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Thursday, January 29, 2009

Spain's Recession Deepens

Spain's economy is now most evidently, and totally and completely officially, in its first recession since 1993. The final confirmation of this came yesterday when the Bank of Spain released its quarterly report on the Spanish economy. According to the bank, gross domestic product fell by 1.1% in the final quarter of 2008 (over the previous quarter), following a 0.2% decline in the third quarter. GDP fell year on year by 0.8%.




Basically the report confirms my analysis in this post which suggested that while technically speaking the recession started on 1 July 2008, the contraction really started in July/August 2007, and it should have been really obvious to everyone by September of that year that the party was well and truly over.

According to the Bank of Spain the main component driving the contraction in the second half of last year was household consumption, with the contraction in household expenditure accelerating in Q4 when compared with Q3. In particular, household consumption fell at a year-on-year rate of something over 1.5% in 2008 Q4, which meant that - taking the year as a whole - it was private consumption which contributed the most to the slowdown in GDP, to a greater degree even than the decline in residential investment (which was nonethelessdown 10% over the year).


The slide in corporate investment also intensified in Q4, in large part as a result of the worsening economic outlook, the sluggishness of demand and the increasing uncertainty, all of this against a backdrop of financing conditions which were completely unfavourable to new business projects. As a result investment in equipment fell off markedly, by more than 7% year-on-year.


On the other hand the contribution of net external demand to GDP growth was positive in 2008 for the first time since 1997, and added at 0.7 percentage points, which compares with a negative contribution of 0.8 percentage points in 2007. This "improvement" was almost totally the result of a decline in imports, which fell much more sharply than exports.

As a result of the recessionary environment, employment dropped by 0.5% in 2008 (which compares with an increase of 3.1% in 2007) and the unemployment rate climbed to an 11.3% average for the year as a whole (13.9% in Q4), according to the Labour Force Survey figures.

Inflation slowed dramatically inthe last quarter of the year, with the CPI rising at a 4.1% for the year as a whole (up from the 2.8% average in 2007), although in the second half of the year it fell significantly, hitting a years low of 1.4% in December, the lowest figure since 1998. Indeed the HICP differential with the eurozone average ended the year negative on a negative footing (-0.1%) – the first time this has happened since the start of EMU. My guess is that we may well see a spike in inflation in January - due to the foolish increases in administered prices - after which we should steadily head deeper and deeper into price deflation territory.

The drop in household consumption and fixed capital investment was also to some extent offset by a surge in government spending. The government sector sustained aggregated domestic consumption in 2008, with government consumption increasing at a 5% rate over the year a whole. As a result public finances deteriorated rapidly, and moved from a surplus of 2.2% of GDP in 2007, to a deficit of approximately 3.4% of GDP in 2008. The public debt ratio was up by 3.3% in 2008 and reached 39.5% of GDP. For 2009, the government now envisages a further increase in the deficit - at the moment estimated at 6% of GDP - although since this estimate is based on a forecast contraction of only 1.9% of GDP over the year and this is likely to be a strong underestimate (see below), the deficit could be 7% or 8%, even if there are no additional funds which need to be spent on the bank bailout (unlikely to be realistic, since more money than currently budgeted for may well be needed, as we are seeing in one country after another). If we get price deflation to boot, and thus a reduction in nominal GDP, then debt to GDP could easily be up by a full 10 percentage points in 2009.


So what about the rate of contraction? Well at the present time, as I indicate above, the Spanish economy is contracting at an annual rate of 4.4%. Now, if we look at the manufacturing PMI (see below), we can see that this coincides with a monthly average reading of around 30 on the index over the quarter. So we could say that a reading of 30 means a contraction of about 5% a year (to begin to calibrate for the future) but this is probably an underestimate, since we have seen a sharp increase in government spending (which is not sustainable at this pace, or better put, we may sustain the present levels, but we simply can't keep increasing by 5% a year, so the impact of government spending will start to wane) plus we have seen, as mentioned above, a significant positive impact from the trade balance - estimated to have been of the order of 1.7 percentage points in Q4 (in other words without this favourable movement in nthe balance the contraction rate would have been much larger).

So really, without these two factors - the imports slowdown and the increase in government spending - we could easily have been talking about a contraction at an annual rate of 7% plus, which is, well, very, very large. But this is what a 30 manufacturing PMI reading might mean as we go forward, so we had just better hope that the index starts to tick up, hadn't we. The next results (for January) are out next week. Watch this space.




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.

Friday, January 09, 2009

Putting Out Fires During Noah's Flood, Or Eyeless In Gaza Part II

Paul Krugman had a short post recently drawing attention to a rather foolish and ill-thought-outstatement originating in the mouth of German Finance Minister Peer Steinbrueck.

Germany’s finance minister told AFP in an interview that cutting interest rates too low in an effort to counter the global recession could create what he called a dangerous “growth bubble.” - "On the one hand we need to boost the economy, on the other hand we must make sure that a policy of cheap money does not lead to a new growth bubble founded on credit, as happened after September 11, 2001," Steinbrueck said."It is therefore important that the focus, at least in Germany, be on sustainable investments in infrastructure and less on consumer spending financed by debt,"


Apart from the point Krugman wants to implicitly make about interest rates, the point about consumer debt in a current account surplus economy like Germany is extraordinarily misplaced. You have about as much chance of fuelling up a property boom in Germany as you have of setting up a ski slope in hell (that is, there is a "ski slope in hells" chance of getting this outcome - or put another way the likelihood is infinitely small). In Spain on the other hand, even while the possibilities of fuelling a further property boom right now are about as close to zero as you can get, the country's leaders waste not a moment in trying to convince people to go out, borrow and buy, even though with a 10% current account deficit to correct, and corporate and household debts which run to over 220% of GDP, what they need to do is start saving, and not borrow more. This very ineptness (and basically I would argue lack of understanding of what monetary policy is all about) was also highlighed recently by statements from the European Union's Economic and Monetary Affairs Commissioner Joaquin Almunia, who said (in an online chat for the Spanish newspaper El Pais) that whille getting financing costs down was necessary and important, interest rates should not be allowed to fall to negative levels in real terms.

"At this moment, it would be good for the cost of financing to go down........We shouldn't go back to a situation in which real interest rates are negative, as we know from experience that this leads to excess indebtedness, low perception of risk and new bubbles which always end by blowing up in our faces."


