Wednesday, May 27, 2009
Thursday, May 14, 2009
Over the first quarter of 2008 (that is year on year) GDP decreased by 2.9%, the sharpest decline recorded in almost 40 years. In fact you would need to go back to 1945 to find a year in which the Spanish economy contracted as strongly as it is likely to this year.
The contraction was mainly caused by a very large slump in private domestic demand, a factor which was partially offset by a surge in government spending, and partly by the positive contribution of external trade, which (ironically) since imports fell more rapidly than exports as the current account deficit closes meant that less demand "leaked out". Of course, such declines in imports also reflect declines in living standards for the population at large.
Basically, even if the output were to remain stationary for the remaining three quarters of the year (which it obviosuly won't), GDP would still fall by 2.6% over the year. However, since the economy will obviously still continue to contract, it is much more realistic to anticipate a fall in GDP of between 5% and 7% for the year as a whole.
The current recession is likely to be a long one. The current financial crisis, which, as I explained in my last post, has simply served to bring into focus the inherent unsustainability of the previous growth model: deep housing crisis, high indebtedness of the private sector, weak price competitiveness, very high unemployment… S0 as I say, ECB and EU Commission help will need to be on their way, and massive structural reforms now seem inevitable.
Despite some recent positive development (decrease in interest rates and prices, fiscal stimulus measures, slight improvement in confidence, ECB purchase of cédulas hipotecarias…), Spain will not recover even as other economies begin to breathe again. The worst year undoubtedly could be 2011, and the unemployment rate by that stage could reach anywhere between 25% and 30% of the labour force if you accept the March 17.5% number as good.
Bottom line, a complete nightmare, with the only bright spot being imminent control of the political system being assumed in Brussels and Frankfurt, since along with the economy the political "automatic stabiliser" system also seems to be broken. Could, I ask myself, recent events in Hungary give us any indication of the most likely way out of this mess.
“The 60 billion euros they announced is peanuts for an economy the size of the euro zone,” economics professor and former Bank of England policy maker Willem Buiter said at a conference in Dublin yesterday. “I expect they will announce more or that the recession in the euro zone will be longer and deeper than would otherwise be necessary. They have a record of being somewhat behind the curve.”
European car sales dropped 12 percent in April.... Bayerische Motoren Werke AG’s registrations dropped by almost one-third to 55,633 even as the German market expanded 19 percent, helped by the government’s 2,500 euro ($3,400) sales bonus .........Spain extended its auto-sales slump with a 46 percent plunge in registrations, the largest among the continent’s main markets, while U.K. sales dropped 24 percent. Eastern European registrations dropped 21 percent, almost twice the rate of decline in the west, as Romanian demand fell by more than half.
The title to this post, and the accompanying photo are obviously a joke. But behind every joke there lies a grain of truth, and my present one is no different from all the rest in that sense, since the ECB is now indirectly buying into a piece of the Spanish property action, and they are about to do so by the acquisition of an instrument known generically as "covered bonds", the purchase of 60 billion euros worth of which was announced by the ECB last week, much to the surprise of the assembled press conference journalists, many of whom either couldn't believe or couldn't understand what they were hearing (see transcript extract below). These instruments may be generically known as covered bonds, but in Spain we call them cédulas hipotecarias.
The only covered bond most of the journalists who attended the press conference seem to have been aware of, however, was the German one - known as Pfandbrief - and hence the move was seen as some sort of "sweetner" for a fairly reluctant Bundesbank. In fact things are rather different, since, although the Pfandbrief do form part of the picture, via in particular the Hypo Pfandbrief Bank of troubled German Hypo Real Estate, in both Spain and Ireland some form or other of covered bond is to be found at the heart of the wholesale money financing strategy invented by the banks (in the early years of this century) when they realised that bank deposits alone were not going to prove sufficient if they wanted to make good on all the mortgage provision opportunities the low interest rate policy (2%) being pursued by the ECB was creating. As it happens, I have long taken an amateur's interest in the subject of covered bonds (and cédulas hipotecarias), in fact I got interested in them just as soon as I realised what an important part of the Spanish picture they were. You can find a convenient summary of what they are, how they work, and why understanding them is important if you want to get to grips with the current Spanish crisis here.
Really, and to cut a long story short, refinancing the cédulas has become important since they were originally issued on a short term (5 or 7 year duration) basis (presumeably to keep debt servicing costs down), but since they were matched against mortgages which were issued with a 20 to 30 year maturity, they were always going to need rolling over (and over, and over), and again, since the quantity of money involved is large (anywhere between 250 and 300 billion euros between now and 2014 at a guess), and since virtually nobody has wanted to know about buying them since the US sub prime crisis broke out in August 2007, they had become a big potential headache for the Spanish authorities, with something like 50 billion euros in the current Spanish bank bailout programme being earmarked for easing the renewal process.
Indeed so important have the cédulas been that you could virtually say that the current Spanish crisis was inaugurated in September 2007 when the wholesale money markets were closed to the Spanish banks who wanted to sell them, even if after hours and hours of talk-show debate (and miles and miles of column print) devoted to the crisis, hardly any Spanish voter knows what they actually are.
Well, to cut a very long story short, the good news is that the refinancing issue is now probably (and bar the shouting, and the details) as good as resolved, so if you haven't the time, interest or inclination to get involved in more of all the detail on this I suggest you now jump to the conclusions section, were I muse a little bit on what some of the political counterparty consequences of this new level of risk assumption by the ECB are likely to be.
Quantitative Easing, Financing Spanish and Irish Mortgages, Or What?
