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Spanish Death Spiral Continues


Spanish 5- and 10-year bonds are now priced as riskier than those of Ireland.

In fact, the divergence between the Irish and Spanish issues has become a gulf since the Spanish bank bailout. This is, at least in part, due to the difference in attitudes between the two governments: Ireland adopted a “clean sweep” approach which terribly overburdened the Irish government at the outset but is now showing improvement. Meanwhile, Spain adopted an incrementalist (a.k.a. “ostrich”) approach, with the result that the Spanish are now well into their fourth “definitive” financial sector reform and likely to see a fifth before too long. The loss of investor confidence has been devastating to the country and it’s ability to finance any sort of economic growth.


 The Spanish central government exceeded its year-end deficit target in June. If anyone thinks that the regional governments are doing better – well, I have some bridges to sell them in Brooklyn…

The Spanish death spiral continues as the government applies ever more rigorous austerity measures that the economy cannot bear. Many of the measures being imposed by the Rajoy government make sense; but they are “fair weather” measures that are normally imposed during good economic times, when the country can bear the pain. Applied during a recession, and they are likely to turn it into a depression.

Striking Asturian miners combat police

How much more pain can the Spanish bear? Already there is a marked increase in both planned and spontaneous work stoppages and protests. From the Asturian coal miners, whose fights with the police look more reminiscent of Syria than Europe, to government employees in Madrid. Spanish society might be reaching a limit of tolerance beyond which government measures meet increasingly costly noncompliance issues.




 Despite the new Law of Fiscal Sustainability, which allows the central government to intervene in regional finances if these fail to meet deficit reduction targets, it is likely that Rajoy’s government will meet very serious legal and procedural opposition – even from regions where the Populares are in charge. This could involve protracted constitutional challenges which will only exacerbate foreign investor doubt over Spain’s ability to meet targets in any meaningful length of time.

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2 Responses to “Spanish Death Spiral Continues”

  1. A good friend of mine in the US sent me this comment regarding Basel III, which I thought was right on target:
    “Man, that isn’t good. Still, I wonder who would lend money to Spain at 6.76%. Right now I’d assume the default probability on those bonds is higher than that. Had an interesting discussion on Basel risk weighting that revealed that government bonds carry a zero weighting, including countries like Greece and Spain, meaning that the Basel formulas view them as riskless. Not very sensible. What do you see the answers as? Spain can’t inflate out of it due to the Euro and unless someone lends them money tightening the belt seems the only option no matter the consequences.”

    Posted by fdbetancor | July 18, 2012, 10:04
    • To which I replied:
      “We’ll get out of this the same way we’ve been keeping the US government afloat: printing more money! The ECB has been printing trillions of euros and loaning them to European banks at 1% rates for 3 years in the LTRO (Long-Term Refinancing Operations) since the beginning of the year. Spanish banks alone have taken some €600 – €800 billion in LTRO funds. This is Europe’s backhanded Quantitative Easing, because the ECB is prohibited from lending directly to governments. No one at the ECB, Fed, BOJ or BOC give a damn right now about the long-term consequences of hyperliquidity, which are not only highly pernicious, but also very long-lasting – God knows how or even if we’ll be able to get back to “normal”.

      Also, there are still people who think Spain is too big to fail, and they may very well be right. A lot of the money is also coming from Spanish institutional investors; the Spanish banks do an excellent carry trade, borrowing hundreds of billions of euros at 1% or 2% from the ECB and then lending it to the Spanish Treasury at 6% or 7%. The Spanish Treasury then uses this to fund the FROB (Fund for the Orderly Restructuring of the Banking sector) or to directly inject equity into failed institutions like Bankia. Nice, huh? That’s good work if you can get it. Unfortunately, most of the rest of us can’t and we’re stuck paying ever increasing taxes.