Essentially two things are being confused here. Negative interest rates (such as those Spain had between 2002 and 2006 - you know, the ones that lead to the current Spanish crisis, see chart below) are highly undesireable during the upswing in a business cycle, when an economy is "overheating", since you are simply giving more stimulus to economies which are already stretched to capacity - and negative rates may thus produce "bubbles", as they obviously did in both Ireland and Spain - but these very same negative rates are obviously highly desireable during a downturn, and especially during recessions of the kind we are seeing at the moment, since they are one of the tools policymakers can use to stimulate slumping economies - all basic Econ 101 really. And of course, we are all currently heading into one of the most important recessions since WWII, or hadn't our "machine-reader" commissioner noticed?



While I'm on this sort of topic, Krugman has a lot of useful and interesting material on the proposed US stimulus plans. The numbers are truly impressive and awe inspiring, with the fiscal deficit set to rise to close to (or even over) 10 per cent of GDP in 2009 according to initial estimates from the Congressional Budget Office.

But even this kind of aggressive fiscal assault may, as Krugman indicates, fall woefully short of what could be needed to stop the US labour market turning really sour, at least in the short term.


The new CBO budget and economic outlook is out. Above is its forecast for the GDP gap — the hole stimulus has to fill. I’d guess that the CBO estimate, which has unemployment averaging 8.3 percent in 2009 and 9 percent in 2010, is actually too optimistic (see 3, below), but even so it puts the Obama plan in perspective: a 3% of GDP plan, with a significant share going to ineffective tax cuts, to fill an 8% or more gap.


A comment which set me thinking about what is actually happening in Spain right now. Unemployment went over the 3 million mark in December, and is now running at something over 13.5% of the economically active population (according to Eurostat estimates). During 2009 this figure is certain to rise further, possibly to 4.5 million, or 20% of the economically active population (my guess, though it is a guess, since there are so many "unknowns" at this point - but we will surely be over the 4 million mark come next December).

Yet Spain's Labour Minister Celestino Corbacho proudly points to a 10 billion euro public works and infrastructure programme which is intended to create 300,000 jobs during 2009 - 300,000 new jobs in an economy losing jobs at the rate over over a million a year, again is like trying to light a damp match during Noah's flood. And obviously Spain's resources are seriously limited in terms of fiscal resources to fight a problem on this scale. My back of the envelope calculations suggest that a capital injection - Japan style - of between 40% and 50% of GDP may be needed to sort out the accumulating pile of non performing corporate loans and grossly over-valued mortgage backed securities. Evidently Spain cannot handle a problem of this magnitude alone. So would those whose monetary policy helped light this bonfire, now like to step forward with the fiscal policy hose to try to help extinguish it? Are you listening Joaquin Almunia?

Thursday, January 08, 2009

Unemployment Up And Mortgages Down In December

Spanish registered unemployment topped 3 million for the first time ever in December, as the government said unemployment was expected to worsen in 2009. Comparable government figures on the number of jobless in Spain go back to 1996 but Employment Secretary General Maravillas Rojo clarified in the press conference that similar levels (proportionately) hadn't been seen since the recession of 1987, and given the large increase in the workforce since the 1980s the absolute numbers now were greater even than in the early 1980s.




The number of people out of work in Spain was up by 139,694 people, the ninth straight month of increases, giving a total of 3.13 million. Spain's Labour Minister Celestino Corbacho also confirmed that he believed the number of jobless would continue to rise in the coming months, though he hoped that this would be at a slower pace than has been recorded since October. I am not at all sure that this hope is realistic. Even though the month on month increase - 4.6% - is down on Novembers 6.08%, the annual rate - 46.93 - is still up on Novembers y-o-y of 43.72%. And with the contraction in industrial output I think it is now only realistic to expect another large wave of industrial layoffs.

Spain's unemployment now nearly matches totals in much larger economies such as Germany, where the December level was 3.18 million.




The fourth quarter unemployment rate will be reported Jan. 23 by the statistics institute, with the rate expected to rise to over 13 percent from 11.3 percent reported in the third quarter. Most analysts had expected Spanish joblessness to rise sharply in December, but were surprised by the scale of the increase which was four times higher than that registered in December 2007.

The Spanish government is still forecasting an unemployment rate of 12.5 percent for 2009, although European Union data from Eurostat confirmed only this week that Spain's harmonised rate already surpassed that figure in November - at 13.4 percent, the highest rate in the whole of the EU.



The Spanish government has launched a 10 billion euro public works and infrastructure programme to create 300,000 jobs in 2009 and currently estimates that the plan will begin to create posts starting in March. If we bear in mind that in 2008 Spain's unemployment rose by 1 million people, we can get some idea of the extent to which this will be insufficient, even assuming that unemployment only continues to rise at the same rate in 2009 that it did in 2008, an assumption which may be overly generous.

Another little detail worthy of note is that it is in fact Spain's service sector which is showing the highest level of job losses, with a current total 1.8 million jobless compared with 591,000 in construction and 400,000 in industry.


Mortgages Continue To Decline, If Slightly Less Rapidly

Spanish home sales fell at an annual rate of 28% in October, according to mortgages data released this week from the National Statistics Office (INE), this compares with a drop in mortgages of 31.5% registered in September.



The value of properties mortgaged fell by 25.3% in October. This is now the 18th consecutive month in which the number of mortgaged properties has fallen year on year, and the October total of 103,629 is now down 43% from the January 2007 peak of 181,296. And, of course, we are nowhere near the bottom yet. In the case of housing alone, the number of mortgages in October was down 33.9% year on year and the total capital loaned was approximately 8.711 million euros, or down 40.7% on October 2007.


Economic Sentiment and Business Climate Indicators plunged to record lows in December in the EU and the Eurozone

Economic confidence in the 16-country eurozone has collapsed to levels not seen in continental Europe for at least 24 years as German industry reels from tumbling global demand.In the latest evidence that the eurozone recession is still gathering intensity, the European Commission reported its “economic sentiment” index for both the eurozone and the EU had plunged in December to its lowest level since its survey began in January 1985.

In December, the Economic Sentiment Indicator (ESI) declined considerably in the EU and the Eurozone, falling by 7.0 points in the EU and by 7.8 points in the Eurozone, to 63.5 and 67.1 respectively.