Basically, most observers have now spent the best part of a week looking into the tea leaves and trying to discern just what it was which lay behind last Thursday's announcement. So peculiar was the announcement (or at least the manner in which it was made) that Bloomberg even have an article headlined "Covered Bond Market Seizes On Plan For ECB Purchases", which explains how the complete confusion now reigning in the secondary market for these instruments (due to the incredible uncertainty over what securities policy makers will actually buy, how they will pay for them, and how great the final quantity purchased will be) has meant that trading in the bonds has all but ground to a halt (again). And this as a consequence of a move which was intended to support the market is a strange result, to say the least.
The initial confusion has only been added to by recent public disagreements between governing board members, and the statement from European Central Bank council member Marko Krnajec (governor of Slovenia's central bank) to the effect that the bank is likely to increase its asset- purchase program from the initial 60 billion euro plan provoked immediate reaction, in particular from Germany’s Axel Weber, who opposes outright asset purchases and has been pushing for the ECB to set an interest-rate floor beyond which they will not reduce further. Indeed Weber was very explicit in reaction to Krnajec yesterday, saying that he sees “no need” for the ECB to buy further private assets to support lending. “I currently don’t see the need for outright purchases of further private debt obligations,” he is quoted as saying. (Joellen Perry at the WSJ Blog has a piece covering similar gound, as she says, maybe ECB predictability has now become the main victim of the crisis, while Claus Vistesen makes basically the same point in his ECB Communication - All at Sea? and his Quantitative Easing à l`ECB? posts.)
The dispute goes even further, and extends not only to what to buy, and how much, but even to how to pay. Kranjec on being asked how the ECB planned to fund its debt purchases, said: “This has yet to be agreed. As a central bank we are creating money. We have no limits with funds to finance projects.” While Weber told journalists tersely: “Note well: It’s not our goal simply to print money.”
The new uncertainty about the ECB’s actions may be undermining market
confidence at a crucial moment. An ECB report Wednesday suggested reviving
investor confidence is key to kick-starting bank funding markets that have dried
up amid the crisis. Lacking steady access to traditional funding sources such as
bond and inter-bank lending markets, the report said, European banks could
curtail lending to households and firms, dampening economic growth.
Joellen Perry, Wall Street Journal Blog
So what is the goal? This is really the key issue, and trying to follow the ECB's ruminations in this sense is more akin to watching a mystery play unfold (in every sense of that expression). Well, where do we look for clues? I can think of no better way than by examining the question and answer to-and-fro Trichet himself had with the journalists in the press conference. So here we go, lets see if you can make sense of all this. The issues are, remember:
a) Does the decision to buy covered bonds constitute quantitative easing?
b) If it is quantitative easing, is it to ease credit, or fend off deflation?
c) Why was the decision taken now?
d) Will the ECB "print money" to finance the purchases, or will the acquisitions be "sterlised"
e) Why covered bonds as opposed to, say, commercial paper?
"The Governing Council has decided in principle that the Eurosystem will purchase euro-denominated covered bonds issued in the euro area. The detailed modalities will be announced after the Governing Council meeting of 4 June 2009."
Jean Claude Trichet, Speaking at the Press Conference Following the Rate Setting Meeting, 7 May 2009.
Question - My second question comes back to the covered bond issue. I wondered if you could explain your general rationale behind this specific asset class? And in that vein, if I can recall correctly, covered bonds are mainly used by the banks in which a lot of German is spoken for refinancing, and not so much in the rest of the euro zone. So are you not implicitly delivering an advantage here to banks that use this particular asset to refinance?
Trichet - On the covered bonds, I remind you that we are in the euro area of 329 million people, this is a single market with a single currency, and what we are doing is what we judge appropriate for the single market with a single currency. All of us in the Governing Council are striving to take the right decisions expected by the 329 million fellow citizens. Covered bonds were considered by the Governing Council as a segment of the private securities markets that in general has been particularly affected, more so than others, in terms of the impact of the financial turbulences.
Question - Firstly a question on the covered bonds. Can you tell us how you came to the figure of around €60 billion? Is that some estimate of the amount of stimulus you feel you ought to be injecting into the economy? Is that what your thinking was? And secondly how are you going to pay for this? Will the purchase be sterilised or can we write that you are going to be printing money?
Trichet - On your first question, I give you a rendezvous for the next meeting when we will discuss all the technicalities for this operation, which is new for us and which calls for appropriate handling. Around €60 billion is only an order of magnitude, appropriate for attaining our goal, to help to revive this particular segment of the market.
With regard to sterilisation, it is included in the question of the exit strategy. I mentioned in the introductory remarks that we consider this issue as absolutely decisive. We have to be up to the present exceptional circumstances. And I don’t want to repeat all the areas where we were the first central bank to act and to take bold decisions. Whether it was the longer-term refinancing of commercial banks, or at the beginning of the turmoil being the most forthcoming central bank as regards its collateral framework, or when we had to take bold action in particular at the very beginning of the turbulence on 9 August 2007. As regards today’s decision taking into account all elements we considered that we could and we should go beyond what had been until now our main channel for enhanced credit support mainly by the refinancing of commercial banks which has, by the way, produced important results. I would like to mention en passant the figures which show that thanks to the decisions we have taken so far - they don’t incorporate of course the new decision taken today - our one-year money market has lower interest rates than in the sister central banks’ money markets. This is also the case at least with one sister central bank for the six- and the three-month money market interest rates. One has to take into account everything, and in particular our handling of our own money market with our full allotment, fixed interest rates procedure, the very forthcoming attitude we have as regards longer-term refinancing, which has even been enlarged today and the collateral that we accept. That being said the Governing Council considers sterilisation and the exit strategy absolutely essential to maintain the maximum amount of credibility in the medium and long term. The public debate emerging on whether or not some central banks are paving the way at the global level for future inflation is extraordinarily counterproductive. We, central banks – and I’m sure that we are all in agreement on this – are determined to solidly anchor longer-term expectations and eliminate these fears about future inflation.
