A bleak future

Premier Jose Luis Zapatero told a stunned nation that public sector pay will be reduced by 5pc this year and frozen in 2011. "We must make an extraordinary effort," he said.

Pension rises will be shelved. The country’s €2,500 baby bonus will be cancelled. Aid to the regions will be slashed and infrastructure projects will be put on ice. Mr Zapatero’s own monthly pay will fall 15pc to €6,515.

Mr Zapatero - who long prided himself on being an "anthropological optimist" - plans to cut the deficit from 11.2pc to 6pc of GDP this year, with further cuts next year. The fresh move is to placate bond vigilantes and to calm German fears that eurozone discipline is breaking. He has already raised income taxes and lifted IBI (VAT) from 16pc to 18pc.

Javier Perez de Azpillaga from Goldman Sachs says Spain has climbed rapidly up the technology ladder. Its exports have grown faster than those of Italy or France. It has a low public debt of 53pc of GDP, but a "highly leveraged" private sector. Real estate companies have debts of €445bn, or 45pc of GDP. "Banks may not be able to recoup large parts of these loans. These losses will have to be recognized eventually, bringing down many institutions and forcing the government to recapitalize them," he said.

The `Cajas’ -- public sector banks -- have assets of €1.3 trillion and account for most mortgage debt. Many are struggling. The saving grace is that the two giants, Santander and BBVA, have global portfolios and are in "excellent shape".

Caixa Catalunya said the stock of unsold homes in Spain reached 926.000 at the end of last year, equivalent to 6.5m in the US. It expects the market to touch bottom this year with real falls of 20pc to 25pc from the peak. Spanish households have been able to draw on a very high savings rate of 17.9pc to absorb the shock.

Realistically, we all knew that Mr Zapetero would have to deliver a bitter pill and he has. Whether it will work and more to the point whether it will trigger social unrest in the form of a general strike remains to be seen. We have become so used to pay rises and year on year house prices increases but those days are over – the debt just can’t go on. If the whole world was allowed to go into debt, who would be left to finance it?