Reflecting the widespread deterioration in economic sentiment, all EU countries reported weakening sentiment. Among large Member States, confidence in the Netherlands fell the most (-13.2 points), followed by Italy (-9.9), France (-8.2), Spain (-6.3), Germany (-5.3) and Poland (-4.5). The confidence indicator fell less significantly in the UK (-0.6); albeit from a very low basis and it now stands at its lowest since 1985.



Axel Weber, German Bundesbank president, has warned that fourth quarter eurozone growth data could prove worse than expected, with “downside risks” identified only last month by the European Central Bank already emerging. Eurozone gross domestic product is thought likely to have contracted quarter on quarter by about 1 per cent in the fourth quarter of 2008 and could decline by the same amount in the first three months of this year. That would dwarf the 0.2 per cent contractions seen in the second and third quarters of last year and make the recession the worst seen in Europe since the early 1970s. Needless to say, these sorts of numbers make the current forceasts coming out of the Spanish government look absolutely ridiculous.


Wednesday, January 07, 2009

Spain's Inflation Plunges As The Current Account Deficit Gradually Eases Back



Spain's inflation (as measured by the EU HICP methodology) was around 1.5% (year on year) in December 2008, according to the flash estimate issued by the stats office (INE) earlier this week. This number only offers us an initial glimpse of the final HICP reading, but, if confirmed, it will mean Spain's annual rate of inflation has dropped 0.9% (nearly one full percentage point) in the space 0f just one month - since in November the annual rate was 2.4%.

It will also mean that Spain's inflation for 2007 dropped its the lowest rate in a decade, down sharply from the 2007 rate of 4.2 percent. This is remarkable since Spanish inflation has generally been over the EU average for more than a decade now, and 1998 was the last year in which prices for goods and services rose as slowly as they did in 2008. And the big question is, just how much more disinflation is there now in the pipeline? Where, indeed, will this process end?


Putting Theory To The Test Over A Cup Of Coffee

Well, in order to dig a bit deeper into all of this in what I hope will be a practical and enjoyable way let me start by offering bit of free publicity for my local bar, which you can see in the photo at the top of this post. The bar is in fact situated in Barcelona's Plaça Lesseps (near to where I, myself, live, and also - for any of you who happen to visit Barcelona - directly en route for the Güell, or Gaudi, Park). The proximity to the park is obviously one of the reasons the chain who own the bar decided to put it where it is, since a significant proportion of the large number of tourists who make the daily pilgrimage to the park need to pass it on their way.

Well, the point of this small publicity spot is not simply to offer them a shamefaced and willy-nilly promotion, but rather becuase I have singled out this little bar for a small experiment. Basically Joaquin Almunia, Pedro Solbes, Miguel Fernandez Ordoñez and I are in disagreement about something. Better put, they all agree with each other, while I find myself in basic disagreement, since they hold that Spain will see very low inflation in 2009 but not outright wage and price deflation. Of course, the devil may be in the details here, since if we are talking about the whole year average, then they may well be right, but if we are talking about the trend, then on my view we are heading for negative price movements - and over a number of years probably - and the only real doubt I have in my mind is when this downward movement will start. Hence my small litmus test.

Basically I am going to take this bar as a test case, and in particular I plan to track the price of one particular product - their café con leche (cafe amb llet in Catalan, café au lait for those who prefer the French version, but NOT, definitely not, the badly translated "milky coffee" - or coffee with milk - in English, since the art of this particular beverage is most definitely in the making).


Now for those of you who can read the price list (below, click on image for better viewing), the price of a café con leche in the bar is currently 1:15 euro (which isn't expensive if you consider the bar, its location, the quality of the coffee they serve - very good - and the level of prices generally in Barcelona). This price is already news, since they did not raise it on 1 January 2009, a move which has all too often been a custom here in Spain. So at least prices are more or less stationary now in Spain (or at least prices in the private sector are - see below). But I expect more. I expect to see these kind of prices fall, and keep falling, and it this process we will be following here on this blog as we move forward.





Now just to be clear where we are at the time of speaking, what we have in Spain at the present time is a strong disinflation process - not outright deflation. If we look at the index chart below, we will see that the general HICP index is not only stationary, it has been falling since July. Now this drop is largely the result of a sharp falling back in food and energy prices, and this is not in itself deflation. If we look at the performance in the core HICP index (taking out the "volatile" food and energy prices) we will see that the position is a lot less clearcut, since in fact the core index has continued to climb - following the line of the inbuilt inflation momentum - and has only started to steady up in the last couple of months.



So my argument is that the disinflation which is being produced by the negative energy price shock, in the context of very, very weak internal demand could in fact produce a negative feedback cycle of price reductions which extend well beyond food and energy.


Price Rigidities

There are two great obstacles to this downward movement, one is the existence of collective wgae bargaining structures which enable wages to rise when prices rise, but do not necessarily allow them to fall when prices fall - but it is inbuilt into my argument that the shock of demand contraction is simply going to be so strong over the coming 12 to 18 months that the ability of these agreements to withstand it in their present form has to be brought into question. The issue is, just how far and how fast are unions and government prepared to see unemployment rise before offering some sort of response, because this is just what the impact of these asymmetric wage rigidities will mean, very substantial pressure on employment as more and more companies are pushed towards bankruptcy. Of course, the "get out" may be the "pagos extra" (additional payments), which may simply become less frequent and less substantial. We will see.

The second rigidity is constituted by the so called "administered prices" - basically those prices which are controlled or authorised by a government agency in some shape or form or other. One area where the role of administered prices is going to be important is in energy. The Spanish government only last week agreed to let power companies raise electricity tariffs over 20 percent over the next three years. The agreement is, of course, part of the government's plan to eliminate the large gap between what utilities charge clients for electricity and the cost of generating it, a gap which is known as the tariff deficit, and of course in the process attempt to reduce that "other" deficit, the current account one. Utilities will be allowed to raise the maximum tariffs they may charge some consumers by between 7 and 9 percent per year over the next three years.

The industry ministry have so far introduced an average 3.5 percent rise in household electricity tariffs and a 2.8 percent increase in rates for small businesses, which come into effect from January 1. In return for permission to hike power rates, utilities will have to write off 2 billion euros of the tariff deficit, which sits on their books as a long-term government-backed credit. The government will guarantee up to 20 billion euros of tariff deficit and back the securitisation of the shortfall. The tariff deficit is estimated by Spain's energy regulator (CNE) to have swollen to 16.2 billion euros in 2008 from the 11.2 billion accumulated by power companies to the end of 2007.