Question - Just again on covered bonds. I understand that you are not ready to answer the question of how these purchases will be financed, but perhaps you could give us an idea of the reasoning behind that decision. Are you doing this to lower any credit spread between covered bonds and the risk-free interest rate, or is the main motivation behind it to inject more liquidity into the system?
Trichet: No, the idea is to revive the market, which has been very heavily affected, and all that goes with this revival, including the spreads, the depth and the liquidity of the market. We are not at all embarking on quantitative easing.
Question - One question for clarification because I obviously mistook something for what it isn’t. When I heard about this covered bond programme, I mistook it for quantitative easing. Can you explain to me why it isn’t?
Trichet: If I might use our own vocabulary, it is part of our “enhanced credit support” operations. We have used this expression for quite a long period of time because we consider all the non-conventional measures we have taken in connection with the refinancing of banks as enhanced credit support. If you wish, you could call that credit easing, because it is a way of improving the functioning of the market that had been affected particularly markedly by the financial turbulences.
As can be seen above, initially observers were completely bemused by the decision. Some saw the move to buy covered bonds as an attempt to boost a market which was now facing competition from state-guaranteed bond issues, while others, like Bodo Winkler, capital market expert at the VDP covered bond association, which represents banks that issue German covered bonds (or Pfandbriefs) argued the very presence of the ECB in the market would bring indirect benefits.
"Interest from an institution as renowned as the ECB could be a significant support to the market. It would mean the ECB would have these quality assets - covered bonds- on its books,"he said. Winkler also argued that the meer presence of ECB activity would help lower spreads for the bonds, which in the German Pfandbrief case are securities created from either mortgage loans or public sector loans. The German market is in fact one of the oldest and largest (dating from the mid 1990s), while the Spanish market is more recent, but has now become the second largest.
Others have also suggested that, depending on how the purchases are conducted - in the primary or secondary market - acquisitions might indirectly free up banks to acquire new bonds themselves, thus also bolstering the market. While the Spanish cedual market has remained virtually a dead duck (Santander did issue a cedula following the ECB decision, for the first time in many months, and at 122 base points above what they were earlier paying) the German one has remained active and German banks issued 7.33 billion euros of Pfandbrief in January (down 42 percent year on year and by nearly half from September's 13.8 billion euros). Data from Thomson Reuters show that Germany is still the largest originator of covered bonds, closely followed by Spain. The two countries account for around a third of the euro zone market each. France is next at just under 20 percent, while Italy has a mere 2 percent.
The exact size of the wider European covered bond market is the source of some confusion, with estimates raning between 700 billion and 1.5 trillion euros. Some analysts estimate that if the ECB sticks with the BB rating currently applied in deciding whether bonds are acceptable as collateral for their lending operations, then around 450 billions worth of covered bonds would be eligable for purchase. (NB - this is the big change, at the present time Spanish banks can take cedulas and deposit them with the ECB as collateral for borrowing, now they will be able to sell them to the ECB direct).
According to the data supplier Dealogic the covered bond market has contracted by €136billionn since May 2007, and currently stands at €1,118 billion.
In general it is possible to say that the analyst response is that the ECB's decision to buy bonds for the first time in its history raises almost more questions than it answers. Reponses from Annegret Hasler and Frank Will (see below) are typical.
"Nobody knows what exactly this means for covered bonds. No one knows whether this will be purchases on the primary market or on the secondary market, and this makes a big difference," said Annegret Hasler, a covered bonds analyst at Commerzbank. "Market participants are likely to go on hold until they know further details."
"What we don't know is if the ECB will focus primarily on covered bonds in trouble, maybe Irish covered bonds, or if they are focused on certain Spanish cedulas?" RBS covered bond strategist Frank Will said on a call for clients. "It is also not clear how they will divide the 60 billion over the various countries."
How to spread the spend is a contentious issue in the euro zone because the covered bond and mortgage markets are more developed in some countries than others, opening the ECB to political heat. The premium that investors demand to hold covered bonds from Spain and Ireland fell on Friday, suggesting they are seen as the most likely beneficiaries.
"There are only two housing markets in Euroland which are currently experiencing
significant distress: Spain and Ireland," said UniCredit credit strategist
Markus Ernst. "Any partial support of specific regions or covered bond
issues would surely raise political criticism."
Italy's La Stampa unsurprisingly (since Italy has only 2 percent of the covered bond market) suggested last Friday that the decision was largely designed to help German banks - they obviously don't know about the cédulas! Germany's Boersen-Zeitung billed the move as the "ECB steps up the fight against recession", while the more "in the know" Spainish daily El Pais ran with "ECB activates money printing machine to combat crisis". Of course, as I mention above, the decision will help the German banking system too, since Hypo Real Estate and its Dublin-based unit Depfa Bank have around a 12 percent market share between them (or about 90 billion euros) of Germany’s pfandbrief bond market, according to data from the VDP Association of German Pfandbrief Banks. So any collapse of Hypo Real Estate Holding (which the German government describe as "systemically important") may indeed threaten the stability of the whole pfandbrief market.
UniCredit economist (and my RGE monitor co-blogger). Aurelio Maccario noted wryly: "Somebody somewhere is probably saying they should also think of something else to help other markets like the Italian market," he said. He also made clear that another key question was whether the ECB would effectively inject another 60 billion euros into markets, or neutralise the purchases' impact on money supply. "To sterilise you have to do exactly the opposite measure with exactly the same amount. If you buy 60 billion euros of covered bonds then you sell 60 billion of some other assets, corporate bonds, government bonds for example ....If you want to sterilise it by selling other assets, you risk rising other spreads, you risk rising long term interest rates. And then if you don't sterilise it then it is a pure easing, which you can label as quantitative easing."
