Spain Real Time Data Charts

Edward Hugh is only able to update this blog from time to time, but he does run a lively Twitter account with plenty of Spain related comment. He also maintains a collection of constantly updated Spain charts with short updates on a Storify dedicated page Spain's Economic Recovery - Glass Half Full or Glass Half Empty?

Monday, January 12, 2009

S&P's Puts Spanish Sovereign Debt On Ratings Watch Negative




Spain yesterday became the third euro zone country within a week to be warned by rating agency Standard & Poor's that its credit rating (currently the highest - AAA) is under threat from the deterioration in public finances being produced by the government's attempt to support the banking system and put a brake on the dramatic decline in the domestic economy. As in the case of Ireland and Greece last Friday, S&P said Spain faces a painful process of rebalancing of its economy and a consequent marked deterioration in its public finances.

The gap in bond yields between the benchmark German bunds and the sovereign debt of Spain, Greece, Ireland, Italy and Portugal has risen fourfold since July (see charts above to get some idea) to levels not seen since the launch of the euro in January 1999, and this despite the fact that bond yields have fallen for all countries since last year’s peaks in July as interest rates have steadily fallen.

One year ago the financing of Spanish government debt was barely more expensive than it was in Germany, but yesterday the 10-year bond spread between the two reached an unprecedented 92.6 basis points (or nearly a full percentage point) before settling at 92.3 basis points. The spread, or additional interest, between Spanish 10-year bonds and similar German debt rose 9 basis points, or nine hundredths of a percentage point on the day.

Credit-default swaps linked to Spanish government debt also rose 11 basis points to 106, according to CMA Datavision, in the biggest one-day move since 23 October 2008. Credit-default swaps, which are used to hedge against losses or to speculate on the ability of companies to repay debt, typically rise as investor confidence deteriorates and fall as it improves.

The Euro was also affected by the news, and is this morning (Tuesday) still trading at a one-month low of around 1.328 to the dollar, as the negative news from Spain simply added to trader sentiment that the European Central Bank will reduce interest rates, and thus reduce the present yield differential with USD instruments.

“Everyone knew that Spain was in trouble, but this is one of the triggers that investors were waiting for,” said Ivan Comerma, head of treasury and capital markets at Banc Internacional-Banca Mora in Andorra. “This is the worst timing as Spain is about to start with its funding plan for this year and the country’slenders are about to start selling government- backed bonds.”
In a climate where governments across the OECD are preparing to significantly increase their bond issues in 2009 , Spain, Ireland and Greece could find themselves paying significantly more to borrow money if their ratings do in fact fall. Spain is set to increase 2009 debt issuance by around 51 percent to 104.5 billion euros to cover the growing fiscal deficit. This borrowing requirement follows government announcements of something in the region of 90 billion euros in various packages of stimulus measures, in addition to measures to support banks, while at the same time tax revenue is falling due to the contraction in the economy. And we may yet see considerable overshoot on this borrowing estimate, since the government had a one percent GDP expansion (much to the chargin of central bank governor Miguel Fermamdez Ordoñez) incorporated in the original budget, and of course what we are likely to see is a contraction of several percentage points in GDP.

In addition the Spanish government has offered to guarantee 100 billion euros of new bank debt this year as well as promising to buy up to a further 50 billion euros in bank assets intended to boost liquidity as banks are forced to seek news sources of refinance for their steadily expiring existing cedulas hipotecarias. The first financial institution to take advantage of such guarantees may well be savings bank La Caixa, who have indicated they plan to issue a 3-year bond next week, a bond which it seems may well be backed by a government guarantee. La Caixa's decision to move ahead with a government guaranteed bond (and ride out the stigma which could be attached) may well be influenced by the outcome of last Friday's sale by Spain's second-largest bank, BBVA, who placed 1 billion euros in 5-year unsecured senior debt on offer, without a government guarantee - the first such operation by a Spanish bank in over a year and a half. The bank set guidance on the bonds at mid-swaps plus 180 basis points, but it is far from clear that the operation was a spectacular success.

“"The Creditwatch placement reflects our view of the significant challenges facing the Spanish economy as it traverses a period of very weak growth...We expect public finances to deteriorate markedly with the general deficit rising,” Standard & Poor’s analysts led by Trevor Cullinan said. The analysts also said they expected the general government deficit to rise well above 3 percent of gross domestic product until 2011, peaking at more than 6 percent this year.


Spain’s public finances are thus threatened with a marked and sharp deterioration. Debt was equivalent to a mere 36 percent of GDP in 2007, compared with a 66 percent average for the eurozone as a whole, 95 percent for Greece, and 105% for Italy. Worse, S&P's and many others (myself included) are worried not so much by the deterioration itself (in times of crisis fiscal spending is entirely legitimate) but by the level of realism in the government's approach to the problem. What we could thus well see, in my opinion, are two or three years of above expectation annual contractions, accompanied by two or three years of above expectation fiscal deficits, with the national credit rating steadily deteriorating. We could then find ourselves arriving at 2011 with one unholy mess of an economic problem still to be sorted out - a construction sector which is still in need of serious downsizing, and an export sector which is still far from competitive, for example - with all the resources in the national coffers effectively exhausted by a completely useless spending spree. So now it isn't only "Edward" who is saying this, we are getting some objective international responses to the situation too, and we are now likely to see more such moves.

In fact I have been warning about the problem posed by lax fiscal policies and mounting concern from the rating agencies in the Italian case for years (their position will be much more serious in the short term if they do get another downgrade), and I recently commented on Greece. Back in August 2007 I even pointed out what "fools" I felt Sarkozy, the EU Commission and some European MPs were being by pointing the figure directly at the ratings agencies in the wake of the sub prime scandal. As I said at the time (16 August 2007):

The sub prime situation is in fact a good "case in point" example of this process at work. And after the agencies themselves admit the problems were worse than previously anticipated, then the markets, predictably, also over-react. So the question I am asking is, would we all now really like to see this situation replicated in the case of the Italian debt problem, or the Baltic overheating issue? Would we, or the EU Commission, be happy with the outcome?I think in this kind of area it is better not to tempt fate, or call on others to do what you are not prepared to do yourself.

In the event that the Italian government is one day forced to default on its sovereign debt, will we be holding the European Commission itself responsible in the way that they would now try to point the finger at Standard and Poor's or Moody's? The root of the problem here is that the EU itself needs to be able to make accurate and clear assessments of the underlying issues involved on its own account, and to develop the capacity to face up to difficult decisions, take them, and then make them stick, rather than simply fudging everything in an ongoing process of political "deals" and horse trading. Nor is it a solution, when the going gets really tough, to outsource responsibility to agencies which really are neither designed for, or adequate to, the task in hand.