Real And Nominal GDP



Now above you will find the first of two charts prepared by Japanese economist Richard Koo which I think will be useful to illustrate a number of points where we might find similarities between what is happening in Spain and what happened in Japan. The first of these points concerns the price of land (which is represented by the pink line in the chart - please click over image for better viewing). As you can see, Japanese land prices started to fall in 1991, and they really have not recovered to any significant extent to date (indeed land prices have now started falling again).

Now land has been the single biggest drag on Japanese asset prices since the early 1990s, and is one of the principal culprits behind all those years of protracted deflation, so I think people in Spain need to take note of this, and be warned. The second point to note is that outright deflation didn't set in in Japan till around the turn of the century, and what I am terming "outright" deflation is represented by the crossover point between real and nominal GDP. (Nominal GDP is GDP in current prices - ie the actual prices charged - real GDP is inflation corrected). Now as we can see, nominal GDP actually fell between 2000 and 2003, and this is a very complicated situation to handle, since debts retain their nominal values, while virtually everything else goes down. As a result, debt to almost anything up goes up, and this is the situation I fear we may see in Spain in 2009, or more probably 2010, where the economy contracts so fast, and prices also fall in a way that we get a sudden fall in nominal GDP. This, I think, would really be a nightmare scenario for everyone.

Consumer Confidence Holds At Its Low Level

As might only be expected, with such a sharp deterioration in operating conditions Spanish consumers are not exactly feeling happy these days, and while Spain's consumer confidence indicator rose ever so slightly in Decemebr - to 48.9 from 48.7 in November (according to the latest report from the Instituto de Crédito Oficial, ICO earlier this week) - is is still way, way below the long run series average.




The slight Decemebr improvement was largely due to a small increase in the sub component indicator for current economic conditions, but then it was December, and it was Xmas time. The current economic conditions indicator rose to 29.7 from 28.2 in November, while the consumer expectations component, on the other hand, dropped to 68.1 from 69.2. All in all we are still above July's historic low, but since confidence is still at a very low level that isn't exactly saying much.


Car Sales Fall Sharply Again In December

Spanish car sales fell 28.1 percent in 2008 over 2007, according to the car industry group ANFAC last week. This was the sharpest yearly drop ever, with Spanish car registrations falling 49.9% year on year in December, rounding out the year on the worst possible note - 72,377 cars were registered in December in Spain , down from 144,441 a year earlier. The car association reported that the drop was due to tougher financing conditions as well as the generally more difficult economic situation.

"Job losses and shrinking disposable income are undermining consumer confidence and hitting car sales," Anfac said. "If market conditions persist during 2009, new car registration will have fallen by over a million vehicles, which gives us an idea of the gravity of the situation."
Services Continue To Contract In December


But it isn't only manufacturing and the key car industry which is now being weighed down by the crisis, Spain's services sector is also feeling the pressure, and the December PMI showed the sector contracted sharply one more time as activity, new business and the workforce all shrank at a pace second only to November's record declines. The Markit PMI, covering Spanish service companies ranging from hotels to insurance brokers, dropped to 32.1 in December - way below the 50 level where growth starts - and the second-worst reading since the survey began in 1999, following November's record low of 28.2.



"The bad news in the Spanish economy just keeps on coming. The terrible PMI data for December were second only to November in their severity," said economist at MarkitEconomics Andrew Harker, "Any slight optimism seems largely based on wishful thinking, while it seems clear that conditions will continue to worsen in the first quarter of 2009 at least."
The Spanish government, who last month announced an extra 11 billion euros on top of the previously announced 40 billion euros in tax cuts and state credit in an attempt to stimulate an economy whose health is deteriorating rapidly, continue to assert that growth should pick up again from mid-2009, but as more and more waves of data come rolling in this looks increasingly unlikely and the Spanish economy seems set to contract all through 2009 and probably shrink again in 2010.


Current Account Deficit Narrows


One of the reasons why there is little room for optimism in the Spanish case is the need to correct the current account deficit, which, while it is now steadily falling back as internal demand weakens, is still running at something like an 8% of GDP annual rate. The deficit dropped again in October, according to the latest data from the Bank of Spain, hitting 7.86 billion euros, down from 8.11 billion euros in September and 9.02 billion euros in October 2007. As can be seen in the chart (below) the deficit has now been dropping steadily since March last year. The driving force behind the fall is more a question of declining imports than rising exports though, and, please note the very important point that the income account, which is the net balance of interest paid on loans and dividends on equities, still continues to deteriorate.




The deficit on income account was 3.53 billion euros in October, up from 1.77 billion euros in October 2007.



The reason for the deterioration in the income account isn't that hard to find, it lies in the growing external indebtedness of the Spanish economy (see chart below). This debt has now risen from 870 billion euros in Q3 2004 (or around 90% of GDP) to 1,686 billion euros in Q3 2008 (or around 155% of GDP). In fact the size of the debt has more or less doubled over this period, and it is still rising. The reason for the increase in debt isn't hard to find, since it lies in the need to attract funds to finance the large increase in the goods and services trade deficit which was created by attempting to run the Spanish economy so far above what could be termed its "capacity", and for so long.


So basically Spain's problem isn't simply a construction boom that went wrong. Spain's current economic malaise has deep structural roots that go back over a number of years - probably the best part of a decade. Basically Spain's economy overheated way beyond capacity for at least six years, and the smoking gun for this is what happened to the current account deficit (see chart below), as imports were steadily sucked in to meet the voracious demand, that was, of course, fuelled by the large rise in construction activity and the wealth-effect of steadily rising property prices.



And how, apart from the CA deficit, do we know that Spain's economy was operating "beyond capacity" - well one piece of evidence would be all that external debt which was accumulated by the inflow of foreign funds (which you can see in the earlier chart), and another would be the large number of migrant workers who were sucked in.

There are currently something like 5 million immigrants living and working in Spain, and they make up about 10% of the population, the highest proportion (of first generation immigrants) in the European Union. Even more strikingly, more than 4 million of these immigrants came to Spain after 2000, during the good years of the housing boom, they filled the toughest and worst paid jobs on building sites and farms.