As I have been pointing out, Maccario gets right to the heart of the matter here, since some Council members, and most notably the German contingent (Axel Weber and Juergen Stark) have been busy expressing reservations with the whole idea of purchasing debt in the first place, while other policymakers like the Greek and Cypriot contingents (Athanasios Orphanides and Lucas Papademos) have been pushing for broader purchases of private securities as a way of keeping deflation from the door.
But as Deutsche Bank economist Mark Wall points out, sterilised purchases would obviously help the covered bond market but it would have little impact on either companies or households, so it would be hard to see the point, and it would be even harder to see why Trichet would consider sterilised purchases to constitute the use of new monetary tools. "In terms of the aggregate effect on the economy, if they are sterilising it they are neutralising it," Wall said.
Spreads on covered bonds from Spain and Ireland have tightened since the decision, pulling government bond spreads with them, suggesting that markets are expecting the volume of purchases to increase, and Spain and Ireland to be the principal beneficiaries. Spreads in Spain and Ireland had been way up, with Spanish covered bonds maturing in 10 years typically trading at about 200 basis points over mid-swaps, compared to about 300 basis points over mid-swaps for an Irish covered bond and just 60 basis points for a German issue.
According to Royal Bank of Scotland analyst Harvinder Sian "The impact on periphery spreads we think is very profound ... This is a credit-easing after all, so we should expect the positive momentum, and that's exactly what we've got." In support of his view Harvinder pointed to the fact that the premium that investors are demanding to hold debt issued by euro zone countries other than Germany fell have fallen, with 10-year Italian, Greek and Spanish spreads among those hitting their tightest levels since late last year. In the government bond market, the 10-year Greek/German yield spread narrowed to as low as 160.3 basis points on Friday, the tightest since early December 2008, while the equivalent Irish/German spread also closed in to 163.8 basis points - the narrowest since early January. "The idea that the ECB is buying assets now does spread risks across the euro area in terms of the economy and the momentum going forward," according to Sian.
So What Are The Consequences (Political or Otherwise) Of All This For Spain?
Well first of all this is obviously very good news from a Spanish point of view. The Spanish economy is evidently in the throes of a major correction (most of which has yet to get underway) which will involve moving from a construction and consumer debt driven economy to an export driven growth model.
But in the path of this correction lie three very strong impediments.
1) The need to refinance the cédulas (estimated cost 250 to 300 billion euros)
2) The need to resolve the issue of the growing volume of builder and developer non-performing loans (or the million plus empty houses) - estimated bank expoure 470 billion euros (Bank of Spain data).
3) The complete lack of competitiveness of Spanish wages and prices.
Basically, we can see a solution in three parts here. The ECB will refinance the cedulas as we move forward (done). This will not only help the banks, it will take some pressure off government finances, and it will effectively give support to the last-man-standing in the Spanish real world economic arena, Bank of Spain Governor Miguel Angel Fernandez Ordoñez. I don't expect to see more interview in El Pais with deputy prime minister Maria Teresa Fernández de la Vega, accusing him of being alarmist about the reserves of the Spanish pension system. He who pays the piper, we should remember, effectively calls the tune.
Which brings us to the second point, the housing overhang, and the bad loans that go with it. Now while the details remain far from clear, I fully expect Spain to follow in some shape or form the "Irish solution" of either buying the houses direct, or buying the loans which go with them (with or without the creation of a bad bank). But neither Spain nor Ireland will be able to sustain the volume of public borrowing necessary to finance this move unaided. I therefore fully expect the issue of EU Bonds to raise its head again. (I have spelt out what this is all about in this post here). As it happens, a journalist friend of mine interviewed EU Economy Commissioner Joaquín Almunia recently, and asked him explicitly about Commission intentions here. I am adding the exchange as an appendix, and as you will see, he neither says yes, nor does he say no, what he says is that they are a logical development, and that they will come gradually, which is EU speak for "they are in the pipeline" (so, this item is effectively done too).
So we are left with the third point, the correction in wages and prices, also known as "the budget from hell". It is most obvious that with the Spanish economy likely to contract between 5 and 7 percent this year (it contracted at a 7.2% annualised rate between Q4 2008 and Q1 2009), and to continue to do so next year, and the government fiscal deficit likely to run at over 9% (the present EU Commission forecast is for just under, but there will be overshoot since the contraction will be more rapid than they are anticipating) then Spanish public finances are headed for an acute crisis. And given the (by then) growing dependence of the Spanish economy on direct EU support then, as I said above "he who pays the piper will call the tune", and the "budget from hell" will be imposed, whatever José Luis Zapatero think he wants.
Evidently ten years of bad craftsmanship cannot be put straight in a day, but Europe is going to have a good try at doing so. The EU is now "in media res" of that much needed restore and restoration work to remedy its institutional deficiencies and address its "crisis overload" problem. Remedies are available and being developed, even if getting Europe's leaders to talk about them explicitly is something akin to leading a reluctant father-to-be up to the altar.
EU (rather than exclusively national) bonds can and will be created. These will effectively give Europe a fiscal capacity that is, for all intents and purposes, equivalent to that of the U.S. Treasury. Second, given the deflation problem, the European Central Bank can now follow the Bank of England and the Swiss National Bank by entering the next tier of quantitative easing, expanding its balance sheet and starting to buy those crisp new EU bonds in the primary market.
Quantitative easing, which is simply a generic way of referring to all the recent attempts to boost money supply when interest rates fall close to zero, becomes in this particular case a euphemism for "printing money," with the unusual characteristic that this time, inflation is exactly what we are looking for. And if we don't get it, well, as Paul Krugman wrote in a recent New York Times op-ed on Spain, we run the risk of ending up with a European economy that is depressed and tending toward deflation for years to come.
