in the euro zone except for Finland -  into an enormous government budget deficit by 2009. The Netherlands is the only other country besides these three that had a surplus in the euro zone in 2006. 
I agree totally with Edward, that the property bubbles in both Spain and Ireland are enormous problems. I think, however, that he forgets one circumstance that partially caused these property bubbles, at least the one for Spain.

Until 1997, the price of houses and ground in Spain and its neighboring country Portugal were fairly low. At that time, you could buy a property with 10,000 sqr ft of ground for about €90,000 in a semi-touristic area, not too far from the sea.

But then came the British and Irish people, loaded with pockets full of money, earnt during their economic boom. These people bought everything at the Spanish and Portuguese coast that was neither too ugly, nor too dirty. To show my point, I will show the following table that I copied from an article from 2006: Spanish Property Bubble

Average Spanish property prices from 1995 - 2006
(source: Spanish ministry of internal affairs)

What you can see from this table, is that the rise of the property prices already started in 1998, with an average growth of 6.25% per year, based on real change.

Of course, the table also shows that the growth of average property prices after the implementation of the Euro soared with 11.75% per year. However, that has (in my opinion) the same reason as the fact that the housing prices in other countries, like The Netherlands, also soared: after the dot-com bubble exploded, Allan Greenspan and the likes of him kept the interest rates extremely low, enabling an amount of cheap money in the financial markets that caused all kinds of bubbles. That was the start of the credit crisis to begin with.

In the years after 2001 not only the British and Irish people were thinking about a second house or apartment in Spain or Portugal, but also Dutch people, based on the overvalue of their houses. This triggered a general demand for Spanish (touristic) housing and apartment space, that was much larger than supply. Result: soaring housing prices. And then (analogue to the pig/pork cycle) the concrete mills start rolling and rolling… until the supply of Spanish housing and hotel space widely exceeded the demand. Result: dropping housing prices.

But was all this caused by the Euro? I don’t think so. Let’s take the inflation before and after the implementation of the Euro from this table above. The inflation of the peseta period (1995-2001) was an average 2.93% and the inflation of the Euro-time was 3.24%: no significant difference.
Youth unemployment figures in Europe
Spain, however, has a few things in common with Portugal and Greece:
·    Massive youth unemployment (see table above);
·    substantial unemployment (ranging from 12.6%-20.7%);
·  a (huge) deficit on the trading balance, caused by massive imports from Germany and The Netherlands;
·    a business model that is mainly based on tourism;
·  agricultural, (financial) services and production industries that are clearly trailing the countries in North-West Europe.
·   A desertification of these countries, that makes it harder and harder to use ground for agricultural purposes.
·  People only having a lower education: Portugal and Spain have both a staggering 31.2% of early school leavers (Greece is with 14.2% much better)

But is the Euro to blame for that?! I seriously doubt it. Did the Euro make things worse for these countries?! I even doubt that. I think that the economic boom of the years before the economic bust, was reinforced by the Euro, as this single currency made it easier for tourists to visit these countries and spend their money there.

The fact remains that these countries lack a truly vivid production industry and that their financial and agricultural industries are also lagging, compared to the north-western countries. It is also a fact that too many people drop out of school early in these countries and that larger and larger parts of these countries are slowly, but surely turn into deserts. And no currency in the world can help to prevent that.

But there is one more thing that Portugal, Greece and Spain have in common. All three were dictatorships until the seventies of last century. Since then all three countries became young and vivid democracies within Europe, but with their fair share of growing pains, like corruption, nepotism and an industrialization rate that is far behind with the rest of Western Europe.

The choice to let these three “young democracies” into the Euro was as much a political choice, as an economic one. A signal that the EU would not allow a Europe of two speeds, but a Europe that is unified in its free markets for goods, services, capital and people and unified in its currency.
To the American readers this might sound like swollen language, but consider this:

American people should have all reasons to dismiss (f.i.) Mississippi and West-Virginia from the ‘dollar zone’ (based on figures from Wikipedia and These states:
·    have the lowest income per person
·    have about the lowest GDP per person
·    have about the highest corruption in the USA
·    are among the states with the highest unemployment.

Ergo: these states cost you a lot of taxpayer money. But everybody will laugh at me, when I consider to kick these states out of the ‘dollar zone’. And why? Because the USA is one country with one single currency.

And although the EU is far from being one country with one single currency, the political reasons for letting Greece, Portugal and Spain in the Euro might be the right ones in the end. When the credit crisis will be over in 5 - 10 years, these countries (just like the East-European countries and new Euro-members) might have a lot of youngsters looking for jobs against relatively low incomes. This might be a reason for German and Dutchs companies to open factories there. Overly optimistic? Maybe, maybe not...

But for now, it is a question of survival for the Euro.The way to do this, might be a ‘controlled’ default for Portugal, Spain and Greece. The strongest countries of Europe could be the receivers/trustees for these countries and help these countries to rebuild their economic and financial strength with a kind of Marshall plan. But just sending more money and hoping for the best seems not a viable strategy at this moment.


  1. Hi, thanks for this great blog.

    I am a Spanish guy (though I was born in Argentina) that works and lives in the Netherlands in the IT world.
    I would like to comment briefly your article.

    The origin of the properties bubble in Spain is not only the interest of foreigners to buy properties in the coast, though it contributed.
    I would say that the origin is more based on local regulations and tax policy. We had in Spain the same kind of policy as you have in the Netherlands regarding deduction of taxes linked to the interest payed in mortgages.
    That was a bad idea, and encouraged people to buy properties.
    Of course low interest rates, and greediness (and irresponsibility) of banks helped a lot also.

    Recently that tax deduction has been removed for all mortgages started after January 2011, and the prices are clearly speeding up on its falling, so it is a kind of an indicator that the problem was quite related to that.

  2. Thank you for your very interesting comment. I wasn't aware that Spain also had a kind of Mortgage Interest Deduction (MID). At least this proved that an MID is disturbing the housing market and that Finance Minister De Jager was indeed wrong, yesterday

  3. well if you would ask me that same question, I would really think about it for a second and then I will answer you with this: "yes it was" as simple as that