So there you have it, an economy is basically a large cement mixer into which you throw money, people and raw materials in certain proportions - and out the product (national income) comes at the other end of the pipe. But Spain had neither the people, the money, nor the energy to fuel all this, hence all of these were imported, and in large quatities. Hence, ultimately, the CA deficit. Not all that hard to understand really I don't think.

But why did the economy overheat? Aha! Well just look at the chart below, and notice how the period when Spain was being subjected to negative interest rates coincides almost exactly with the sudden surge in the CA deficit. This is another tell-tale sign, another smoking gun. The monetary policy applied in Spain between 2002 and 2006 was thoroughly inappropriate. But now is not the time to quibble about this - when things are back under control again there will be plenty of time for a post mortem. Now is the time for action, and for doing something to try to ensure a more orderly correction than the one we are currently "enjoying", and it is this plan of action I find lacking, far more lacking than the mere absence of reflective self criticism.



Finally, (below), one last chart on Japan, again prepared by the Japanese economist Richard Koo. The thick blue line (please click over chart if you can't see adequately) shows the perception of large businesses of the willingness of banks to lend to them, as surveyed by the Bank of Japan for the Tankan index. You will note the line plunges twice, and it is the second plunge, or "credit crunch", which interests me at the moment. This was the crunch 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.


Finally, to end, where we started, and on a happier note. Here I am, with my photographer friend Marta, in my local bar, where my dedication to my work will take me, for those regular cafés con leche, you know, just to check on how my local consumer price inflation is coming along.

Saturday, January 03, 2009

"No One Saw It Coming" - José Luis Zapatero

"Nadie podía saber lo que se nos venía encima". El presidente del Gobierno, José Luis Rodríguez Zapatero, pronunció esta frase hace escasos días durante una entrevista televisiva. ¿Nadie?
El Economista

"No one could have known what was in store for us", according to the President of the Spanish Government, José Luis Rodríguez Zapatero, speaking in a Spanish TV interview a few days back. No one?


Oh, so no one saw the Spanish crisis coming? Can he really believe that? Is this man really serious, or is he but an idle Jester. Or could it be that, like Homer's hero before the Cyclops, my name in fact is no-one.

Beyond The Rosy-Fingered Dawn

"I gave him more of the glowing wine when I had spoken, and he gulped it down,
Three times I brought it, and three times he washed it down.
Then as the wine went round and round the Cyclop's brain
I gave him the kindly answer he was seeking.
You asked, Cyclops, for my well-known name and I will tell you
Then give me my guest friend gift as you have foresworn
For my name is No-one: no-one is the name they have called me:
my mother, my father, and all the rest of my war weary friends."




Hot Labour Anyone? - 26 January 2006

My partner's parents have an Ecuadorian women looking after her mother who has Alzheimer. This woman went home to Ecuador for xmas, and now she has come back she has decided she needs a document of salary (or nomina in Spanish). She needs this since talking to other female migrants (she has btw residence papers) she has decided that she would like to go to the bank and borrow 10,000 euros. She needs this money, since she wants to rent a flat in her own name so she can offer accommodation to new immigrants coming - on a sub-let basis - and thus make money from the boom herself (here in Barcelona there is now a new weekly paper for Latin American migrants which they hand out in the metro - it's called appropriately enough Latino - and last week's front page item was about a small flat in the very centre of Barcelona with 25 Ecuadorian women living in it. So there is certainly scope for business.

The point of all this is that the arrival of so many immigrants so quickly has pushed the rent on flats out of the roof: it is more expensive - in monthly payments - to rent a flat than it is to buy one, and that surely is a sign that something is badly amiss. The other point of this little homily is that ideas traval fast. In the age of mobile phone connectivityyou can quickly have viral entrepreneurship, and of course, rapidly built pyramid chains.

So what might happen when the 'boom' ends. Well in the case of our Ecuadorian woman, with a flat which she can't rent if no immigrants come, and with a rent liability she herself cannot meet, and with an outstanding loan to the bank of 10,000 euros she cannot pay, possibly the most intelligent thing she could do would be to get on a plane and go home. The owner of the flat would have a different problem set: they have an empty flat with no tenant in sight, not for kilometres and kilometres and kilometres. And of cousre the bank wants to know about next months mortgage payments, since the majority of these flats which are up for rent are being bought by someone who doesn't need it 'as an investment'.


Now lets think about the building contractors problem set. Well people in this occupation normally live on credit, and normally pay salaries and other costs out of money borrowed from the bank till the building in question is sold. The bank accepts the situation as long as it has good reason to assume that the building eventually will get sold. But this is just it, when the boom breaks for some significant period of time the flats won't get sold, at least not in anything like the quantities they were (Spain's last boom ended in Olympic year 1992, and the property market didn't recover till 1995). Now when the bank sees that their customer isn't going to be able to sell, what does it do? It cuts the line of credit, that's what it does.

What this means is that one fine Friday the boss has no money to pay his workers. So he goes to the site and tells them this, sorry lads, off you go, and no money for now, I'm afraid. That's if he has the 'face' to do this. Some of them of course simply launch themselves from the 13th floor of the unfinished building.

Now imagine what is actually going to happen the day the bubble bursts. This process can happen in building sites all across Spain, and in a very rapid period of time. The Spanish workers will be more or less Ok, but the migrants? Again it's hard to put numbers, but I reckon we could at some point see a million migrant workers, on the streets with no work, and no reasonable prospect of employment, with their home governments possibly pressurising the Spanish one to organise flights and fly them home.

And just when might this nighmare end game to Europe's best known fairy story come to pass? No one has any idea. Since the thing which is driving the boom is the ridiculously low interest rates which are currently on offer from the ECB (in Spanish, not German terms) and since there is little likelihood of any substantial rise in these any reasonably foreseeable future the show looks like it will continue to run, until, of course, the day it doesn't that is.


Or.....