The most important thing to realize is that the arrival of deflation is not only a threat; it is also an opportunity. Having the power (nay the necessity) to print money should give Europe's central administration one hell of clout should it need to use it, and it will. As Joaquín Almunia said not so long ago, "You would have to be crazy to want to leave the eurozone right now," given the economic climate. It's precisely this fear that will serve as the persuasive stick to accompany that ever so attractive financial carrot which is now being dangled forth. (Assuming, that is, that Europe's leaders understand: in this case at least, sparing the rod would only amount to spoiling not only the child, but all the brothers and sisters and aunts and uncles, too.)
So though the first argument in favor of buying cédulas hiptecarias and issuing EU bonds (etc) might be an entirely pragmatic one - namely that it doesn't make sense for subsidiary components of EU, Inc., to pay more to borrow money when the credit guarantee of the parent entity can get it for them far cheaper - the longer-term argument is that the ability to make such purchases and issue such bonds might well enable the EC and ECB to become something they have long dreamed of becoming: an internal credit rating agency for EU national debt. Caveat Vendor!
Appendix: Extract From Interview With Joaquín Almunia
Question - The Euro has proved to be an effective shield protecting eurozone economies from the shocks of the crisis. But some argue that the crisis has highlighted the fact that European financial markets are fragmented and that there is a need for a single market for government bonds. George Soros argues that “a eurozone bond market would bring immediate benefits in addition to correcting a structural deficiency”. It would lend credence to the rescue of the banking system and allow additional support for the more vulnerable EU members. Do you agree?
Joaquín Almunia - As the Commission itself pointed out in the report on 10 years of Economic and Monetary Union published in May 2008, the euro-denominated bond market indeed remains very fragmented on the supply side. The issue of European bond issuance has been discussed on and off for several years now and even more frequently since the financial crisis started. I think this is something we should consider in future to promote greater financial market integration and more efficient European government bond markets. But I also think this is likely to be a gradual process. Better coordination of national government bond issuance, for example, could be a first and necessary step.
I would like to stress also, that for all governments, both inside and outside the euro area, the best way to gain credibility in investors' eyes and avoid problems with financing is to carry out responsible fiscal policies.
Tuesday, May 12, 2009
Sharp Reduction In The Rate Of Global Manufacturing Contraction In April
The Spanish economy, like any other, is to some extent sensitive to movements elsewhere in the global economy, and it is not unimportant to note that the JPMorgan Global Manufacturing Purchasing Managers’ Index (PMI) - which is based on surveys covering over 7,500 purchasing executives in 26 countries which between them account for an estimated 83% of global manufacturing output - posted a reading of 41.8 in April, thus coming in well below the critical 50 neutral mark separating expansion from contraction for the 11th successive month. In rising from the 37.3 level shown in March, the PMI managed to post its largest month-on-month improvement in the series history attaining in the process a seven-month high. The sharpest point in the contraction was last December, when the indicator hit the all time series low of 33.7.
The picture painted by the index was, however, a mixed one, and emerging economies generally fared rather better than developed countries. This was especially the case in China and India, the only two countries covered by the survey to actually to report increases either for output or new orders. Rates of contraction in output eased to a seven-month low in the United States and to the weakest since last October in the euro area. And please note, output and new orders in Spain and Japan continued to fall significantly faster than the global average, although even in these cases the contraction rate improved markedly over earlier rock bottom lows.
The rate of decline in Spanish manufacturing slowed again in April (for the fourth consecutive month), and April's PMI rose to 34.6 from 32.9 in March. This is now significantly up from December's record low of 28.5, but the contraction remained very strong, and this was still one of the lowest readings globally.
The pace of deterioration eased in output, new orders and employment, though stocks of purchases and finished goods hit series lows. Survey responses suggested the rate of decline in the badly hit jobs market had eased slightly from earlier falls, but the reading still remained well below growth levels, and Spain's economy continues to bleed jobs, adding to levels of employment which the latest labour force survey data suggests has now risen above 4 million (or 17.3% of the economically active population). Staffing levels have declined every month since September 2007, according to survey records.
The PMI - which is simply a survey indicator - backs up the findings of Spain's own National Institute of Statistics, who announced last week that the industrial production in March declined by a calendar adjusted 24.7% year-over-year, after falling 22.5% in February.
The seasonally adjusted index gives a dramatic and clear indication of the long march into decline which currently characterises Spanish industry.
Services Also Contracts More Slowly
The contraction in global services activity also seems to be easing up, following the pattern displayed by the manufacturing sector, and the JPMorgan Global Services Business Activity Index rose for the second month running in April, registering at 43.8 its highest level since last September. It is important to keep clearly in mind, however, that the headline index remained well below the critical dividing line of 50 which separates growth from contraction, and thus we are still firmly within global recession territory. So stabilistation in the contraction is not the same thing as recovery.
Spanish service sector activity continued to decline in April although as elsewhere the rate was much slower than in previous months. The headline activity index stood at 42.5, still well below the critical 50 level indicating growth, but way above 34.1 in March and November's record low of 28.2. April's figure was in fact the highest recorded since May 2008 but nevertheless marked the 16th consecutive month of contraction as the deep recession weighed on new orders and jobs. According to Andrew Harker ,economist at Markit Economics, "Jobs continued to be lost at a fast pace, indicating that the labour market remains a key source of weakness."
The survey showed staffing levels declined in April for the 14th month running as service providers cut jobs due to lower activity and to keep costs down. Hotel and restaurant firms were the hardest hit. However despite Spain's deep and ongoing economic crisis, April's survey was marked by confidence levels not seen in 15 months. Many of those surveyed by Markit said they believed the crisis would end within a year, with two-fifths of panellists expecting activity to be higher in 12 months and just 22 percent forecasting lower activity. However, companies remained relatively cautious about short term economic prospects.
The service sector thus is showing a significantly sharper rebound from the record declines of the last few months than is to be seen in the manufacturing sector, which continued to contract at a rapid pace in April.
