Bank of Spain says economy shrunk in the final months of 2011

Bloomberg reports that the Bank of Spain says the Spanish economy shrunk in the final months of 2011.

Perhaps I am the only one who feels this way, but given the choice, and it most certainly is a choice, between investing funds in some form of a bank bailout or investing funds in programs to get the economy growing again, I always would invest in growth.

Regular readers know that this choice exists because there is an alternative to bailing out the banking system.

The alternative is to allow the banks to continue to provide loans and payment services even when they have negative book equity.

Everyone knows that the banks are currently holding more bad real estate debt than they have book equity.  Despite this, there has been only a modest run on deposits in the banking system.

Why would acknowledging the real value of the bad real estate debt and showing negative book equity cause depositors to run from the banking system?

The reason that depositors have not staged a full scale run on the banking system is that they think the government will guarantee the safety of their deposits.  This guarantee does not change if the banks have a negative book value.

In fact, the guarantee is enhanced by the Spanish government not bailing out the banks.  Clearly, the Spanish government has more capacity to borrow if it doesn't have to borrow to recapitalize the banking system.

Not borrowing to bailout the banks also means the government can instead focus on pursuing economic policies that support growth.

As for the banks, they should be required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  Market participants can use this data to assess the riskiness of the banks and exert market discipline less the banks try to gamble on redemption while they are rebuilding their book capital through retained earnings.

The Bank of Spain said available data suggest the euro area’s fourth-biggest economy contracted (SPNAGDPQ) in the final months of the year, a day before Prime Minister Mariano Rajoy is set to unveil his first budget measures. 

The central bank said in its December monthly bulletin published today that tourism and exports showed signs of weakening from October while household spending and investment worsened, adding the data aren’t yet complete. 

Spain’s fragile recovery in the first half was sustained by exterior demand as the most drastic austerity measures in three decades pushed unemployment to a 15-year high. 

The Bank of Spain confirmed earlier forecasts that the economy is worsening as Rajoy, who holds his second Cabinet meeting tomorrow, has said he’ll announce his plans to carry the nation through until a 2012 budget is presented in the first quarter. 

Rajoy’s People’s Party, which inherited a stalled economy from the Socialist government after winning in a landslide on Nov. 20, now faces the double challenge of tackling the euro area’s third-largest budget deficit (EUBDEURO) and Europe’s highest jobless rate (UMRTEMU). 

“After the Spanish economy stalled in the third quarter, available data show that activity contracted in the last months in an environment of strong tensions in the financial markets” and weakening growth prospects in the euro area and the rest of the world, the central bank said.