At the present time it isn't clear that there will be an immediate downgrade in Spain's credit rating, and at AAA there is of course quite a long road to travel before we reach the precipice of being awarded the "junk bond" status (BB+) which was attached to Romanian sovereign bonds by S&P's on October 27 last. At the same time, this is a road, however long it may be, that it would have been better never to have gotten started down in the first place. Even the activities of Spain's Instituto de Credito Oficial, a government body which issues bonds in its own right as part of the bailout programme - and which only this week sold a five-year euro-denominated benchmark bond - will see its triple-A rating lowered in the event of a downgrade, since the rating is effectively supported by the Spanish national one. The ICO - in theory - provides backing to small and medium-sized businesses, long-term loans for infrastructure projects and financial support in cases of economic or natural disaster.


The Problems Of Resolving The Credit Crunch

The difficulty I see coming in all of the above refers to the need for a large injection of funds at some point in the not so distant future to decisively unblock the credit crunch. Let's look again at my "exhibit A" from the Japan experience - the chart, prepared by the Japanese economist Richard Koo, which shows the evolution of lending conditions in Japan during the 1990s (those who read my "coffee deflation" post will already have seen this). The thick blue line (please click over chart if you can't see adequately) show large business perceptions of the willingness of banks to lend to them. You will note the line plunges twice, and it is the second plunge, or "credit crunch", which interests us here, since it is my conjecture that we have yet to see this part of the Spanish crunch, but that we will, when push finally comes to shover and the banks throw the towel in on the mounting pile of non-performing loans.

This was the crunch remember, the one that finally drove Japan decisively off into deflation, and produced that now famed "liquidity trap". Basically the first credit crunch was resolved via large scale government contruction spending, the guaranteeing of bank deposits, and the swallowing by the banks of a large number of non-performing loans. Does all this sound familiar? It should. But then Japan reached a point were the financial system could struggle forward no further. So the crunch broke out again, and this time the only way to resolve the problem was with two massive injections of capital into the banking system. These injections served to push the Japan government debt to GDP ratio sharply upwards, and it is this part of the story that I feel we will see repeating itself here in Spain. Maybe in 2010, maybe in 2011. It all depends how far the system can limp forward before it folds in on itself.



And while I am here one further point on all this, since a friend of mine asked me earlier in the week some searching questions about my "back of the envelope" calculation of a 50% to 60% of GDP cash injection requirement. That conversation has lead me to see that I may have been responsible for causing some confusion here. What I want to try and make clear is that I am not saying that the extent of DEFAULT in Spain will reach the order of 50% to 60% of GDP (I mean private sector, household and bank default, we are not talking about government default here, and I hope that in the Spanish case we never will be), but that the size of the government cash injection needed to break the back of the credit crunch will be of this order.

To try to explain the distinction I am trying to make let's look at one of the most publicised recent defaults in Spain - that of Martinsa Fadesa. Now in this case the non-performing loan was something in the order of 6 billion euros. So in a way the press are right to talk about it as a 6 billion euro default. But of course not all the 6 billion euros is lost, since the administration process will recover something from the assets which are still to be disposed of. And so it will be with the rest of them. Ben Sills at Bloomberg recently drew attention to an estimate by R.R. de Acuna & Asociados, a Madrid-based real estate research firm, that there are more than 1.6 million unsold homes (new and second hand I presume) in Spain, while annual demand for housing was down to 220,000 units in 2008 from a peak of 590,000 in 2004. That is we could have an inventory of some 8 to 9 years worth of unsold homes, and the question is who is going to fund holding them while we all sit back and wait.

So even while the fact the Spanish state has to fund in some way or another some 300 billion euros in non performing loans doesn't mean that net government debt needs to rise long term to pay for them (since in the end something can be recovered) some massive "bridging finance" is going to be needed.

The same thing goes for the cedulas. In my opinion the Spanish state will have to buy out all the cedulas which need refinancing over the next 5 years, and they will need to fund this. I estimate there may well be between 250 and 300 billion euros involved here. So someone has to raise this money, and I am saying the Spanish state cannot do this alone, or the yield spread will go through the roof as the credit rating goes down, as we are now starting to see.

One possibility might be the creation of EU bonds which could be used to expand the ECB balance sheet in the way that the US Treasury has done for Bernanke and the US Federal Reserve, but this raises a structural question with important political implications, since non eurozone countries like the UK and Sweden would also be being asked to underwrite eurozone debt. Or are we talking of a "shotgun-fushion of the EU and the eurozone to created that much maligned federal state which some have been arguing we need to make the eurozone a coherent entity, but which others have resisted tooth and nail?

In times of need, you do what you can.

Basically my view is that our EU architecture is in something of a mess here, simply because not enough thought was given to the possibility that something like this might happen when the eurozone was first set up - in the same way little attention was paid to the question of how to avoid the kind of bubble Spain has been subjected to by having a single size for everyone interest rate policy thrust upon it. The problem is there is no eurozone-specific fiscal equivalent of the EU commission which could issue bonds and regulate fiscal policy.

Acknowledging, however, that all this debt doesn't need to go straight onto those widely quoted debt-to-GDP ratios, doesn't amount to saying that all those extra debt obligations don't matter, as we can see in the Japanese case. The true level of Japan debt to GDP is still a hugely controversial issue. The OECD insists on using the gross figure 182% - due to their unwillingness to put a value on assets (like land) still held by the government, and for which no one really knows the mark to market prices. Other agencies quote the much lower net debt to GDP - which is still near 100% - and until someone actually disposes of the assets the Japan government holds post the credit-crunch-bailout no one will really know what the true level of Japan sovereign debt is. In Japan's case this doesn't matter so much, since most of the people buying the debt are themselves Japanese (home bias) and Japan is a current account surplus country. This is not Spain's case, and Spain will need non Spaniards to buy some significant part of this extra debt, hence the problem.



Santander Under Investigation

Well, as we say in English, it never rains but it pours (sempre plou sobre mullat) - and if only to confirm the validity of the old adage I simply can't end this post without mentioning that we have learnt today that Spanish prosecutors are currently investigating Banco Santander's loss of more than 2.3 billion euros of its clients' money by investing with alleged swindler Bernard Madoff. Just what Spain and its badly mauled banking system needed at this moment in time - a crisis of confidence in the professional judgement of Emilio Botin.


According to the Wall Street Journal yesterday Spain's anticorruption prosecutor is set to examine the relationship between Santander, Fairfield Greenwich Group, and the Madoff funds. Fairfield Greenwich Group is an investment fund, whose clients stand to lose $7.5 billion in the alleged $50 billion Ponzi scheme. According to the Journal, investigators are looking into why Santander Chairman Emilio Botin sent his head of risk management operations to visit Madoff weeks before the scheme fell apart. Investigators are also reported to be looking into whether several people who managed money at Santander funds were aware of problems at the Madoff funds.

30 comments:

Anonymous said...

I wonder what the effect of the construction collapse will have on town hall and regional finances that used to gain so much revenue from building licences?

Anonymous said...

@ last Anon,

Quite big one, but much lower than in USA where the house tax is so high to pay schools, firemen and so on!

Anonymous said...

Italy is trading flat with Bank of America. It would seem odd that a bank (even a large bank) would trade flat with a reasonably productive state, but there is a double whammy working for B of A (and everyone like B of A) and against Italy (and everyone like Italy).

