Spain's new prime minister has looked into the abyss and recoiled.
"We have reached the point where `taxes kill taxation'. The therapy is turning fatal
and is starting to take on a highly political tone. Sixty years after the end of the war, Germany is again coming to be seen as an overbearing enemy, and an atmosphere of hostility is building up in a Continent divided between a rich and flourishing North and a South in danger of being reduced to a protectorate. If we carry on like this we are going to destroy the European project," he said.
Though he swept into office as an apostle of orthodoxy, Mariano Rajoy has since delved into Madrid’s ghastly accounts and concluded that it would be "suicidal" to try to slash the budget deficit from 8pc of GDP to 4.4pc of GDP this year, as demanded by Europe's fiscal Calvinists.
Such a policy would require a further €40bn or €50bn of cuts and accelerate the downward spiral already underway, beyond the 1.7pc contraction expected this year by the International Monetary Fund.
The unemployment rate would rise to well over 25pc with six million out of work by the end of the year, equivalent to 30pc under the old definition used in the last jobless crisis in the early 1990s.
A study by BBVA of 173 cases of fiscal squeezes in OECD countries over the last thirty years concluded that demands on Spain are almost unprecedented. They found only four such cases, and three were offset by devaluations. The fourth was Ireland in 2009. The country crashed into slump, culminating in a 54pc fall in Dublin house prices.
and is starting to take on a highly political tone. Sixty years after the end of the war, Germany is again coming to be seen as an overbearing enemy, and an atmosphere of hostility is building up in a Continent divided between a rich and flourishing North and a South in danger of being reduced to a protectorate. If we carry on like this we are going to destroy the European project," he said.
There is near unanimity across the political spectrum that drastic pro-cyclical tightening at this stage is unwarranted and dangerous. Josep Borrell, ex-president of the European Parliament and the voice of Spain's pro-European establishment, said such debt-deflation risks pushing the banking system over the edge. "To cut the deficit almost four points in one year would be a true depressionary shock for an anaemic economy, made worse by the requirement for banks to mark their real estate losses to market prices."
The popular pressure gauge has been rising for months but the mass protests of the last two weeks have had a new and sharper edge -- even if you disregard the outbreak of violent street clashes with police in Valencia, already dubbed the "Valencia Spring".
A report last week by the Caritas wing of the Catholic Church warned that "there are more poor people than last year, and they are poorer. After four years of hardship, poverty is more widespread, more intense, and more chronic" than at any time in recent memory, with a gap between rich and poor that "threatens to polarize society". The poverty rate has risen to 21.8pc (38pc in Extremadura), the third worst in the EU after Romania and Latvia.
While the Greeks may or may not put up with ever-escalating EU demands -- most recently talk of parachuting 160 German tax collectors into the country -- any such treatment of Spain would set off the sort of `levantamiento' faced by Buonaparte in 1808, and the scale of damage to the European banking system would be catastrophic even for Germany.
The Spanish have good reason to feel maligned by North Europe's self-serving narrative of the EMU crisis. They never violated the Maastricht debt rules. They ran a budget surplus of 2pc of GDP during the boom.
Private credit spiralled out of control in part because the European Central Bank missed its inflation target every month for almost nine years and gunned the eurozone M3 money supply at double the bank's own target rate to help Germany, then in trouble.
Such a loose policy was toxic for an Iberian tiger economy, flooded with North European capital that it could not keep out under EU rules. Rates were minus 2pc in real terms for year after year, washing over the heroic efforts by the Bank of Spain to contain the damage.
Mr Rajoy has discretely requested a relaxation of the budget target to 5pc, pointing out `a la Grecque' that he inherited an even bigger shambles than feared.
Europe's answer has so far been iron inflexibility. “Backtracking on fiscal targets would elicit an immediate reaction by the market,” said ECB chief Mario Draghi -- a fiscal German, though a monetary Latin.
The Spanish must be sorely tempted to hurl sand back in the face of the ECB since the unforced errors of Frankfurt itself were the chief reason why the economies of Spain, Italy, and the rest of southern Europe buckled violently late last year.
The Trichet-Stark rate rises last year to “counter” the deflationary oil shock of the Arab Spring were as crass as it gets in central banking. Almost all prevailing scholarship warns against such a reflex. The rate rises compounded the fiscal squeeze already under way in the Latin bloc and led directly -- and inevitably -- to the collapse of the money supply in five or six countries.
By the end of 2011 all key measures of the money supply were contracting in the Euro zone as a whole. Hence an entirely avoidable Euroland recession. Hence the two-year economic slump now predicted by the IMF for Spain and Italy. Hence too an expected rise in Italy's debt/GDP ratio by seven points to 127pc by next year, and Spain's by eleven points, such is sensitivity of debt trajectories to growth rates.
Europe now faces another energy mini-shock as Iran pushes Brent crude to an all time-high in euros, tantamount to a €200bn tax on EMU consumers. Let us hope sense prevails this time.
Mr Draghi has done what he can to contain the damage from last year's tightening. His blast of unlimited three-year credit to banks at 1pc has averted a credit crunch as lenders frantically deleverage to cope with the EU's ill-judged pro-cyclical demand for 9pc core Tier 1 capital ratios by June.
But the Draghi Bazooka is a very blunt form of quantitative easing and contains the seeds of its own failure since it is leading to structural subordination of unsecured creditors and a concentration of systemic risk as the weakest banks load on the sovereign debt of the weakest states. Once again, the ECB is tying itself in knots -- and engaging in legal tricks to circumvent the Lisbon Treaty -- because Germany will not let it carry out plain-vanilla transparent QE that is perfectly legal and arguably necessary to keep nominal GDP growth on an even keel.
Ultimately, politics will decide the matter, and Mr Rajoy is not alone in Europe. He has a champion in Italy's Mario Monti, de facto leader of the Latin bloc and increasingly the man in whom the US, Japan, the IMF, and the rest of the world, are investing their hopes. As Mr Borrell put it, he is the only European statesmen with enough credibility to confront Angela Merkel "face to face".
Mr Monti's joint letter with twelve EU states last week calling for an end to self-defeating contraction marks a key moment in this crisis. If Francois Hollande is elected French president in May, the shift in Europe's balance of power will be complete. Germany will lose its stifling grip on EU policy machinery. The EMU bloc will start to tilt towards reflation at long last.
Whether it can come soon enough to avert a social explosion across Europe's arc of depression remains to be seen. Nor can such stimulus overcome the fundamental flaws of EMU since Germany is at an entirely place in the deform structure, with unemployment at 20-year lows of 5.5pc.
What is needed to save the South must endanger the North. Germany would overheat, pushing its inflation to 4pc or 5pc until Bild Zeitung erupts in Teutonic fury. It is impossible to reconcile the conflicting imperatives.
My guess is that Germany's refusal to countenance any form of EU subsidies, debt-pooling, or fiscal union -- other than policing the budgets of captive states -- has definitively broken the EMU spell. Latin nations by increasingly regard talk euro of solidarity as humbug. It has been a nasty shock. The era of national economic rearmament in Europe has begun.