Why Spain Turned Right

In my column for CNN, I explain why the conservatives were able to win in the Spanish elections:

Signing up for a monetary union with Germany created a temporary illusion of wealth for the people of Spain.

The German economy is much more productive than the Spanish economy. One way a less productive economy can adjust its trade is by allowing its currency to depreciate. The advent of the euro deprived Spain of that option. Instead, the price of German goods and services steadily declined inside Spain. Result: Between 2002 and the onset of recession in 2008, the Spanish trade deficit tripled, from 3% of GDP in 2002 to more than 10% in 2008.

You might wonder: wait a minute! If the price of German goods and services declined inside Spain, then logically the price of Spanish goods and services (including vacations) must have risen to Germans. So how did Spain finance its German buying boom?

Answer: The same currency union that cut the cost of buying goods from Germany also cut the cost of borrowing money from Germany. The euro did to the German-Spanish economic relationship exactly what China's currency manipulation has done to the U.S.-China relationship.

Between 2002 and 2008, Spanish households went on a borrowing binge. They used the borrowed money to build and buy new homes. Through the 2000s, Spain built houses at a rate of 700,000 a year - more than Britain, Germany and France combined.

Spain built shopping malls and office buildings to match. By 2008, construction accounted for a staggering 16% of the Spanish economy. And all of it was financed by debt: Spanish households accumulated debt equal to 90% of GDP (only slightly less than U.S. households at the top of the housing bubble), and Spanish businesses had accumulated debt equal to 205% of GDP (vastly more than U.S. business has ever borrowed).

Americans well-understand how this game ends. One day, the market loses faith that housing values must endlessly rise. The bubble pops. Asset values tumble. The debts remain. As debtors scramble to service their debts, they cut back their buying of goods and services. That causes a recession, which causes asset values to tumble more, which causes debts to go into default -- and the whole economy painfully unwinds.

Click here to read the full column.