First, the bottomless bailout has effectively made several, privileged entities in the US financial sector (including B of A) sovereigns by pulling them into the protective ring of the Treasury. Consequently, Italy isn’t really trading against B of A, it’s trading against the US Treasury.

Second, the US Treasury keeps borrowing by the boatload, and the US Dollar remains the world’s reserve currency. That means that every borrowing sovereign finds itself in line behind the US at the door of every lender out there, and the US isn’t leaving much for everyone else.

Which leads us to this: How long before sovereigns, or coalitions of sovereigns, start putting ring fences around their financial systems to restrict the flight of capital to the US? And when (not if) that happens, how will bailouts and stimulus packages be funded, and where will the credit loosening the MOAB was supposed to generate come from?

And to finish, Hugh, do you think that UK & USA deserve a AAA?

Auskalo

Anonymous said...

Maybe, we'll have to get used to a spanish version of that:

http://tinyurl.com/a7z2lm

-:)

Auskalo

Edward Hugh said...

Hi everyone,

"And to finish, Hugh, do you think that UK & USA deserve a AAA?"

Well, look. I most certainly am not in the rating agency business. In the second place, and perhaps surprisingly for someone who was born British and whose father spent 11 years in the US (1922-33) as a poor immigrant, the US and the UK economies are two of the ones I know least about. So frankly I don't think my opinion would be worth the words it would be written in.

Basically I tend to think about debt sustainability in terms of demographics in the longer run - which is why, for example, I think of Italian, Japanese and Hungarian sovereigns as pretty risky.

What I look at is longer run fertility and immigration, since these two factors alone determine the size of the elderly dependency ratio, and the age structure of the working population. These factors are what seem to me to underpin the ability to pay back over the longer term.

In both cases the US and the UK do rather better than many other developed economies.

The problem we have here are short run dynamics, and funding debt over the next five years or so. This is a rather different issue. But basically I don't think either the US or the UK are likely to have the smae levels of difficulty as a Hungary, or a Ukraine, or a Portugal, or a Greece.

Spain is in the middle here, since I am not forecasting sovereign default or anything near it for Spain, I am just indicating that the cost of raising debt is likely to rise, and this can create a lose-lose dynamic where it gets more and more difficult for the government to support the economy and prevent PRIVATE defaults.

The risk to the Spanish economy is much more from the balance sheet conseqquences of large scale private defaults (households and corporates) and from downward rigidities in wages and prices which delay adjustment to export driven growth.

This problem set can of course put pressure on Spain's euro membership, but only via the mechanism of the impact of debt deflation on a strongish currency.

I mean, I think people have to decide which way they have their story here. Is it a weak dollar, or a weak euro? It seems to me we can't have both, thus if we get a weakish dollar, and without this I don't see how the US is going to get the inflation and the export growth it needs to sweat off all the debt, then we get a strogish euro, and this is what can put pressure on for break up.

But in neither case do I see Spanish sovereign default.

The FT's John Authers has quite an interesting video on the evolution of the sovereign bond spreads in the eurozone (click on "Greeks bearing gifts" to the right if it doesn't show directly). He points out those who are betting now give a 30% possibility to at least one member leaving the zone by 2010. I have no idea whether this is realistic, but the possibility is there, and a one in three chance may be about right.

One thing people don't seem to have gotton hold of yet is that a default on a sovereign with an ageing and declining population scenario (say in Japan) will be really quite a serious matter for everyone, since apart from the backdraft on the whole global financial system, it will be quite different from a default in an emerging economy like Ecuador or Argentina, since in the ageing population context it is very hard to see how you stage a comeback, ever.

As I keep saying, the whole future path of the Spanish economy actually depends to quite an important degree on what happens to the migrants.

BarcaRich said...

Hi Edward,

you mention that the Spanish housing market is experiencing a "correction" after the boom. I´d be interested in hearing your comments on how far and how long this correction will go, with reference to the limits to finance for the consumer. Also, living in Barcelona as you do, how you feel this is likely to affect the market as Catalans very much dislike losing money, and therefore we have seen a much smaller drop in prices than in the rest of Spain. They just seem to refuse that anything bad is happening!

Edward Hugh said...

Hello BarcaRich

"I´d be interested in hearing your comments on how far and how long this correction will go,"

Well I think at this point it is nearly idle speculation to put too many numbers, but I think we will see quite a substantial drop. And it will probably extend over various years.

The thing is we may well see general price deflation too, so this will complicate the issue of measuring the fall.

The other point is I wouldn't be expecting any sort of rapid rebound. They are going to fall and stay there.

I think generally people are underestimating the size of the shock that the Spanish economy just received.

"how you feel this is likely to affect the market as Catalans very much dislike losing money"

Well, I think no one likes losing money, but I think there is a very strong tradition of small dynamic businesses and entrepreneurship here, so I think Catalonia will be one of the quickest areas to adapt, although "quick" here is relative, and you are right, almost everyone is still in denial on the scale of the problem.

Edward Hugh said...

Hi,

"I wonder what the effect of the construction collapse will have on town hall and regional finances that used to gain so much revenue from building licences?"

A big effect I think. Ben Sills says this in the link I have in the post:



In 2006 -- the peak of Spain’s real estate surge -- municipalities issued 911,000 building permits, more than the U.K. and Germany combined. “They are swallowing up the coastline and the countryside,” Sanchez-Lambas says. “This is the legacy we will leave for our children.”.....The newfound wealth and borrowing power created a potential bonanza for Spain’s 8,111 town halls, which have limited powers to raise taxes yet have to pay for local police, garbage collection and sports facilities. Spanish law does give the municipalities power to grant all permits for new homes, shopping centers and factories.

“All they’ve got is land,” says Lorenzo Fernandez Fau, a former mayor of El Escorial, near Madrid. “So they’ve sold it.” Even many legal projects involve the mayor’s cutting a deal with developers, who may agree to build fire stations or put up street lamps in addition to paying for building permits. Some officials also demand bribes. “Local administrators have the power to decide who gets rich and who stays poor,” says Victor Torre de Silva, a professor of law at Madrid’s Instituto de Empresa business school. “There’s a great temptation to share in the wealth that you can create.”

Anonymous said...

Dear, Hugh, I'm an everyday reader or checker of spaineconomy blog since I read your first post in rgemonitor about spain last year.

First of all, thank you very much for giving me a long answer to my last question without commenting at all the other questions. I know quite well your thinking about Spain economy, but I was asking about UK & USA.

Anyway, today, Macro-man was responding to a similar question: Exactly what does a debtor need to do to lose their AAA rating?

MM: I am guess that the answer to your question is something like "forget to pay your annual premium to the agency doing the rating"

And there were other interesting comments that could refer to Spain or USA:

"Macro Man cannot find the mechanism or gameplan within Europe should, say, Greece decide to withdraw from th single currency because they cannot afford their euro liabilities."

