Spain – Europe’s ‘bubble-central’ – has been blown up by printed money

The transformation of the Spanish economy is probably the most dramatic the global economy has witnessed in the last decade. Only a couple of years ago the country was a burst bubble, with crushing unemployment, a banking crisis, and soaring bond yields. It looked a sure bet to be the next country to join the eurozone’s bankruptcy club, alongside Greece, Ireland and Portugal. Yet now it’s suddenly the star of the developed world, with a growth rate of 2.6% this year.

The trouble is, there’s nothing durable about this recovery. In reality, Spain is emerging as the eurozone’s bubble-central. With the European Central Bank (ECB) printing lots of money, cheap cash is flooding into Spain, just as it did during the build up to the last crash. It may grow for a while yet, but it is not going to last.

Investors have got it wrong

The markets seem to think that Spain is not only fixed, but is in fact roaring back to rapid growth. The Ibex 35, the main stockmarket index, fell to almost 6,000 back in 2012. It’s now touching 12,000. That same year, the yields on ten-year Spanish debt rose to 8%, a level at which it was unlikely the country would ever be able to service its massive debts. And now? They’ve come back down to 1.7%. If you’d bought into Spain during its darkest days, you’d have done well.

Meanwhile, the economy will expand almost as fast as the UK this year, and a lot faster than France or Germany. Unemployment has started to fall, with a 2.7% drop in the jobless total in April alone. Manufacturing has begun to recover and exports are up. Its recent performance is so strong that Prime Minister Mariano Rajoy has declared that the “crisis is now history”.

But hold on. Yes, Spain has made some reforms to improve its competitiveness. Its notoriously inflexible labour market has been freed up, although it is still a long way short of British or American levels. The banking system has been stabilised. The budget deficit has come down a bit. Yet that’s not what’s really behind the turnaround.

Instead, Spain has been the main beneficiary of the efforts by the ECB to revive the eurozone. Mario Draghi, the president of the ECB, has engineered a substantial devaluation of the euro, at the same time as launching Europe’s own version of quantitative easing. The result has been a sugar rush – and most of the sugar ended up in Spain.

The numbers make that clear. The initial recovery came from the manufacturing sector, which might have been durable. But this year it has been construction and consumer spending that have driven the economy forward. Household consumption was up by 3.9% in 2014, a very high number for a country that is only painfully emerging from a recession, and is still meant to be paying down debt. Retail sales are rising by 2.6% year-on-year, despite the jobless total remaining at a crushing level. A building boom is under way, with construction output rising by 14% year on year.

That seems extraordinary, given that Spain built on a vast scale in the last bubble, and we kept reading of ghost towns of new houses and brand new airports with only one flight a day. It is hard to imagine what’s being built – but even so the cranes are back in action.

As households consume more and a building boom gets underway, imports have started to rise again, easily swamping the modest improvement in exports. The trade deficit jumped by more than 50% in 2014 and is still going up. Meanwhile, the budget deficit is still running at 4.5% of GDP this year, well above the supposed limits laid down for eurozone members.

A rickety building boom

In short, Spain’s economy is increasingly driven by retail sales and a building boom – just as it was before the global financial crisis. And just like last time, it’s been enabled by a flood of borrowed foreign money. Back then the European Central Bank (ECB) was holding interest rates down at crazily low levels to help Germany, despite the evidence that Spain, along with the other peripheral countries, was dangerously overheating.

This time round the ECB’s actions – pushing down the currency and printing money – are intended to salvage the stagnating economies of France and Italy and Greece. But once again, the money pouring into the system is ending up in Spain. That is the problem with the eurozone.

A monetary policy set in Frankfurt doesn’t work for all the members of the single currency. While the ECB continues, Spain may carry on booming for quite some time. Just because something is a bubble does not mean it can’t last for several years. The Ibex may well double again and Spanish bond yields could easily turn negative over the next couple of years. It might well be using half the concrete in Europe quite soon, just as it was in the middle of the last decade.

Yet behind the façade, it’s clear that Spain is just being pumped up by cheap money. There is little sign of a durable recovery. So the boom will inevitably turn to bust, just as it did last time.