Spain, what next?

Spain's risk premium hits an all time high while the disgruntled public takes to the streets. What are the implications and how does it affect you?

Spain is experiencing massive daily demonstrations with no let up in sight. And this is just the beginning.

I've been ranting it for the past several months - raising all kinds of taxes while making drastic public spending cuts in an effort to reduce the budget deficit will only produce more unemployment and Chapter 11s, the exact opposite of what the government wants to achieve.

Rajoy says that they had no alternative but to take these difficult steps in order to save Spain from itself. In his State of the Nation speech to Congress last week, he reiterated that the decision to raise taxes and cut spending was undertaken in consultation with the private and banking sectors and was the correct decision regardless of how difficult it might be.

See, I don't buy the part about how difficult it was to make this decision. On the contrary, they took the easy way out...the easiest way out. In a business, if you have to reduce your losses, the first thing you do is cut expenses - a dollar saved is a dollar earned. That relationship is direct: when you reduce your cost by one dollar, you increase your profit by one dollar. Secondly, if the market can bear it, you raise your prices. This is the easiest and most time-honored way to minimize losses.

Government operates the same way. If the deficit exceeds an acceptable level, reduce operating costs and increase revenue. However, unlike the private sector which raises prices ONLY IF THE MARKET CAN BEAR IT, government doesn't give a hoot whether the public can bear it until it blows up in its face. When you're faced with 25% unemployment, the last thing you do is raise taxes. The market cannot bear it.

According to NationMaster.com, as of 2010, Spain had approximately 24 million people between the ages of 20 and 65 (the workforce), while the remaining 16 million were either retired or too young. If, of that 24 million work force, 25% is out of work, then it is clear to see that one-half of the population works, not only for itself, but for the other half. Since 95% of private sector companies in Spain are SMBs, it is safe to assume that these people are not millionaires. In fact, the average yearly wage of people in the private sector is normally between 24 and 30000 euros.

Spain is the fourth largest economy in the eurozone yet its wages rank only 15th in all of Europe (see graphic upper right hand corner). Spain's has a higher internet connection cost than France, Germany and Holland. All this only goes to show that the Spanish people can ill afford any tax increases as envisioned by this administration.

I've always maintained that the difficult decision, but the right one, would have been to reduce taxes and reduce costs. Make the country attractive to foreign investment, don't kill it.

At present, Spain's risk premium is at 593 points or 5.93% for seven year government bonds, 5% for two year bonds. These are ridiculously high premiums to be paying, but it reflects the level of uncertainty that exists. It is generally accepted that the panic point is 600 points. I have no doubt we will surpass it.

Europe will have to pour more money into Spain that much is clear. Furthermore, the current situation (recession) will extend way beyond the 2014 target the government is setting for itself, which is wishful thinking.

What I can say for certain is that Spain has the potential of dragging the whole of Europe into a deep recession. And if that happens, the rest of the world will be affected because imports from developing countries (SE Asia and Africa) will be greatly affected. The bigger scenario is that the world could end up in the worst depression since 1929.