      BTW – next time you feel like complaining about taxes in the US, just remember that my overall (not top marginal) income tax rate is 40%. That doesn’t include my property tax or the now 21% value-added tax I’ll be paying on goods and services. No wonder I wait until I’m home before buying anything not absolutely indispensable.

      Anyway, the problem in Spain hasn’t been with the public sector debt, until the past few months. The problem in Spain has been very high private sector debt and a huge asset bubble, which has now burst. That has cut-off private sector financing for any sort of economic growth as the banks have an urgent need to deleverage. However, since neither they nor the government have adequately dealt with the housing problem, the banks can’t deleverage because their books aren’t strong enough to take the hit in the valuation of their assets. So one part of the government’s problem is shoring up the banking sector, which could sum to hundreds of billions of euros, not the paltry €60 billion they are talking about. The other problem is the collapse in tax revenues due to poor economic performance. The unemployment rate surged from around 8% to 25% and has clung there for the past couple of years. The rise in mandatory payments and the fall in both worker and corporate tax revenues is what is generating the large budget deficit, not “waste” (though there is undoubtedly that as well – but there was grotesque waste in the private sector as well, just look at the > 1 million unsellable houses built for purely speculative purposes between 2005 and 2008).

      Spain can’t export its way out of the mess because it no longer has a competitive export sector. It spent the last 10 years building up a services sector, determined to become the “Florida” of Europe. To the extent that they succeeded, they are now ill-positioned to suddenly start manufacturing precision instruments or high technology goods. For that to happen, the Spanish government would need to invest very heavily in education, worker force retraining, industrial R&D, and probably tax subsidies for large-scale investments in plant and equipment. That would be the opposite of austerity – in fact, they have chosen to cut all of those items from the “austerity budget from hell”. So if Spain has:
      1. An illiquid private funding market;
      2. Prohibitively expensive access to global credit markets for both private and public actors;
      3. An industrial base and workforce which are structurally unfit to compete for export markets;
      4. A 25% unemployment rate and a massive tax revenue deficit;
      Then it seems clear to me that austerity is probably not the best answer. Why? For one thing, austerity is meant to deal with problem #2 by convincing international credit markets that Spain is “serious” about its reforms and thus is worthy of a lower risk premium. Unfortunately, austerity also exacerbates #3 and #4 and does nothing for #1. Furthermore, the second order effect of austerity is that, while it may make investors think you are serious, unless they are complete idiots, they also know that you are making your recession worse, lowering consumption, bankrupting businesses, etc… So while they may admire your stamina, they also fear that it is unsustainable in the face of economic realities.

      So it is likely that the Euro Zone will continue to muddle through. Europe is rich enough to keep putting off the real structural reforms it needs to make, perhaps indefinitely. It took 80 years for the Soviet Union to collapse from its internal contradictions, and Europe has more money and less defense spending than the old USSR ever did. Spain, Portugal, Italy, Greece – probably none of them will leave the euro; they’ll just continue to suffer from massive political and social upheaval, with waves of emigration to northern Europe, North and Latin America. God help these countries in 20 years if they fail to achieve meaningful economic growth – all four of them face a demographic disaster of enormous magnitude, which will only get worse as Third World immigration evaporates and native emigration of young professionals increases.

      As for Basel, sure it fulfills the European ideal of “if it moves, regulate it” and the Brusselsian love for dotting “i’s” and crossing “t’s”, but I think everyone recognizes that some of the provisions are really ill-timed. Increasing core capital requirements is a grand idea, or would be if it weren’t being done in the middle of a banking crisis. And the idea that sovereign debt is risk-free has never made any sense; history is replete with sovereign defaults, even in modern times. But if they forced banks to change to a risk-based valuation of their sovereign bonds, half of Europe´s banks would fail, and then drag down the other half. European core capital is simply stiff with sovereign assets, all valued as risk-free. It is not something that can be changed any time soon, no matter how illogical it is.”

      Posted by fdbetancor | July 18, 2012, 10:08

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