Wouldn't we just be talking about a pure and simple Argentina-style default? Rightly or wrongly the euro is popular in Southern Europe, and I think it would be (a lot) more palatable for politicians to default than withdraw from the euro.

The question is "will Greece get there before California"?

A much longer answer for anglo-saxons to “Europe is doomed”, was given by W. Buiter on FT:

FT.com | Willem Buiter’s Maverecon | Eurosceptics remedial education class 1
http://blogs.ft.com/maverecon/2008/11/eurosceptics-remedial-education-class-1/

So, enough for today about yesterday questions.

Paraphrasing Berlanga, the great spanish film maker, you are a very lone palm tree in the the middle of the desert of spanish economic analysis, and so, I take of my hat, for your good work.

Anyway, thanks to Alah or some other other faith distributor franchise's boss, I'm living in San Sebastian (not totally dependent of ZP in economic matters), and I have lots of friends in Barcelona, because I spent tree years studying there years ago, in the old area of Sants, not in the modern area of Lesseps.

Going back to economy, I read a couple of very good posts today, and one was about your beloved Ben Bernanke and economists in general:

http://www.nakedcapitalism.com/2009/01/bernanke-expert-on-great-depression.html

And the other was about his speech yesterday in London, by James Hamilton:

http://www.econbrowser.com/archives/2009/01/bernanke_on_the_2.html

I don't think we are living very stimulating years in economy, though talking a lot about stimulus, but I expect a comment from you about those links.

To finish, in the same way that banks don't open their books to government in Spain (and they aren't asked to do it, either, Obushma style), spanish government doesn't open its books about finances of different autonomic areas, and the councils in those areas take captives their town hall, in a perfect military style that is very far from democracy.

Who gave them the license to sell land?

After they sold their land, who will buy their souls, if any? In this bipartisan Obushma, Aznartero world?

That's the real question, I think.

We're rediscovering Benito, the italian ally, at home.

But as Orlov says in the link I put in my first comment: “People is the problem”, for Benito and Stalin, for Barak and Bush, for josemari and ZP.

As far as thinks are going, Citi breaking up (but Rubin on Obama's board afresh), US negotiating to backstop BofA purchase of Merryll (do you remember Italy is trading flat with BofA, yesterday?), let's see where is the end...

Moltes gràcies

Auskalo.

Anonymous said...

The end is coming fast:

http://www.moonofalabama.org/2009/01/obamaclinton-on-nonexisting-iranian-nuke-programs.html#more

Auskalo

BarcaRich said...

Hi Edward, thanks for your comments. I was particularly interested in "The other point is I wouldn't be expecting any sort of rapid rebound. They are going to fall and stay there. "

I have always thought that economies based upon housing markets and bubbles are a bit of a lie. A la Japan, when the bubble grew and then burst and stayed down, how in your opinion would a society based upon the bricks and mortar notion of wealth change, and what happened in Japan in the similar instance?

Anonymous said...

The problem with the widening spreads are not in level of the public debt

The financial sector will "seize-up" because their spreads will also increase. So, the cost of their funds will increase much more that the revenue from them.

As a result they will curtail lending much more, driving the whole economy into a free fall.

Wiht defaulting loans exploding, and the health of the financial people continually getting worse. people will start to put their money abroad.

That will be the last nail in the coffin (as in Argentina), and Spain will leave the euro (unless is "saved" by or a pan-european rescue fund)THIS YEAR.

Edward Hugh said...

Hi again BarcaRich,

"how in your opinion would a society based upon the bricks and mortar notion of wealth change, and what happened in Japan in the similar instance?"

Well, basically there are two, and only two, ways to do this on the macro economic front, a huge devaluation to restore competitiveness, or a massive correction in relative wages and prices. Since Spain doesn't have its own currency to devalue (surely the least painful way - look at the UK) then there only is the second option.

But this isn't easy. Basically, the big problem with implementing internal wage deflation
is that people tend not to like it, and again the population put
pressure on the politicians. Dominique Straus Kahn had to fly
personally into Budapest this week to stop the politicians back
tracking on the public sector wage cuts they were committed to. As we
have been seeing in the newspapers these policies have not been
proving too popular in Latvia, and so we go on.

Meanwhile the Irish PM had to threaten the unions with bringing in the IMF to get them to acquiesce in this weeks five percent public sector wage cut, and this of course is only the start.

The difficulty is that this is simply a process that feeds on itself, since as wages and living standards fall, then so does domestic demand, and if everyone's domestic demand is falling, where does the "recovery" come from. That was why the 1930 to 1933 thing was so slow in turning round.

Well, it would have been not to have gotten here in the first place, but we are, so I reckon the main thing is to look reality straight in the face, not flinch, and get on with it.

Spain needs to have much more industry, and it needs to be able to export. To be able to do this the Spanish need to save rather than spend, and then wages and costs need to be cheap enough for people to feel that it is worthwhile borrowing some of those savings and investing to build productive capacity, with the sure hope of being able to comepete (say) with Eastern Europe.

I don't think it is realistic for Spain to enter markets like machine building, capital goods etc and compete with the US, Japan and Germany, the workforce simply doesn't have the skill set and the experience profile. So you are inevitably competing for rather lower value work, and this is what people had been hoping they wouldn't have to get into.

But then there are 5 million immigrants and they do need work, so there is an area of opportunity. Basically, rather than sending all the work out to Morocco, it would be better to be doing some of it here, and this is what people will have to wake up to. As wages come down this will become more realistic.

Don't think I want this. It is horrible, but quite simply I don't see there are too many alternatives now. We shouldn't have come here, but we have.

On Japan, basically they moved over to an export surplus - the German case 1995 to 2005 is virtually the same one - and as we are seeing this is not entirely satisfactory as export dependence makes you very dependent on your customers, and hence liable to sharp contractions. But once the whole domestic population are hopelessly over indebted, really what other alternative is there?

Now, the big question is who can buy the imports?

Well remember, two thirds of humanity currently live in povery, and are hoplessly "under-leveraged" so bring up living standards in much of the world can create a huge market. Basically we need something like the post WWI Marshall Plan (which was for Europe), but I guess we probably won't even get round to talking about this till say 2011, when people finally come out of denial and recognise we need to have some major concerted initiative.

First they will try - as we are seeing - internal fiscal stimulus, but you can't restart a car when the engine crankshaft is simply broken - ie we don't have here what Krugman likes to call simply "magneto" problems. The issue is larger and structural.

Basically Japan, Germany and the US can sell producer goods to developing economies, while places like Spain, Italy, Hungary etc can sell consumer durables to the US, Japan and Germany, if you want some sort of simple blueprint, but the devil here really will be in the details, and what I am offering are only loose thoughts, and not yet a worked out proposal.

Maybe this will come, but from someone with rather more resources than I have (the G8???).

OK, well I hope that gives some sort of answer to your question.

Edward

Edward Hugh said...

Hi

"Wiht defaulting loans exploding, and the health of the financial people continually getting worse. people will start to put their money abroad."

But where would "abroad" be here? In London, or New York, or Tokyo?