Spain's Looming Economic and Financial Crisis - 16 March 2008

I didn't quite have the story right at this point, but still, I was getting there:

Perhaps the first thing to get absolutely clear in our minds from the outset is that the economic correction which is currently taking place in Spain is very unusual one in terms of what we have become accustomed to in developed economies in modern times, since the transmission mechanism for Spain's current difficulties does not run in simple one-way-street fashion from problems which have their source in the real economy (a correction in house prices for example, or a downsizeing of the construction industry, although both of these undoubtedly form part of the picture), nor does it run from an attempt by a central bank to "burst" some sort of perceived asset bubble or other (Trichet and the ECB's tightening of interest rates), rather the mechanism operates via a direct blow-out in the cylinder-head-gasket of the global financial system, a blow-out which has produced an immediate and direct change in global credit and lending conditions, and in the level of risk appetite which prevails in the securitised mortgages/covered bonds sector of the wholesale money markets (leading to a situation where these markets are now effectively closed to Spanish banks) , and it is this change in financial and credit conditions which is now making its impact felt on the real economy in Spain, with the actual and present danger that these negative consequences for the real economy may then in their turn feed back into the financial sector, in the process creating some kind of ongoing lose-lose dynamic.

As I say, such a phenomenon is certainly unusual in a modern European context, although some may wish to point to parallels with what happened in Japan in the early 1990s, and the subsequent "lost decade". I wouldn't go so far at this point as to suggest that Spain is facing a lost decade, although the situation is very very serious (as I hope to show in the charts that follow), and at the very least Spain now faces several "lost years" and a massive macroeconomic structural adjustment.


Or.......

Has Artemio Cruz Suddenly Reappeared in Spain? - June 28 2008

The Mexican writer Carlos Fuentes once wrote a novel entitled "The Death of Artemio Cruz". The novel begins with an elderly Artemio who suddenly finds himself awake and lying on his deathbed, gripped by repeated spasms of excruciating pain, and terrified even to open his eyes for fear of what it is he might get to see if he does. After years of debauchery and loose living (shade's of Oscar Wilde's Dorian Gray here) the thing which seems to frighten him the most is the possibility he might get to take a look at himself in a mirror.Of course, there are comparisons and comparisons here. Spain's economy is far from moribund, nor is it in its death throes. But Spaniards are suffering, and the process of adjustment is painful, and the attitude of the country's leader - José Luis Rodriguez Zapatero - does somewhat resemble the case of Artemio Cruz in that he appears, at least from the outside, to be totally obsessed with looking at anything that isn't an actual reflection of the actual state of the Spanish economy.And of course it's easy to criticise here, since the problems Zapatero is reluctant to look too closely at are serious ones, and worse still, it isn't at all clear that anyone really knows what to do about them at this point.


Or.........................

What Is The Risk Of A Serious Melt-Down In The Spanish Economy? - July 18 2008


Now the recession in Spain is, I think, more or less most certainly already served. The Spanish press were talking earlier in the week about a quarter on quarter contraction of 0.3% in Q2, and it is hard to see any acceleration of the economy in Q3. Pedro Solbes, when questioned explicitly by Punto Radio on the possibility that whole year growth for 2008 could turn negative replied diplomatically "It's not my feeling at the moment", which means basically that it might well turn out to be the case.

If this expectation if fulfilled then Paribas may have to revise their latest forecast slightly (see above link) since - in what is really an excellent general analysis - they pencil-in the recession to start in Q3 2008 and then move on to anticipate a contraction in the Spanish economy of 0.75% in 2009 (although as they freely admit all the risks here are skewed to the downside). My own personal call at this point is that the recession may well have started in Q2 (we will soon know) and that the contraction in whole year 2009 will be over 1 percentage point. Further than that I am not willing to go at this stage, since it all depends, and in particular it depends on whether or not we get a nasty "event" or series of events which send the economy hurtling out of the "hard landing" bracket and into the "melt down" one. It is because I strongly believe we be should doing everything we possibly can to avoid that eventuality that (and not continue to languish under our blankets with a heavy dose of the Artemio Cruz syndrome) that I am writing this post now.

Before continuing, however, I should point out that even the Paribas idea of negative growth in 2009 is still very nonconsensual, despite the widespread pessimism which currently surrounds the Spanish economy. The consensus economic survey for June gives a median 2009 growth forecast of 1.5%. The lowest forecast in the survey is 0.4% but most are grouped in the range 1.0-1.8%. Maybe the consensus will catch up with the curve in due course.

Of course, I wasn't the only one to see it coming, not by a long stretch I wasn't, but then as Alberto Saiz says, in this quote which will have to be for my Spanish reading audience, people tend to hear what they want to hear, and simply that.
El director general de HSM España, Alberto Saiz, opina que "la gente al final oye lo que quiere oír. Era muy difícil predecir el efecto psicosis de esta crisis y además hay que diferenciar entre los gurús que hablan de temas de gestión y organización y los analistas financieros. A éstos últimos, si estaban relacionados con algún tipo de inversión, sí que deben pedírseles explicaciones", aclara. Saiz apunta además la actitud de la que ahora hacen alarde algunos inversores. "Muchos dicen que nadie les avisó, pero el problema es que muchos de ellos no quisieron oír lo que se decía. Es muy fácil hacer leña del árbol caído", asegura.

Everything But The Sky Falls In On Spain - Producer Prices, Industrial Output, Retail Sales, Credit Ratings All Down

Well, these are not easy times for those who are economically active in Spain, and doubly not-so when many of those with money to spend over the holiday season decide to take advantage of the cheap pound and go and spend it over in the UK. As we will see below, retail sales inside Spain are now steadily falling by the month, and there is no reversal to this trend anywhere in sight.

But first off, lets start with the news of the moment, Spain's falling industrial output.

Spain's Composite PMI Registers Another Record Contraction In December

Now, as I noted in my last post, according to the JPMorgan Global Manufacturing PMI report for December the weakest manufacturing performance was registered by Japan, whose output and new orders indexes fell to levels which were unprecedented in the history of any of the national manufacturing surveys included in the global manufacturing PMI. But at the end of the day this must have been a pretty close call, since while the composite reading for Japan was only 30.8, for Spain it was 28.5. Thus, on aggregate, Spain's manufacturing sector was still leading the global charge down. Of course, if we are only talking about industry the situation in Japan is more critical, since the economy there in general is more dependent on manufacturing industry than the Spanish one is. The thing is - we will know on Monday - the services reading for Spain in December may not be much better.






Thus Spain's manufacturing sector shrank at a record pace for the fourth month running in December, according to the Markit Purchasing Managers Index. The indicator fell to 28.5 from a previous low of 29.4 in November and marked the lowest level for any country in the near 11-year history of the survey. Around 43 percent of Spanish manufacturers in the PMI survey said they cut jobs in December to compensate for falling production, marking the highest level of layoffs in the series history and taking the employment indicator to a world series low of 29.4. Jobs have now been cut in the Spanish manufacturing sector for 16 consecutive months.


