Spain Upsets the Apple Cart… Budget Deficit Misses the Mark

As the year draws to an end of a rollercoaster ride, everyone was hoping that the EU and the debt crisis would stay out of the news just for a few short days, so that investors, economists and politicians could have a few days to breathe and relax. The ECB provided needed liquidity to the banks so they were off the front pages, for a few days. Italy and Greece were quiet. Data from China and Japan was a bit disappointing, but nothing to upset the markets. US data was promising and everything continued to point to positive recovery.

Along out of the blue, the Spanish government throws a wrench in all the works. Now the last day of the year with markets closed for a long weekend, the Spanish government announces that their 2011 budget deficit will come in around 8%, way above the projected 6% mark.

Spain’s newly appointed government has outlined 8.9bn euros ($11.5bn, £7.5bn) in new spending cuts and tax rises to lower the country’s borrowing. The announcement is the first in a wave of austerity measures, with a total of 16.5bn euros to be cut in 2012. Regardless of austerity announcements and programs, no matter how much you cut spending, if income is also declining, you end up in a cycle and never catch up. With new austerity measures comes lower taxes, lower taxes means larger budget deficits which spiral to more austerity measures.

We witnessed the same problems in Ireland, who were forced by the EU to cut their deficit and their spending to secure bailout funds. Greece was similar.

Yes you need to cut spending and reduce costs, but not drastically to harm growth and income. It is a fine tightrope that Finance Ministers and budget committees need to walk but when the dictates are attached to emergency bailout funds, a country is stifled. Spain will most likely be the next country that will require a bailout and they are preparing for the necessary requirements, much as Italy.

Perhaps, the Sarkozy-Merkel team has things wrong.

The UK adopted austerity measures voluntarily to reign in their deficit, and it has hurt the economy, but it is also part of a plan to increase growth and taxes, so that the government can increase income while reducing spending.

The government of Prime Minister Rajoy has vowed to meet Spain’s target of reducing the public deficit to 4.4% of gross domestic product in 2012, no matter what. Is this good for the country?

Today, the Deputy Prime Minister maintained a freeze on public sector wages for another year and ruled out practically all government hiring.

Taxes on the wealthiest Spaniards will also be raised for at least two years, raising 6bn euros,

Spain’s borrowing costs have jumped in the last year – reaching as high as 6.7% for 10-year debts – as investors feared that Spain might join Greece, the Irish Republic and Portugal in needing a bailout.

The country’s economy has shrunk sharply since a housing bubble burst in 2008, and it has an unemployment rate of 21%, the highest in Europe.

The austerity measures have sparked a number of large protests across the country.