With all the major developed economies having major problems it is far from clear where the safe haven is these days. Certainly not Iceland :)

Or perhaps you have Brazil, India and Morocco in mind?


"That will be the last nail in the coffin (as in Argentina), and Spain will leave the euro (unless is "saved" by or a pan-european rescue fund)THIS YEAR."

Basically I am convinced that Spain is going to see serious problems, but I don't think they will come this year. My guesstimate is push comes to shove time will be 2011. But then, as you say, there may be a pan european resucue. I think this will be tested first in Greece, not Spain. Spain still has AAA and this has a long way to drop, Greece is now on A-, the last rung on the A ladder.

So people are going to have to decide what to do when push comes to shove in the Greek case. My feeling is that the eurozone is now too big simply to fail, that is the financial repercussions would hit New York, Tokyo and London, and hard. Remember what happened when Lehman Brothers went down.

Well Greece folding would mean all sorts of counterparty risk across the eurozone and then if the eurozone cracked under the weight for the other major financial regions. So they won't simply sit back and watch Greece go down the tubes.

That is why I think it is interesting to see the idea of EU bonds being floated, although this will ultimately mean the EU becoming a federation like the US. But when people are faced with collapse as the alterantive it is amazing to see how quickly they can sign up for things.

Basically, again the details will matter here. It is not possible simply to write more blank cheques to underwrite countries, so as in my previous response the devil will be in the details and the conditions, and in this environment it won't be possible to return to the old sins of the stability and growth pact.

Times will be hard, but there are solutions, there have to be solutions, even if we need two or three years simply to work them out.

In this climate all I can say is beware of anyone who claims to have all the answers written down on that bit of paper he ever so conveniently just happens to whip out of his back pocket.

New circumstances require new thinking, of this I am sure.

BarcaRich said...

Hi Edward,

bearing in mind that wags in Spain are very poor anyway, and the people are constantly moaning about their poor salaries, would it not be politically safer to get out of the Euro? As our politics are geared towards Populism and not what is actually best for our future, is it not more likely that any politician in power will use a sticking plaster to paper over the gorge?
From my experience, the problem with Spanish industry is the lack of competitiveness in the job market. All of the highly qualified people move abroad to earn realistic salaries, and we are left with the dross. This means lack of ambition, low productivity, and poor management. Companies stagnate for lack of dynamic employees. This is obviously a generalisation, but in my area (IT sector), its very much a truism.

How is reducing wages likely to influence the productivity (of an already floundering country) positively when there is a brain drain already.

Secondly, in the case of Japan, did the housing market crash and stay at low levels because people moved their money out of bricks and mortar, or due to some other arcane financial reason? Does this mean that there is likely to be a shift in thinking of the populous, and "Investment" in property is likely to stop? Is the day of the expat estate agency over?

Anonymous said...

"But where would "abroad" be here? In London, or New York, or Tokyo?"

German public debt, french public debt, other euro area banks, etc.

The health of spanish banks, specially small cajas, is worsening. Very fast.

And consider that the gov. thinks it will get out of this mess SPENDING MORE, MUCH MORE.

Which rules out any "deflation talk" here.

SAEED KHAN ABBASI said...

Such a situation confronting by the Spanish economy is part of the recent global recession too. I have a good news for you that I can offer my SEMFO Economic Plan to Spain to get rid of internal and foreign debts and socio-economic stability. My SEMFO Plan can be seen at: www.saeedabasi.blogspot.com

Anonymous said...

"don't think it is realistic for Spain to enter markets like machine building, capital goods etc and compete with the US, Japan and Germany, the workforce simply doesn't have the skill set and the experience profile"

Thats really weird and funny, since almost 40% out of the spanish youth holds some kind of university bachelor whereas Germany, for instance, scratches mere 20% and falling back.

This outstanding waterproof should have been some effect on the spanish economic output, but it doesnt seem to work out like this. Why does Spain lag so far behind Germany in this concern, having such an outnumbered surpluss of high qualified workers? another spanish conundrum?

Txs

Edward Hugh said...

Hi Barca Rich,

"bearing in mind that wags in Spain are very poor anyway, and the people are constantly moaning about their poor salaries, would it not be politically safer to get out of the Euro?"

Just very quickly because I am very busy at the moment. All this crisis is giving me a lot of work.

I think poeple at the moment just don't realise how serious all this is. The Lehman Brothers bankruptcy nearly caused a meltdown of the whole banking system. No one is going anywhere out of the euro zone at the moment, becuase the potential implications for the US and Japanese financial systems (let alone the UK and other European ones) as just so massive that people will fight tooth and nail to avoid this. We are way, way beyond playing with some sort of Ambrose Evans Pritchard euro-sceptic game.

You need to appreciate that the countries who have been running a CA deficit owe their money elsewhere, so if they leave the eurozone to "restructure" their debt it will be the German, French etc banking systems who will have to take the write downs.

I mean, you only need to look at how the small Baltic states are making the Sedish banks so fearful to see what the dimensions of all this could be.

Which doesn't mean of course that we will be able to prevent this eventuality, just that no one will be seeing this as an easier option, even though putting through wage cuts isn't easy either. I am on record about Latvia that the IMF have it wrong (and even got a response in an article from the IMF regional representative), so I do not underestimate the difficulties here.

Again, we have to distinguish between those in danger of sovereign defaults - like Greece and Italy - and those in danger of massive private sector defualts which hit the banking system - like Spain and Ireland.

Italy, for example may well end up with a sovereign default (I have though this a possibility for years), but most of the debt is held by Italians, so it will be largely an internal affair (same case Japan, or Germany if it ever comes to it). It is easier for Greece or Portugal to do the default in some ways, since others hold the debt, but then you have the problem that they cannot borrow money again and will be reduced to poverty in all probability if it were to happen. You should never ever forget the ageing population factor in all this. They just go down and down.

"All of the highly qualified people move abroad to earn realistic salaries, and we are left with the dross."

Well this problem is simply going to get worse whatever happens, since wage and salaries are going to go down.

"Secondly, in the case of Japan, did the housing market crash and stay at low levels because people moved their money out of bricks and mortar, or due to some other arcane financial reason?"

No, this is straight demographics. The median age simply went above the critical level at which you can fuel housing booms (same case Germany). If you are interested in this go and look at my "Did or Didn't Japan just introduce quantitative easing" post on the Japan Economy Watch blog, and the small theoretical model from Paul Krugman I include as an appendix which shows how all this might work.

This is why what happens to the immigrants here in Spain is so important, since if large numbers leave then Spain is set to become the oldest country on the planet over the next ten years and there will never be any real recovery.

Basically, no society with a median age over 41 (which currently are very few, but we are steadily going to get a lot more) ever had one of these huge housing bubbles, since the borrowing to current income ratio evidently falls as people get past 50. To get booms you need a lot of people (proportionately) in the 25 to 40 age group. This group was very large in Spain 2000 - 2008, but has now peaked, and proportionately will simply go down and down, which means if you don't get immigrants and UK second home owners, you are going to have a hard time moving that accumulating housing inventory here.

