Financial chaos would ensue in Madrid and Catalonia

By Don Quijones, Spain & Mexico, editor at WOLF STREET. His blog: Raging Bull-Shit.

Until the early eighties, divorce was not an option in Spain. The only way for a couple to end their marriage was by annulment or legal separation, both almost impossible to obtain. Because of the legal and financial obstacles to a formal split and the social stigma attached to failed marriages, particularly for women, many couples chose to live apart, in a situation that came to be known as “Spanish divorce.”

In many ways, this is what is playing out right now between Catalonia and the rest of Spain. The two parties are going through the rigmarole of a Spanish divorce. A huge majority of Catalans want, at the very least, the right to decide whether to stay in a loveless marriage with Spain or to seek real, lasting separation. For Madrid, an official divorce with its North-Eastern province is not just unpalatable, it’s unthinkable.

Unlike Scotland, Catalonia is a net contributor to Spanish tax revenues. It is also the country’s richest province, accounting for close to one-fifth of Spain’s economy, 20% of its tax revenues and 25% of its total exports.

Given that Spain’s current finances are already on a preposterously unsustainable path – the country’s public debt has exploded from around 40% of GDP six years ago to its current level of just over 100% and shows no sign of receding – losing its richest region would not bode well for the country’s economy. Before you could say “hijo de puta” large-scale international investors (i.e. banks, hedge funds and the like) would have withdrawn their funding of the nation’s debt, resulting in the collapse of bond prices and sky-rocketing yields.

Even the grand master of the dark arts of financial alchemy, ECB President Mario Draghi, would be hard pushed to stall the inevitable.

Big, Fat Blow-back

In the worst case scenario, financial chaos would ensue – not just in Madrid, but in Catalonia, which would witness an unprecedented flight of capital and, in the likely event of default on its share of Spanish debt, the complete loss of trust of the financial markets. Its banks would probably also be shut out of ECB funding and its two biggest banks, La Caixa and Banc Sabadell, would likely relocate to Madrid.

Not only that: the nascent nation-state would almost certainly be shunned by the “international community,” in the all-too-familiar guise of the European Union, the United Nations, NATO, the IMF, the World Bank and the World Trade Organization. [Some might argue – with reasonable justification – that such an eventuality would be an added bonus. However, no matter how malign these institutions’ global influence may be, international isolation would hardly be a good thing in a hyper-connected world!]

Severed from ECB financing, Catalonia would have to assemble its own currency, which would very quickly plunge in value. Its firms may also be cut off from both Spanish markets and European ones, which together represent over 50% of the region’s total trade flow. Likewise Spain would be shorn of its only viable transport link with Northern Europe.

In short, the pain for both Spain and Catalonia would be close to unbearable.

Slow-Falling Dust

That is not to say that Catalonia would not be viable as an independent country – there are already 150 nation states on this planet that have smaller populations. Indeed, according to the renowned U.S. economist Jonathan Tepper, once the dust had settled Catalonia would have an economy similar in size to Finland or Israel.

The problem is that it would take an eternity (at least in today’s terms) for the dust to settle – especially in the face of potential hostility from neighbors and rejection from the international community. As the Spanish economist and investment manager Daniel Lacalle warns:

There is not a single case in the past in which independence has not been accompanied by a significant drop in available credit, GDP or welfare. See the study on the independence of the Baltic states of the European Journal of Political Economy. An average five years of recession…

Catalonia spends 15 percent more than it earns. If independent, it would see lower revenues and expenses from the transition costs would rise. The Catalonia government, Generalitat, often compares itself to Ireland or Finland. Yet its private and public debt together exceeds both.

Even if we assume Catalonia stays in the EU and continues to receive public financing, the loss of GDP for Catalonia could be anywhere between 10-15%, according to even internal analysis. Meanwhile, the cost to the rest of Spain is projected at anywhere between 3% and 5% of GDP. The total value destroyed on both sides of the border could be close to €50 billion.

An Impossible Dream

In light of the potential fallout of a far-from-amicable divorce between Catalonia and Spain, the only sane option is to jaw-jaw. The problem is that Madrid remains as ill-disposed as ever to granting meaningful concessions to Catalonia. All it does is threaten and bluster, in the process creating even more converts to Catalonia’s independence cause.

As Rajoy is so fond of repeating, every word of Spain’s constitution is set in stone, unchangeable unless voted for by a majority in parliament. [Naturally, this did not apply to the words erased from the constitution in 2012 to allow for the Troika’s generous bailout of Spanish banks, in return for Brussels’ eternal “supervision” of the Spanish economy].

At the same time the Catalonian government and separatist civil organizations continue to peddle the pipe dream that independence would be the cure-all to the region’s problems. Once unburdened of its spending obligations in Spain, unemployment in Catalonia would fall and public spending would rise, they say. Corruption would disappear, Brussels would roll out the red carpet (despite vetoes from Spain and who knows where else) and the world would celebrate the birth of a new nation called Catalonia.

All of which may sound nice. The problem is that it’s an impossible dream, for not only is Catalonia’s independence bitterly opposed by Spain, it is bitterly opposed by Europe’s governing institutions – institutions whose gaping democratic deficits rise in lockstep with their growing power. Despite the fact that most Catalans and their national government continue to support the European Project, a referendum on its soil would be tantamount to treason. During the recent Scottish referendum EU Trade Commissioner Karel De Gucht laid out in the clearest possible terms how the European Commission views popular independence movements:

“A Europe driven by self-determination of peoples … is ungovernable…”

There you have the ultimate admission: as long as Europe is run from Brussels, nation-state sovereignty has no role in European governance.

Not so long ago, national independence in Europe was traded in for interdependence between Member States. Soon, far sooner than most Europeans realize, that interdependence will give way to centralized dependence (a lá Greece). For Catalonia, what that means is a stark choice between an impossible divorce from Spain – and with it Europe – or the continuation of a bitterly unhappy marriage with both. By Don Quijones. An exclusive for Wolf Street.

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