"The truly horrendous PMI data for December mean that Spanish manufacturing heads into the new year with little reason for optimism - 2009 is all set to be a very difficult year," said Markit economist Andrew Harker.
December PMI data also showed the second steepest contraction on record for both new domestic and foreign orders, with cancellations from the United Kingdom, France and Germany


Retail Sales Continue To Fall In November

Spanish retail sales (at constant prices) were down by 9.6% year on year in November, according to data from the national statistics office.




This was the twelfth consecutive month of year on year declines, and retail sales hit a seasonally adjusted monthly high in November 2007 (see chart below), since which time they have continued to fall, and will continue to fall for some considerable time to come. Quite frankly I have no idea at all about when they will get back to those "heady" levels of late 2007, certainly not in 2009, and most probably not in 2010. And after that we will see.



Producer Prices Fall Back Dramatically

Spain's factory gate prices fell sharply between October and November - by 2.6% month on month, bringing the annual rate of producer price inflation down from 5.9% in October to 2.9% in November.




Now falls like this are certainly not "normal", and are an indication of massive underlying structural forces. Let us remember what JP Morgan said in their December report:


"The Global Manufacturing Input Prices Index posted 31.3, its lowest ever reading. The rate of deflation was especially marked in the US, were purchase prices fell to the greatest extent since June 1949. Rates of decrease in costs hit series records in the Eurozone, Russia, Switzerland, the Czech Republic and Denmark."

So basically, if the PMI readout is anything to go by we could well hit negative year on year prices in December, and if not then certainly in January. As can be seen in the index chart below, prices have already been falling since July. All of this is quite important since producer prices give us an early indicator of the likely path of consumer prices in the coming months, which means, I think, that the deflation threat in Spain is a very serious one indeed.





Another Wave Of Credit Downgrades In The Works

Hardly surprisingly in this environment, Spanish financial organisations are now seeing quite frequent downgrades in their credit ratings. The latest here - as Jaime Pozuelo-Monfort reminds us on RGE Europe Monitor - Caja Mediterraneo (CAM) and Bancaja who have been downgraded by Standard and Poor’s from A- to BBB+ with negative outlook. At this point CAM and Bancaja still maintain their investment grade status, which is held for ratings of BBB- and above. Prior to the Standard & Poor’s downgrade, CAM and Bancaja were also downgraded by Moody’s (who use a different classification system) in August 2008 from A2 to A1.

Standard & Poor's rebajó hoy la calificación crediticia a largo plazo de Caja de Ahorros del Mediterráneo (CAM) y Caja de Ahorros de Valencia, Castellón y Alicante (Bancaja) a 'BBB+' desde 'A-', y seguidamente procedió a retirar todos sus ratings a petición de ambas entidades, informó hoy S&P. La agencia de calificación, que afirmó el rating a corto plazo 'A-2' para las dos cajas valencianas, indicó que la perspectiva de la calificación era 'negativa' en ambos casos. En el caso de la CAM, Standard & Poor's justificó su decisión en las expectativas de "un significativo debilitamiento" en el perfil financiero de la caja en los próximos trimestres debido a una mayor vulnerabilidad que sus rivales a la desaceleración económica. Respecto a Bancaja, indicó que su calificación refleja su previsión de un significativo debilitamiento del perfil financiero de la entidad en los próximos trimestres, "en el contexto de un cada vez más difícil entorno económico". Además, S&P señaló que la perspectiva negativa refleja la posibilidad de un nuevo descenso del rating si percibe que el perfil financiero de Bancaja del perfil financiero "se va a deteriorar más allá de sus actuales expectativas".

Bancaja is Spain’s third largest savings bank, with total assets of EUR 102.1 billion as of end-March 2008 and a market share of 8.26% in Spain’s financial system. CAM had total assets of EUR 69.8 billion as of end-March 2008 and a market share of 5.65%. Bancaja also have the misfortune to be bankers to crisis ridden Valencia football club, who are rumoured to be prepared to sell their international "crack" striker David Vila if the offer is good enough, after Bancaja denied them further credit (watch out for the football casualties to this crisis I think).

This little extract from Europa Press, which explains how Banco Pastor have decided to "dispense with the services of" Standard and Poor's is also interesting for those of you who can read Spanish, as is their explanation for why they have done it (which, naturally, has nothing whatsoever to do with their October downgrade from A to A-) , which is basically that since the wholesale money markets are closed to Spanish banks then they can live without getting rated anyway. What's more, they say, the guarantee they are sure to receive from the Spanish Treasury for their forthcoming issues (watch out Spanish taxpayers) makes the ratings agencies unecessary. Amazing! I couldn't have believed it if it hadn't actually happened.
Banco Pastor decidió hoy rescindir el contrato que tenía con la agencia de calificación crediticia Standard & Poor's, informaron a Europa Press en fuentes de la entidad. El banco presidido por José María Arias adoptó está decisión debido a las actuales circunstancias del mercado, ya que los mercados financieros siguen cerrados, con lo que no hay apenas posibilidad de colocar deuda. Además, el aval del Tesoro es quien refrenda las próximas emisiones, por lo que la entidad considera que no es necesario la calificación de las agencias de rating. Banco Pastor, que no tiene vencimientos hasta 2010, mantiene una holgada posición de liquidez con un ratio de cobertura del crédito de los depósitos del 68%. La entidad gallega, que mantendrá su contrato con la agencia Moody's, tenía actualmente un rating de 'A-' de Standard & Poor's, tras ser rebajado el pasado mes de octubre por la agencia desde 'A'. A finales del pasado mes de noviembre, las cajas valencianas Caja de Ahorros del Mediterráneo (CAM) y Caja de Ahorros de Valencia, Castellón y Alicante (Bancaja) también solicitaron su baja del servicio de Standard & Poor's.

The article also informs us that the Caja de Ahorros del Mediterráneo (CAM) and Caja de Ahorros de Valencia, Castellón y Alicante (Bancaja) also asked to end their contracts with S&P's following their respective downgrades. Petlulence will get you nowhere my child!