Also, if you do want to follow all this up, go and take a look at my recent posts on a Fistful of Euros, or over at RGE European EconMonitor, and especially the pieces on Germany and Portugal.

Basically you may be shocked to see how serious the German banking problem could become.

Edward Hugh said...

Hi,

"German public debt, french public debt, other euro area banks, etc."

See what I just said to BarçaRich, but in particular note the fragility of German finances. Over a 5 to 10 year period the dynamics of German debt are really not that attractive. Not that they are likely to default, since the political will is there to avoid this, but they are going to have a very hard time of it as a result, with constant cutbacks in health and pendions and possibly negative GDP growth (and falling per capita income) for quite some time.

German bonds could end up like Japanese ones, paying very very little that is. I still would favour Brazil or Indian ones, but then I am a mere macro economist and not an investment analyst, and no one should take any notice of what I am saying (disclaimer).

"The health of spanish banks, specially small cajas, is worsening. Very fast."

Yep. But I just think your time scale is a bit off. I think Spain can soldier through to 2011, if there is no major "nasty" external event to take everyone off course.

Where the pain will be felt in the short term is the real economy, which I reckon could contract by 5% this year.

"Which rules out any "deflation talk" here."

I think you are assuming that governments printing money can cause inflation, while the evidence from Japan (and now increasingly from the US) suggests that this is not so simple. I am predicting deflation in Spain for 2009. In January we will obviously see a spike, as administrative prices have been pumped up. By my feeling is that this will be a "last gasp" and then steadily month by month we will see lower prices.

Let's imagine that by December 2009 prices on the core index are down by 2% over December 2008 - this woul only be a drop of 0.17% a month. I don't see the problem. I think this will happen.

But imagine a real GDP contraction of 5% and a 2% drop in prices - that would be a drop of 7% in money value (current prices) GDP, we are getting close to the order of magnitude of the US in 1930 here - since nominal GDP was down 10% a year for three years. It is the drop in prices that screws everything basically, especially government budgets, since government spending is much more rigid and resistant to downward movements, which is why in Iraland they are already proposing a 10% public sector wage cut, to be followed by another 10% cut later.

Edward Hugh said...

Hi Txs,

"Thats really weird and funny, since almost 40% out of the spanish youth holds some kind of university bachelor whereas Germany, for instance, scratches mere 20% and falling back."

The problem is here what economist call "scale externalities". Basically to do machine building you need a core workforce with the experience of doing it, or to build Boeings for that matter, or cars.

The human capital component here is learnt on the job, not in the university. Spain has experience in the car sector, for example, and that makes this viable (if wages and prices were right). Since they weren't a lot of foremen (capataz) and management level people moved East to help them set up, since they obviously didn't have the expertise.

In China they have been able to set up so many factories so quickly by bringing in managers who were early retired in Japan at 55 following the long crisis labour market reforms. Basically, in value added terms, these people weren't viable in Japan conditions (basically their productivity wasn't high enough) but they were very much a going proposition in China.

Edward Hugh said...

Hi everyone.

Since it is causing a lot of debate on this topic, I am reproducing (next comment) a piece from Wolfgang Munchau in today's FT, since, for once, I really agree with him. I mean I think we have all learnt a lot by what happened after Lehmann Brothers. Basically, when I specualted about the possibility of a Spanish exit at an earlier point, I imagined Spain would be having very special problems (which it will be), but I didn't imagine this would all be happening against a background of the Second Great Depression, which is what it more or less looks like we have on our hands now.

I particularly note this bit, which is what I have been arguing.

But governments would soon discover that simply saying No was not going to work either. Back in the real world, governments would have to take into account the risk of contagion. For example, a sovereign default by a small country could wreak havoc on the markets for credit default swaps and might even destroy financial institutions in other eurozone countries.

A default could also trigger a panic rise in bond yields elsewhere, which could turn the threat of contagion into a self-fulfilling prophecy. If confronted with this more realistic situation, governments would, I suspect, react similarly to the way they responded in the aftermath of the collapse of Lehman Brothers, the US investment bank. Complacency would be followed by anger and by grandstanding lectures on the virtues of fiscal discipline (I can see a speech coming by the German finance minister). This would be followed by an emergency meeting one weekend in Brussels in which the European Union, perhaps together with the International Monetary Fund, would agree a package of credits to stabilise the defaulter.

Edward Hugh said...

‘What if’ becomes the default question
By Wolfgang Münchau

Published: January 18 2009 19:26 | Last updated: January 18 2009 19:26

What if one of the member states of the eurozone were to default on its debt? On the occasion of the euro’s 10th birthday, this has become the most frequently asked question about the single currency zone.

The probability of a default is low but clearly rising. The decision by Standard & Poor’s, the ratings agency, to downgrade Greek sovereign debt and to put Spanish and Irish debt on watch seriously rattled investors last week, for good reason. If the financial crisis has taught us one thing, it is to take perceived tail-risks more seriously.

Before I answer the question, it is best to consider what would not happen. For a start, the eurozone would not fall apart. A government about to default would be mad to leave the eurozone. It would mean that, in addition to a debt crisis, the country would also face a currency and banking crisis. Bank customers would simply send their euros to a foreign bank to avoid a forced conversion into a new domestic currency.

So if a default were to happen, it would almost certainly happen within a eurozone that remained intact. If you put your mind to it, it is quite difficult, even in theory, to think of a circumstance in which the eurozone would blow apart. One theoretical possibility would be for the European Central Bank to generate massive inflation, prompting Germany to leave in disgust – not exactly the most likely scenario right now.

So we are stuck with the eurozone for better or for worse. If a default happens, the central banks and governments of the eurozone would be forced to co-ordinate their policies whether they liked it or not. Under its statutes, the euro system, which includes the ECB and the national central banks, is not allowed to monetise (that is, buy) new sovereign debt or to grant overdraft facilities. But the ECB is allowed to buy debt in the secondary markets, which is a way of monetising debt. All it would take is a decision by the ECB’s governing council.

What about a direct fiscal bail-out by other member states? I suspect that the non-defaulting governments would be reluctant initially. Many of them had difficulty selling austerity-type policies to their domestic electorates and they might not achieve the parliamentary majorities needed for a bail-out. Some would no doubt argue that a bail-out would carry the risk of moral hazard.

But governments would soon discover that simply saying No was not going to work either. Back in the real world, governments would have to take into account the risk of contagion. For example, a sovereign default by a small country could wreak havoc on the markets for credit default swaps and might even destroy financial institutions in other eurozone countries.

A default could also trigger a panic rise in bond yields elsewhere, which could turn the threat of contagion into a self-fulfilling prophecy.

If confronted with this more realistic situation, governments would, I suspect, react similarly to the way they responded in the aftermath of the collapse of Lehman Brothers, the US investment bank. Complacency would be followed by anger and by grandstanding lectures on the virtues of fiscal discipline (I can see a speech coming by the German finance minister).

