Spain Is Struggling With Its Debt, and You Should Be Worried
As it turns out, these four little words are very relevant.
Lately, "rising Spanish bond yields" has been code for the potential return of economic crisis in Europe, something that, with two Greek bailouts already on the books, many hoped was over.
Here's a primer on the bond market, a look at what's happening in Spain, and why those four little words should make all of us very nervous.
The Simple Scoop on How Countries Get in Debt Trouble
When you need money over and above what you have in your checking account or stuffed in your mattress, you go to the bank and take out a loan, promising to pay the bank back its money over a defined period of time, plus interest. That's how banks make money. When a company needs money, it can also get a loan or issue what's called a bond.
A bond is a debt instrument in which a group of investors loan a company a certain amount of money for a certain period of time and receive ongoing interest payments in return. That's how bond investors make money. At the end of the agreed-upon period of time, the bond matures, and the company returns the original amount of the bond to the investors.
When a country needs money over and above what it's taking in from taxes, it too issues bonds, called sovereign bonds. And just like with a company, when a country can't keep up with the interest payments on its bonds, it can default on its debt.
The Bond Market Demands its Pound of Greek Flesh
This is essentially what happened in Greece. Since the early 2000s, the country has issued an Olympian-sized number of sovereign bonds, going deep into debt on the bond market. As word got out in 2009 that the country was running a significantly higher fiscal deficit than previously thought, the bond market got nervous about Greece's ability to make good on its debt and therefore started demanding higher interest rates on new Greek government debt.
As a result, interest rates on debt rose to a point where the country was no longer able to keep paying investors. Greece was clearly headed toward default.
Since no one was certain how a Greek default in the tightly knit, globally connected eurozone would play out on the world economic stage, Europe organized two enormous bailouts designed to keep the country solvent.
The Pain in Spain Falls Mainly on the Rest of Us
This is where you and I come in. Greece's economy is the 11th largest in the eurozone. Spain's is the fourth. Right now, Spain is struggling to control its deficits and is at the top of the list of the bond market's worries. As such, interest rates on Spanish debt are rising.
Now, back to us. Between banking and business, America and Europe are inextricably linked. Europe is currently in a recession, and after years of being in recession itself, the U.S. is on the edge of a very fragile recovery. If the bond market pushes interest rates on Spanish debt up to the breaking point, and Europe can't manage a bailout and Spain defaults, there's concern that the ensuing economic shockwaves could cross the Atlantic and send us back into recession.
From our own experience at the height of the financial crisis -- when the banks stopped lending to each other, to businesses, and to those of us who needed to buy cars and houses -- we know that when the banks aren't working, nothing's working.
So the next time you hear "rising Spanish bond yields," prick up your ears, and tell your brain to file those four little words under "frighteningly important."