Property Prices Down Too

Spanish Property Buff Mark Stucklin reports that even on the rather questionable official House Price Index, published by the National Institute of Statistics (INE) average Spanish property prices fell by 3% over 12 months to the end of the third quarter. Mark comments that:

The index, which has only been published for 2 quarters, needs to be treated with scepticism, as its figures are simply not credible in the current market. In reality, prices are sharply down, though nobody knows by exactly how much. And as I have pointed out here before, new build prices in the official statistics do not reflect the prices developers are offering today to make sales. With a glut of around 1 million new properties, and developers falling like flies, industry sources report that new build prices are falling fast.

He also informs us here that Catalonia is suffering more than other parts of Spain. Taking data from reports published by webportal Idealista.com, he explains that sales have fallen by around half, new housing starts are down by 80%, and prices are falling significantly. In Barcelona city, prices are down 8.6% over 12 months, pushing resale prices back to where they were in 2005. Prices are falling more in Barcelona than in Madrid, Valencia or Seville.

According to the latest data from idealista.com, a leading Spanish property portal, nominal prices in Barcelona capital have fallen 10.6% in the last 2 years, which translates into a fall of 16% in real terms (after adjusting for inflation). A typical flat of 70m2 is now 30,000 Euros cheaper than it was 12 months ago.

Over 12 months the asking prices tracked by idealista.com have fallen by 14.7% in Sants-Montjuïc, 12.9% in Sant Andreu, 12.7% in Horta-Guinardó, and 11.7% in the Ciutat Vella, Barcelona’s famous old town Gothic Quarter. Coastal resorts around Barcelona popular with second home buyers are also in trouble. Asking prices have fallen by 15% in Malgrat, Pineda y Premià de Mar, 13.3% in Roses (Costa Brava), and 13.5% in Segur de Calafell (Costa Dorada).
And finally, for this batch, Mark also draws attention to the way in which Spanish banks are increasingly turning themselves into property companies.

Spanish banks are turning into some of the biggest real estate companies in Spain, just as they did during the last property crash of the late 80s and early 90s. To a greater or lesser extent, banks are running some of Spain’s biggest listed developers, companies like Colonial and Metrovacesa, who were forced to throw themselves at their bankers’ feet when they couldn’t cope with their billions of Euros of debt.

It’s not just the big developers with billions of Euros of debt that the banks are having to take over to prevent their loan default rates from going through the roof. All around Spain many small regional banks and savings banks have been quietly taking over small local developers for the same reason. Having taken over developers or their assets in return for cancelling debts, many banks and savings banks, known as cajas, now find they own a wide variety of real estate assets from land and flats under construction to finished developments and business parks.

As Mark also points out the banks seem to be taking some consolation from the fact that on both previous occasions this move turned out to be extremely profitable to the banks as boom followed slump, and prices rebounded. But what if this time it is different. What if this time - following the trail blazed by Japan in 1992, and Germany in 1995 - prices come down and stay down; for decades.


Oh yes, but don't worry, not everything in Spain is going down. Unemployment, for example, is surely going up, and strongly so, as we will more than likely find out on Monday. So, in true Goethean spirit, ready yourselves, since onwards and upwards they will undoubtedly lead us.

December's JPMorgan Global PMI Shows Just How Far The Infection Has Spread

Well, here's the chart I think everyone really needs to see (below). The JPMorgan Global Manufacturing PMI hit 33.2 in December, a series record. More to the point you can get a comparison between what is happening now and the 2001 "recession lite" with only a swift glance, and, of course, the 2009 long recession is only just getting started.



Now let's stick it alongside the one Paul Krugman put up last week of the US Great Depression:



Arguably, what we can see here is that the current collapse in industrial activity is starting to get near the US historic one in terms of proportions, but we still aren't quite there yet. What we could note that JP Morgan in their monthly report suggest that the present rates of output are equivalent to an annual fall of between 12% and 15%. Really to compare with the fall in the US we need to get up into the 20% region, but remember the global index is based on an average for 26 countries, and some of these are much worse than others (Japan, Spain, possibly Russia) and will already be around the 20% annual contraction rate in December. The point is also that the situation is still deteriorating, so hang on a bit, since it is not at all excluded that we will hit a 20% annualised contraction rate for the whole aggregate 26 sometime during the first quarter.
"The second half of 2008 has been dreadful for global manufacturing and the sector enters the new year mired in its deepest recession for decades. Manufacturing will therefore continue to weigh on world GDP figures, with December PMI data consistent with a drop in global IP of around 12%-15% saar as indexes for output, new orders and employment slumped to record lows."

"The weakest performance was registered by Japan, whose output and new orders indexes fell to levels unprecedented in the histories of any of the national manufacturing surveys included in the global manufacturing PMI."

"Employment fell for the fifth successive month in December, and to the greatest extent in survey history. All of the national manufacturing sectors recorded a drop in staffing levels, most at series-record rates including all of the Eurozone nations, China and the UK. The sharpest falls in employment were signalled for Denmark, Spain, the US, Russia and the UK."


And watch out for the deflation backslap:

"The Global Manufacturing Input Prices Index posted 31.3, its lowest ever reading. The rate of deflation was especially marked in the US, were purchase prices fell to the greatest extent since June 1949. Rates of decrease in costs hit series records in the Eurozone, Russia, Switzerland, the Czech Republic and Denmark."


And for those of you who are still sceptical that any of this has any validity, here's a PMI/GDP comparison chart for Japan - GDP rates to the left, diffusion index PMI readings to the right (click over image if you can't view too well). Not perfect, but not a bad guide I would say, if you like your football live, that is.



So never mind the depth, what about the duration? Well that is where I think that all of this will differ from what happened back then. As you can see in the US Great Depression Chart the 20% annual decrease went on for several years. At the present time I think there is no reason to assume that this will happen, ie that we will keep getting massive year on year contractions (in some cases maybe, Latvia perhaps?????), but activity does look set to fall to quite a low level, and there is no strong reason at present for believing it will simply bounce back up again. More than likely we will simply trawl the bottom, at least for some months, and who knows, maybe a couple of years.

Well that's it for the big picture stuff, but I have actually been pretty hard at it all day down at the individual country level, so there is plenty more detail to come. In forthcoming posts. Incidentally, despite the fact I wander off my main patch here from time to time, I do try to keep this blog pretty much focused on what is happening in Spain. Those who want to find more material on the so called "second great depression" debate may like to keep a watchful eye on my postings over at A Fistful of Euros, most notably this one, and my latest one on China.