This would be followed by an emergency meeting one weekend in Brussels in which the European Union, perhaps together with the International Monetary Fund, would agree a package of credits to stabilise the defaulter.

The recipient would, in turn, have to accept an austerity programme, perhaps even the temporary loss of fiscal sovereignty, to ensure that the loan was repaid and to reduce moral hazard. In other words, the Europeans would bail out one of their own, but it would not be fun for anyone, especially not for the defaulter.

In the long run, a conditional bail-out combined with persistently positive bond spreads could even be a healthy development for the eurozone. Putting roughly the same value on Greek and German debt – which is what financial markets did for most of the last 10 years – never made sense.

If that situation had been allowed to persist, it would have produced serious difficulties for the eurozone further down the road. When the euro was launched in 1999, many commentators, including me, predicted that the markets would exert sufficient pressure on member states to run responsible fiscal policies. It took 10 years for that prediction to prove correct (which means, of course, that it was not such a great prediction).

A far more serious threat would be a cascading series of defaults that would eventually include one or more of the eurozone’s large countries. That would be a momentous challenge for the system but the policy response would be no different, only faster.

In extremis, you could conceive of a scenario under which the bail-out had to be so large that it would bring down the entire system. This could then provide the non-defaulters with an economic incentive to leave.

But dream on. If Germany, for example, had such an incentive to leave, it would almost certainly forgo that perceived economic benefit and stay for political reasons. If you assume the worst-case scenario of a default by five or six countries, a full fiscal union would be more probable than a break-up.

Most likely, we will see neither, but we may see conditional bail-outs.

Edward Hugh said...

Here's the LSE's Willem Buiter on the same topic. I certainly don't agree with Buiter on general theoretical issues - I can see no meaningful sense in which we can talk about eurozone "convergence" as between countries, for example, but I do think he raises some interesting points, and is in the right ballpark on this one.

I will try and find the time to put my own thoughts together, but frankly there is just so much going on at present.


Sovereign default in the eurozone and the breakup of the eurozone: Sloppy Thinking 101
January 14, 2009
A recent (January 13, 2009) column in the Financial Times by John Authers provides a good example of a logical slip on the banana peel of an alleged link between the external value of the euro, the likelihood of the eurozone breaking up and sovereign default by a eurozone national government. Versions of this fallacy can be found all over the place, even in the writings of those who ought to know better.

The relevant passages from Authers’ The Short View follow in full:

“Greece has always been treated as a peripheral eurozone member, not only in geography. Even before last year’s civil unrest, its bonds traded at a significantly higher yield than those of Germany - showing a higher perceived default risk.

The market is nervous about other nations on the eurozone’s periphery, notably Ireland and Spain, which grew overextended during the credit bubble.

A eurozone country defaulting and leaving the euro is close to an unthinkable event. But Friday’s news from Standard & Poor’s that Greece and Ireland were on review for a possible downgrade, followed yesterday by Spain, left many thinking the unthinkable.

The spread of Greek bonds over German bunds is 2.32 percentage points, almost 10 times its level of two years ago. Spanish spreads yesterday rose above 90 for the first time. An Intrade prediction market future puts the odds on a current eurozone member leaving the euro by the end of next year at about 30 per cent.

The euro dropped more than 1 per cent against the dollar within minutes of the Spanish news, and is down 9.8 per cent in the last few weeks.”

Three issues are being linked in this passage. The emergence of high levels of sovereign default risk premium differentials between different eurozone member states, the external value of the euro and the likelihood of the eurozone breaking up. There is no self-evident link between these three issues. The first is neither necessary nor sufficient for the second or the third. More than that, the threat or reality of sovereign default by a eurozone member state is much more likely to reduce that country’s incentive to leave the eurozone than to increase it.

It is obviously true that market perceptions of sovereign default risk in the eurozone (as reflected in CDS rates) are rising across the board and are now very high indeed by historical standards. According to Markit, on 12 January 2009, Germany’s 5-year CDS rate was 44 basis points, France’s 51 basis points, Italy’s 155 basis points and Greece’s 221 basis points. The same is true, of course, for the US, with a CDS rate of 55 basis points and and for the UK, with a 103 basis points CDS rate. Sovereign CDS markets may not be particularly good aggregators and measures of default risk perceptions because issuance is patchy and trading is often light, but the numbers make sense.

In addition to the average level of sovereign default risk premia rising across the world, the differentials between the sovereign default risk premia of the various eurozone members have risen. The spreads on the yield on 10 year government bonds over Bunds on January 12 was 88 basis points for Austria and Belgium, 52 basis points for France, 90 basis points for Spain, 105 basis points for Portugal, 135 basis points for Italy, 171 basis points for Ireland and 233 basis points for Greece. These numbers are not directly comparable with the spreads between the CDS rates reported earlier, both because they refer to default risk over different horizons (5 years for the CDS and 10 years for the government bonds) and because the government bonds are traded in liquid, organised markets while CDS are traded over the counter.

Greece and Ireland were put on credit watch (on a negative outlook) last week by the Standard & Poor’s, and this week Portugal and Spain followed. The actual downgrade today of the Greek sovereign debt rating by Standard & Poor’s from A to A minus, only five days after the country was put on credit watch by the same rating agency, will no doubt increase both the level of the Greek sovereign default risk premium and the spread over Bunds of the Greek sovereign 10-year bond yield. The ECB has adopted the (self-imposed) rule that it will not accept as collateral in repos and at the marginal lending facility (its discount window) sovereign debt rated lower than A minus. If the ECB/Eurosystem stick to this rule, the next downgrade of Greek sovereign debt could have a major impact on the Greek government’s marginal funding costs. The three countries remaining on credit watch - Ireland, Portugal and Spain - are likely to suffer actual downgrades in their credit ratings in the very near future. It is surprising to me that Italy has not even been put on a negative outlook as yet. I expect this will not be long in coming as the eurozone economies continue to deteriorate, increasing government deficits, and rising default risk spreads undo the beneficial effect on sovereign funding costs of declining risk-free interest rates.

It is certainly possible that a eurzone government will default on some of its debt in the near future. It will no doubt be presented as a ‘restructuring’ of part of the sovereign debt, but the markets and the courts interpreting the covenants associated with CDS for the non-performing sovereign debt instruments will recognise what happens as an event of default.

Would a eurozone national government faced either with the looming threat of default or with the reality of a default be incentivised to leave the eurozone? Consider the example of a hypothetical country called Hellas. It could not redenominate its existing stock of euro-denominated obligations in its new currency, let’s call it the New Drachma. That itself would constitute a further act of default. If the New Drachma depreciated sharply against the euro, in both nominal and real terms, following the exit of Hellas from the eurozone, the real value of the government debt-to-GDP ratio would rise. In addition, any new funding through the issuance of New Drachma-denominated sovereign bonds would be subject to an exchange rate risk premium, and these bonds would have to be sold in markets that are less deep and liquid that the market for euro-denominated Hellas debt used to be. So the sovereign eurozone quitter and all who sail in her would be clobbered as regards borrowing costs both on the outstanding stock and on the new flows.

