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How long can Spain afford to hold on?

(Money Watch) How long can Spain hold on now that its bond rates have all-but broken the critical 7 percent mark?

Investors reacted to more dismal Spanish economic news by pushing yields on the nation's 10-year bond to 6.98 percent in mid-day trading today. That's the highest they have been since Spain joined the euro in 1999. The increase came after Moody's Investors Service became the latest ratings agency to downgrade the beleaguered Iberian nation's debt. It dropped Spain's sovereign debt three notches from A3 to Baa3 Tuesday night, placing it one grade above "junk status."

The governments of Greece, Ireland and Portugal all sought international bailouts within weeks of their bonds hitting 7 percent. That level has become an indicator that the nation has lost the confidence of the markets and that the banks within that nation can no longer buy enough bonds to keep the interest rate down.

Spain's position was becoming untenable even before this. A week ago, when the interest rate hit 6.2 percent in the wake of the collapse of the nation's 4th largest bank, Budget Minister Cristobal Montoro said the nation was effectively shut out of the bond markets. The European Union responded by putting together a $125 billion loan to recapitalize the entire banking system. This move failed to reassure investors who have been pushing up the bond yields all week.

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Why the Greeks will vote to default

If Spain is no longer able to borrow enough money to pay its bills, the world's economy would be facing the gravest challenge since the Great Depression. Spain is the world's 14th largest economy in terms of GDP and the fourth largest in the EU. Greece's economy, the 41st largest in the world, is roughly the size of that Spain's most prosperous region Catalonia. Because of its size, a bailout of Spain is impossible - even if the EU, European Central Bank and IMF were to combine all of their resources.

If Spain were to collapse it would have an enormous impact around the globe. Although it is believed U.S. financial institutions have little direct exposure to either Spain or Europe at this point they would undoubtedly be badly hurt by other institutions calling in loans so they could repay demands to others. Further this would cause a collapse in the already struggling global demand for goods and services.

There are few options open to the EU at this point. The one most frequently suggested is the creation of Eurobonds, which would be guaranteed by all the EU's member states. Germany, the most powerful economy in Europe, has staunchly opposed this idea. Even if it were approved, there is little chance it could be implemented in time to aid Spain.

Unless someone comes up with a revolutionary idea to save Spain the world can only wait and hope that the bond rates come down for some other reason which no one has thought of yet.

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