The best analysis of Spain and the Euro crisis that I’ve seen, comes from the Peterson Institute of International Finance:

“Certainly, Spain faces serious economic growth and labor market challenges as it works its way through a devastating real estate collapse. But it has neither the debt stock of Greece, the bust banks of Ireland, or the complacent government of Portugal.

General government debt was 53 percent of GDP in 2009. This debt, moreover, has a high degree of domestic financing. More importantly, the contingent liabilities associated with the Spanish government’s support for its banking system (large banks and the savings banks known as cajas) is less than 5 percent of GDP (in Ireland it was 176 percent of GDP). If you factor in the reliance of the large Spanish banks BBVA and Santander on large emerging market operations, which could be sold off in an emergency, it is hard to see how Spain is in serious trouble on a consolidated “sovereign + private banks” basis.

Certainly, Spain has seen a dramatic real estate collapse that has weakened the broader economy and the banking sector. But because of Spain’s tough “recourse” mortgage debt laws, which give a lender the right to seek repayment of a mortgage loan from the borrower’s (and/or guarantor’s) personal assets, it is not clear that the immediate cost of the residential real estate collapse will be as high as it was in the United States. In addition, debt-burdened Spaniards seem less likely than the Irish to migrate out of their native country, weakening its economic base still further. Many people point to the high Spanish unemployment rate of about 20 percent and infer that the country might be on the verge of a “social revolution.” But as sad as Spain’s difficulties are, joblessness is now back at levels seen in the mid-1990s, before declines in real Spanish interest rates led to the real estate boom associated with the country’s entry into the euro. History suggests that even a 20 percent unemployment rate is not associated with large scale social unrest.

There is also another side to the Spanish story on jobs, if one focuses on employment rates rather than unemployment. Here Spain has suffered a dramatic drop in employment from 66 to 58 percent in the 16-to-64 year age group. The 58 percent employment, however, is still the rate experienced as recently as 2003. It is also more than 15 percent higher than in the mid-1990s. Not all the labor market gains of the boom have been lost in the subsequent bust.

Then there is the issue of private sector debt held by foreign institutions—just over 100 percent of GDP in 2010. This level is much higher than it is for the Spanish government, but the real issue is not so much the scale but the type of liabilities and maturities in foreign private sector hands. Fortunately for Spain, two-thirds of the private sector foreign debt is in long-term bonds, notes, or loans. The actual immediate short-term private sector funding risk in Spain is consequently limited.

Most important, though, the Spanish government has embarked on a constructive policy trajectory since the Greek crisis peaked in May. It forced publication of the EU banking stress tests over the summer and for its own part went considerably beyond what other EU members did in terms of the stress test assumptions and transparency. The socialist government cut spending and public wages, committing political hara-kiri in the process. It has also finally begun liberalizing the Spanish labor market.

Moreover, for 2011, the government has announced further austerity measures, more labor market liberalization of collective bargaining, and a pension reform raising the retirement age from 65 to 67. In sum—Prime Minister José Luis Rodríguez Zapatero “gets it,” and Spain is taking its medicine preemptively.

What we are seeing, therefore, is a largely speculative attack by the markets on the inability of current EU policy tools (EFSF/EFSM) to address Spain in the same way as Greece, Ireland, and Portugal. This does not mean that the European Union lacks the will or capacity to assist Spain. The European Union functions best in crisis, and the political will to preserve the eurozone should not be underestimated.

Or to put in another way, one of the implications of Angela Merkel’s fight to “preserve the primacy of politics over markets” is that EU politicians can throw out the rulebook again to fight off markets’ speculative attacks on Spain. In extremis, the ECB—with German political acceptance—could simply print money before seeing Spain forced into a disorderly default scenario by irrational market contagion and associated excessive interest rates.

Despite the temporary market volatility, as long as the underlying health of the European economies are being aggressively addressed through the austerity and reform measures politically enabled by the economic crisis, speculative attacks cannot break the eurozone apart.