A sharp depreciation of the nominal exchange rate of the New Drachma vis-a-vis the euro would for a short period improve the competitive position of the nation because, with domestic costs and prices sticky in nominal New Drachma terms, a nominal depreciation is also a real depreciation. Nominal rigidities are, however, less important for eurozone economies than for the UK, and much less important than in the US. Real rigidities are what characterises mythical Hellas, as it does real-world Greece, Italy, Spain, Portugal and Ireland. The real benefits from a nominal exchange rate depreciation would be eroded after a year - within two years at most - before you could say cyclical recovery. The New Drachma would be a little currency in a big global financial market system - not an instrument to be used to gain competitive advantage or to respond efficiently to asymmetric shocks, but a source of extraneous noise, excess volatility and persistent misalignments, rather like sterling.

A eurozone member state faced with the prospect of sovereign default, or just having suffered the indignity of sovereign default, would be immensely relieved to be a member of the eurozone. The last thing it would want to do is give up the financial shelter provided by membership in the eurozone to try and emulate Iceland, New Zealand or the UK.

Was the depreciation of the euro that more or less coincided with the sovereign credit warnings and the Greek downgrade (although it started earlier) due to increased concern about the fiscal sustainability of some eurozone member states? Who knows? And what is more: who cares? The eurozone member states no doubt welcome the weakening of the euro, which had become the world’s second most overvalued currency, just as UK Ltd welcomed the decline in sterling, which reached more than 25 percent from its previous peak until the recent weakening of the euro. Depending on the fiscal measures taken by the sovereigns of the fiscally challenged nations, and depending on the response, if any, of the ECB to the threat or reality of sovereign default, any response of the euro can be rationalised.

I view the widening of the sovereign risk spreads inside the eurozone as a welcome development. With the revised Stability and Growth Pact effectively emasculated as a fiscal discipline device, it is essential for national fiscal discipline in the euro area, that the market believes (1) that national sovereign debt is indeed just national, not joint and several among all eurozone member states, and (2) that the ECB will not bail out ex-ante or ex-post a eurozone member state that gets itself into fiscal problems. The very low sovereign risk premium differentials in the early years of the eurozone were worrying to me, because it seemed to indicate that the markets believed that a fiscally incontinent government would be bailed out by the other eurozone national governments or by the ECB. The new larger and healthier sovereign risk premium differentials indicate that the markets may be able to provide more fiscal discipline than suggested by the early years of the common currency. That is good news indeed.

So we may well see sovereign defaults by EU national governments, both inside and outside the eurozone. But it is more likely in my view that Scotland will leave the sterling monetary union (and the United Kingdom) and adopt the euro as its currency than that an existing eurozone member will leave the eurozone. We shall see.

Anonymous said...

Thanks, Edward

By the way, your post has been quoted in http://www.acratas.net, and I guess your blog unfortunately will become more famous and widespread in the spanish internet ranks, at the same pace you are threatening people and unraveling the blatant lies of this spanish government and the system underpinning it.

Thanks and please get started to shoot at will.

Andrew said...

Hi Edward,

Looking at the PMI data it looks as if the widening of the CDS spread is in line with what's happening with the economic fundamentals (see link for info).

http://www.markit.com/information/news/commentary/markit-economics/contentParagraphs/016/document/ESP%20CDS%202009-01-16.pdf


Just a quick question on house price data, which would you say is the most accurate data series (if there is one)?

Thanks,

Andrew

Edward Hugh said...

Hi Andrew,

"Looking at the PMI data it looks as if the widening of the CDS spread is in line with what's happening with the economic fundamentals (see link for info)."

Thanks for the link which was very interesting. I have become a real fan of the PMIs during this crisis as very good short term indicators generally, but why they should correlate so with CDs is a mystery to me, since CDs should be some measure of longer term default potential, and if that exists it should be to do with level of bank exposure, and not the 2009 rate of industrial contraction. I mean the two may coincidentally be connected, but I can think of no necessary reason why they should be.

"Just a quick question on house price data, which would you say is the most accurate data series (if there is one)?"

I really can't help here I'm afraid. I think the Barcelona Aguirre Newman have been up with the curve, and the TINSA data seem to be getting better, and as the government realise that it is in their interest to provide market participants with accurate data I assume the INE index will improve, but which if any of them is currently near the mark I couldn't honestly say.

to be able to answer the question I would need to know what the rate of decline was, and since I don't do my own survey, I am a bit at a loss :).

I have lots of data on many topics, but it is all publicly available stuff.

Also, the topic doesn't interest me THAT much at present, since all the macro data tells me that prices are going to be coming down for some time to come, and the big question is how far will they go, to which the answer I really think is we will have to wait and see.

Personally I have a lot of trouble seeing much beyond 2009 at this point, since while I am pretty sure all this is only just starting rather than being nearly over, what will happen in 2010 (ie the rate of contraction) depends so much on things that are going to happen in 2009 that it is hard to make any kind of valid estimate before we get to know what actually does happen in 2009.

I think in this case pacience is a virtue.

lavigi said...

Hey Edward,
Have you seen that Mr Paul Krugman links to one of your articles in his column in the New York Times??

http://krugman.blogs.nytimes.com/2009/01/19/the-pain-in-spain/?scp=2&sq=krugman%20spain&st=cse

Good stuff!! :)

John said...

Hi Hugh

Excellent blog, as we know it is very hard to find accurate information in the mainstream press and unfortunately many politicians are in denial.

Have a quick look at this
http://news.bbc.co.uk/2/hi/business/7839375.stm

salud

Edward Hugh said...

Hi Lavigi,

"Have you seen that Mr Paul Krugman links to one of your articles in his column in the New York Times??"

Yes, I had. Maybe I will put it up as a "guest post" - this is the third time in a month he has cited my material, once on Latvia, once on Ukraine, and now this.


John,


"Have a quick look at this
http://news.bbc.co.uk/2/hi/business/7839375.stm"

Interesting story about the Korean blogger. As it happens I doubt I could get off an airplane in Riga (Latvia) at the moment, since I have been getting a reasonably high profile in the devaluation argument there and they have detained (briefly) and questioned a number of well known economists who openly disagree with the peg. They cite a law which makes it illegal to destabilise the countries currency or finances.

Indeed someone purporting to be a member of the state security police (old KGB) did leave a warning comment, but it isn't clear to me whether this was a genuine threat or a spoof. Due to the surreal nature of the whole situation it is hard to tell.

Indeed, there are indications that Krugman and I may be winning this argument. The IMF head in the Baltics (who is a nice guy) published a reply to me on RGE Monitor, but there are growing signs that the wage cuts are so painful and controversial, and industry is having so much difficulty exporting as both the Russian ruble and the Swedish Krona themselves devalue, that the government may finally back down, which would be a pretty spectacular victory for bloggers I would say (if Krugman counts as a blogger).

http://krugman.blogs.nytimes.com/2008/12/23/latvia-is-the-new-argentina-slightly-wonkish/