Prices continue to fall, and services output prices registered the third-fastest decline in the survey's history, second only to February and March this year, with those surveyed citing increased competition for new business and pressure from clients. Service providers also reported falls in input costs due to reduced labour costs and lower prices from suppliers, but, according to Markit, the decrease here was less marked than that for output prices.
House Sales Continue To Fall (More Slowly)
Spanish house sales fell again in March, but as the desperate seekers of green shoots are so eager to point out, at the slowest pace in the last 11 months, according to data from the National Statistics Institute. Home sales fell 24.3 percent to 34,895 in March in what for what was the 13th straight month of decline, but the level was below the rates of 37.5 percent in February and 38.6 percent in January. Of course, once contractions have been running for more than twelve months you start to get what are known in the trade as "base effects" (since this years figure is simply down from an already reduced number the year before), and it is possibly more interesting to follow the actual number of sales, which you can see on a three monthly average basis (to iron out some of the seasonal quirks in the data - an old economists "quick'n dirty" trick) in the chart below. It's not too clear that we can talk about any "easing" in the recession looking at this chart. Even with monthly sales running 10,000 or so higher than the present level, the construction industry would still be in a huge slump.
In fact some increase in sales is only to be expected as banks repossess homes from houseowners and property developers due to the soaring rate of debt defaults, only then to put them on the market at ever lower prices. And again, the March housing results were influenced by the statistical impact of a sharp, 39 percent fall in March 2008 sales (the base effect) and the fact Easter fell in March last year. Nonetheless the number of sales was slightly up on February.
So what we are talking about is less deterioration, not any visible improvement.
While The Number Of Mortgages Goes On Dropping
The average value of the mortgages signed in February was down by 12.1% year on year and reached 148,798 euros The number of mortgages that change conditions increases 24.6%, while registered cancellations decrease 29.7% During the month of February, the average amount per mortgage constituted stood at 148,798 euros, 12.1% less than for the same month the previous year, and 1.2% lower than that recorded in January 2009. The average value of housing mortgages was 123,643 euros, down 17.0% year on year, but up 1.3% on January.
The number of new mortgages was down 28.5% year on year.
So basically, while it is true to say that we undoubtedly saw a moderation in a number of indicators in April, this is still a far cry from any kind of green (or even Brussels) sprout, or anything vaguely resembling one. And the key to the story is to go back to where we started - the credit crunch. It may all seem like a long time ago now (like in August 2007) but all this started after many years of exaggerated bank lending to Spanish households and corporates sent property prices, and with them relative wages and prices, way out of line with the true net worth of the underlying economy and labour force. It is like Spain suddenly developed a version of "twisted vertebrate illness". And now all these distortions need to correct themselves. And since for two years now the Spanish government and people have vigourously failed to face up to the underlying cause of the problem, there is little alternative at this late stage in the game to a pretty violent correction.
The heart of it all has been excessive bank lending, lending which basically came from the exterior (since Spain was low on domestically generated saving, everyone wanted to "invest" in property) and basically made possible and funded a large external deficit (which is now also closing, again painfully, since exports are not rising, and all the work will be done by falling imports and living standards). Basically to get 4% annual GDP growth Spain's corporates and households were increasing borrowing at a rate of around 20% per annum. The credit crunch has put a stop to all that, and year on year household borrowing is gradually dropping to zero (before going negative, see chart below).
In fact total household borrowing is now below the level of June 2008, so the rate will turn negative in June at the latest.
And of course the same thing is happening with housing loans, and total mortgages outstanding have now dropped for the last four months.
The rate of decline in lending to corporates has been slower (all those non performing loans building up, since more debt and less revenue and profit ultimately don't add up), but the key moment will come when the banks can no longer hang on to all the debt and they have to start to let things go in earnest.
In fact, total Spanish debt reached something like 250% of GDP before this burst (with a 20% y-o-y growth rate in loans and a 10% of GDP annual current account deficit) and this level is evidently completely not sustainable. During this correction the net indebtedness of the Spanish nation will have to drop significantly as a proportion of GDP. Ironically, as GDP contracts, debt has still been rising, as government has simply stepped in to take on the burden with more or more state borrowing. Ultimately this won't work. The EU commission estimate that the Spanish deficit will hit around 9% of GDP this year, and my guess is that this is the last year where such abuse of borrowing will be tolerated. I say abuse, since while no one would argue Spain doesn't need to run deficits at this point, there is simply no sense at all in running them without a plan, simply to buy time, and hope. This in Spanish is called a "huida hacia adelante", and this is exactly what Spain's policy has been about - running ever faster to try to catch up with your own shadow.
So as I say, debt to GDP is most probably rising even now, but it is obviously going to have to come substantially down, which is why I insist on saying, this correction has hardly even gotten underway yet.
Monday, May 11, 2009
As we shall see, what we have here is not necessarily a simple "fudging" of numbers, but rather a conflict between two different ways of measuring unemployment, since the two data sets are compiled using different methodologies. That being said, I am not putting the question on the table to offer any definitive opinion of my own, since I think in a country with an informal economy which amounts to over 20% of the total it is impossible to "really" know how many people are actually working and how many aren't. What I would like to do is try and clarify a bit better what is actually happening to employment is Spain, highlight just how serious the situation is, and sketch out a bit more of the reality which lies behind the headline data.
But before we get into all that, the really important point to get hold of is that in the sort of economic conditions Spain is experiencing it not the actual headline catching base number that matters (4 million, 3.6 million, or whatever), but rather how quickly the numbers are rising. This detail is important, since it is the rate of increase in unemployment that ultimately determines the rate of increase of two of the other important indicators for the Spanish economy - the volume of non-performing loans and the size of the government fiscal deficit.
More, or Less, Unemployment?
Well, the cat really was let out of the bag for the great Spain unemployment "non-debate" (since amazingly none seems to have ensued) by the publication of last months quarterly labour force survey (by the national statistics office, the INE), which showed that number of unemployed in Spain had almost doubled over the last twelve months, rising to more than four million by the end of March, and sending in the process the jobless rate soaring past 17 percent level. This rate is, of course, far and away the highest in the 27-nation European Union, where the average was 8.3 percent in March according to Eurostat data.
The INE release was alarming, however, not only for the high headline figure (which was, of course, scary), but for the speed with which the survey showed Spain's jobless rate rising - from 13.91 percent at the end of December to 17.36 percent three months later (see the dramatic surge in the chart below, based on the INE data).
Thus an additional 802,800 persons were estimated to have lost their jobs in the space of three month, bringing the total number of unemployed to 4.01 million - a rise of 1.836 million over 12 months. The percentage of the economically active population who were unemployed was the highest in Spain since the fourth quarter of 1998, when the level hit 17.99 percent, and the total number of unemployed is the most since at least 1976, when comparable data were first recorded.
Of course, the political theatricals surrounding the release were vivid, since the new economy minister Elena Salgado was quick to declare "We will do everything possible to reduce these unemployment numbers, and of course will guarantee unemployment benefits for every person in this situation." How exactly the Spanish government is going to be able to honour this latter guarantee as we move forward (since benefits are exhausted after a maximum of 24 months) is just one of the many puzzles which currently perplex day to day observers of the Spanish economy, since the number of longer term (and thus unfunded) unemployed rises by the month, while government revenue is steadily shrinking along with the Spanish economy.
Naturally Salgado, who replaced former EU commissioner Pedro Solbes in the post a little over a month ago, was quick to add that the fiscal stimulus measures being implemented by the government of Prime Minister Jose Luis Rodriguez Zapatero would begin to take effect the very same month (April), to the evident skepticism of many more seasoned observers.
In hindsight, however, it is not that hard to imagine why Salgado could be so confident in predicting an "easing" in the unemployment level, since she (like me) knew only too well that the next set of employment numbers from the employment office (INEM) were due to be published only a week or so later, and the headline catching number they would report was bound to be a lot lower, since they have been all along as the methodology on which the INEM data is based (labour office signings) is quite different from the labour force survey data.
And so it was, the INEM release came and went, in the process taking in at least some of the international press corps - the Financial Times's Victor Mallet, fort example, felt able to report that:
"The rise of Spanish unemployment slowed markedly in April and consumer confidence increased for the second month running to return to the level of a year ago, according to official figures released on Tuesday. Registered unemployment rose by 39,478 people or 1.1 per cent – a third of the rise in the previous month – to reach 3.64m, the labour ministry announced. It was the 13th consecutive monthly increase."
“We might already be seeing the impact of the crisis wearing off,” said Elena Salgado, finance minister, insisting that spending measures had “begun to bear fruit”.
Now what we have here is a rather judicious use of fact, (which should not surprise us since this is, after all, the world of politics) since while it is certainly true to say that the headline unemployment only rose by 39,478 between March and April, following much larger rises between January and February (and February and March), there is one other little detail we need to think about here, and that detail is Easter (and the fact that tourism is an important part of Spain's services sector), and that Easter fell, of course, in April. So a more valid comparison might be the year on year one (with April 2008), and here we find the annual rate of increase (55.86) was not that much lower than the one registered in March (56.69%, see chart below), and certainly the difference was hardly sufficient to claim that the "rise of Spanish unemployment slowed markedly in April".
In fact it is the case that a number of indicators in Spain and elsewhere did improve in the spring, but I would suggest that there is as yet no special evidence that Spain's economy is moving out of recession, or even that the government's "crisis" measures are having anything like the impact they ought to be having.
Spain’s consumer confidence index did indeed (like the sun) also rise - to 61.9 points in April from 53.7 in March, according to the Official Credit Institute (ICO). In fact, the index hit a record low of 46.3 last July, and has been rising steadily since, but to put things in persective we should bear in mind that the ICO themselves consider that any reading under 100 means that Spanish consumers are feeling "pessimistic", so perhaps we should say that they are a little bit less pessimistic at this point (although as political spin that doesn't sound quite the same, does it?). Indeed, if we look at the chart for the sub-indexes (see below) we will see that the lions share of the improvement is still in the expectations component, which really means that people are still hoping (like Elena Slagado) that things will start to improve sometime soon. Like Charles Dicken's Mr.Micawber, Spain's consumers are always to be found "waiting for something or other to turn up". ...
Two Different Measures
Spain's Economically Active Population Survey forms part of an EU wide standardised system of measurement, and, unlike the INEM signing measure, is a sampling-based survey whose results are published quarterly in Spain. As of 1999, however, the EAPS became a “continuous survey”with interviews (whether in person or by phone) being conducted throughout each of the 13 weeks in each quarter. Thus the EAPS results are in complete harmony with the European Union Labour Force Survey and indeed their findings are published by Eurostat on a monthly basis, even though, curiously, nobody seems to publish this data inside Spain on any sort of regular basis. However, when the latest EAPS data was published, I (for one) was curious to know what it was exactly that lay behind the sudden surge that seemed to have happened in March, since I had been followingmonthly Spanish unemployment via the Eurostat releases as well as via INEM. In fact, what I really wanted to know (taking the data as valid, a posture I normally adopt unless there is really good reason to think the contrary - as in the case of the Spanish Housing Ministry house price data, for example) was whether there had been a sudden (and inexplicable, since it fitted in with none of the other data I was seeing) surge in March, or whether there had been some sort of data revision (not a problem in itself, but it would be nice for somebody to explain these things) . I mean the INE is perfectly entitled to revise its earlier estimates, but if we are to attribute some kind of value and significance to the data we are served up then we do really need to know something about why it takes the form it takes, and especially when it is so surprising.
On checking, what I found was that there had indeed been a revision to the whole data set, and that the revision went back to last October (I show in the chart below the earlier unemployed numbers and for the new "revised" ones - in red). So we didn't have a sudden surge in unemployment, and in fact unemployment had always been rising at a slightly faster rate than had been being estimated, but the big the question is why? Something has obviously changed, and they atre picking up now something they weren't picking up before, the question is what? It would be nice to know, or do policy makers in Spain simply like to make their policy blindfold, or with all the lights turned off?
One very big longshot of a guess here would be to do with the informal economy, since evidently one (little mentioned) by-product of the present crisis (generally, not just in Spain) will surely be that more and more economic activity is being forced "underground" and into the informal economy. So has the rate of labour displacement now accelerated in informal jobs, and is this what we are picking up now that we weren't before?
Certainly the survey found unemployment to have risen very rapidly among Spain's migrant population, far more rapidly than among native Spanish workers, and migrants are, of course, disproportionately represented in the informal economy. In fact 28.39 percent of the migrant population were found to be unemployed in the first quarter of 2009 as compared to 15.24 percent for Spaniards. Thus, while the number of employed Spaniards decreased by 546,500 between January and March, the number of employed foreign nationals decreased by 219,500 persons, proportionately a much more rapid rate of job loss.
The number of registered foreign residents in Spain shot up from 500,000 in 1996 to the current level of around 5.2 million, with migrants mainly coming from Latin America, eastern Europe and north Africa. Many of these workers, of course, came to work in Spain's booming construction industry, and with firms now shedding workers at such a rapid pace, the low-skilled jobs typically occupied by immigrants are amongst the hardest hit, especially since migrants depend much more on being in employment than their Spanish counterparts. This simple fact is reflected in the comparative activity rates, which are 77.99% for the foreign population and 57.61% for the Spanish population. As a result, in the first quarter of 2009, 13.97% of the total employed persons were foreign nationals. The difference between the two activity rates (over 20 percentage points) largely reflects the differences in the age structure of the two populations, which is one of the reasons why, for example, with such a rapidly ageing population Spain could have considered itself fortunate to have attracted so many potential social security contributors. The tragedy is that in order to do so Spanish society had to mount this ridiculous economic boom bust scenario.
Indeed, one of the key questions associated with the present Spanish crisis is what exactly the fate of this large immigrant population will be. In particular, how many will stay and how many will leave (remember that in the short term these migrants need employment, which Spain's economy now finds it hard to offer, while in the longer term Spain's pension system needs the contributions these migrants can pay, and the stock of one-million-plus unsold dwellings also suggests the country badly needs all the population it can get, if the housing market is ever to recover).
Fortunately not all Spain's statistics prove to be as hard to interpret as the unemployment numbers, and the INE does keep a monthly record of net migrant flows (see chart below). The inward flow remained reasonably strong during 2008, but in 2009, the inflow has reduced significantly, while the outflow has increased, with the result that we are very near a historic turning point, where more people might start to leave than actually enter. Monitoring the future evolution of these flows will be fairly important, since whether the Spanish authorities recognise it or not, this is now one of the lead indicators for the Spanish economy.
Employment In Decline Since June 2007
One of the key features of the present economic crisis is the way in which Spain's previously dynamic job creation machine has now moved over into almost complete reverse gear. What we have at present is better called a "job destruction machine", since the number of employed in the first quarter of 2009 was only 19,090,800 - 766,000 less than in the fourth quarter of last year, and 1,311,500 less than in Q1 2998. Year on year employment has fallen by 6.43%.
The number of wage earners was down by 465,100 quarter on quarter, and hit 15,843,100. Year on year the number of wage earners is down by 974,400 persons. The number of wage earners with a permanent contract, on the other hand, rose by 63,400 persons during the quarter, while wage earners with temporary contracts dropped by 528,500. The temporary employment rate was down to 25.41% of the total active population, a decrease of 2.52% compared with the previous quarter.
Employment was down in all Spain'sAutonomous Communities, but the greatest decreases were recorded in Catalunya (168,800), the Comunitat Valenciana (120,900) and the Comunidad de Madrid (107,000). The economically active population has, however, continued to grow throughout the crisis, and has now reached 23,101,500, up by 36,800 compared with the previous quarter. The activity rate was 60.15%, that is, one hundredth more than in the previous quarter.
Heading For The Budget From Hell?
One of the key questions I will now consider in my coming posts is the extent to which Spain could be sliding uncontrollably towards a series of harsh budget cuts just like those which have recently been forced on another former euro zone high-flyer, Ireland. Ireland's growing fiscal deficit and increased exposure to bank losses lead its government intervene in the housing market last month, and at the same time forced them slash spending and hike taxes to reassure investors and the European Commission as to its long-term solvency. The budget which followed was what critics dubbed "the budget from hell". Spain is already fuelling the economy with one of Europe's biggest fiscal stimulus packages, and these are largely being paid for by public borrowing. Like Ireland, Spain is already earmarked by the EU Commission for an excess deficit procedure, and continuing deficits and additional bank bailouts could lead to a massive jump in national debt.
Spain's recession may be currently be somewhat shallower than the one facing Germany's export dependent economy, but most observers agree that the Spanish version is likely to last a good deal longer than those in most Euro Area countries. The International Monetary Fund have already said that Spain faces a minumum of two full years of negative growth, with the economy contracting 3.0 percent this year and 0.6 percent in 2010. And the numbers could of course be significantly larger, indeed I am sure they will be, and especially in 2010. Unemployment is expected by the IMF to rise to over 20%, and such a level is now virtually guaranteed. The question is not whether we will reach 20%, but how much above it we will go, and the answer you give will, of course (and returning briefly to the question I ask at the start of my post), depend on which version of the current unemployment data series you take as your point of reference. My own feeling is not (and on either series) when we pass 20% of the economically active population, but how near to 30% we finally see.