tag:blogger.com,1999:blog-250644472024-02-19T07:42:10.816+01:00Spain Economy WatchUnknownnoreply@blogger.comBlogger298125tag:blogger.com,1999:blog-25064447.post-39745553862352851912015-04-13T19:56:00.005+02:002015-04-14T09:27:02.733+02:00Is The Crisis Now History In Spain?Mariano Rajoy is a man who is not shy when it comes to being controversial, as the <a href="http://www.bloomberg.com/news/articles/2015-02-22/spain-said-to-lead-eu-push-to-force-terms-on-greece">storm surrounding his stance</a> over the recent Greek bailout negotiations clearly illustrates (<a href="http://www.globaltimes.cn/content/909651.shtml">and here</a>). So it is perhaps not surprising that he did not notably blush <a href="http://www.theoslotimes.com/the-economic-crisis-is-history-spanish-pm-mariano-rajoy/">when he informed a Madrid audience</a> recently that "In many ways, the crisis is history." Such was the storm that followed that he was forced to at least partially retract the offending phrase <a href="http://www.thelocal.es/20141216/spanish-pm-steps-back-from-crisis-is-over-comments-spain-economy">after a meeting with union officials some four days later</a>. "In many ways the crisis is history, but its consequences are not," he clarified.<br />
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Of course all of this is mainly political rhetoric at the start of what is set to be an election year, but still, it does raise interesting questions. Where exactly is Spain? What is the outlook for the future? Is the country still in crisis, or is it, as Rajoy 2.0 suggests simply suffering from the legacy of an earlier one? These questions are not as easy to answer as they seem at first sight, nonetheless in what follows I will take a shot at it.<br />
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<b> Questions to be discussed below are</b>:<br />
<ul>
<li> has enough been done in terms of international competitiveness to be able to guarantee a "complete" labour market recovery?</li>
<li>to what extent is Spain's housing market really going to recover?</li>
<li>is the external correction complete, or is there more to do?</li>
<li>Spain's population (and especially it's working age population) is in decline, what are the economic implications of this? And what is the long run growth outlook for Spain?</li>
<li>the cost of paying pensioners continues to grow more rapidly than income from contributors - does Spain need another pension reform.</li>
<li>Spain's economy will grow comparatively quickly in 2015, but the ECB is buying Spain government bonds, ECB interest rates are near zero, and the country is running the largest fiscal deficit in the EU. What would Spanish growth look like without the deficit and with a "normalisation" of interest rates?</li>
<li>Spain's sovereign debt is about to pass the 100% of GDP level, will the next government be able to stabilise the debt, or will it continue to grow?</li>
<li>Spain's recovery at present is largely a services and domestic consumption based one. Industry and capital expenditure continue to lag behind. Is this profile sustainable in the longer term? </li>
</ul>
<span style="font-weight: normal;"> The sections on deflation, population ageing and the pensions crisis are summaries of the following earlier posts.</span><br />
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<a href="http://Spain's "Good" Deflation?" target="_blank"><span style="font-weight: normal;">Spain's "Good" Deflation?</span></a></h3>
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<span style="font-weight: normal;"><a href="http://spaineconomy.blogspot.com.es/2015/03/why-is-spains-population-loss-economic.html" target="_blank">Why Is Spain's Population Loss An Economic Problem?</a> </span></h3>
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<span style="font-weight: normal;"><a href="http://spaineconomy.blogspot.com.es/2015/03/spain-fuelling-todays-retail-sales-by.html" target="_blank">Spain - Fuelling Today's Retail Sales By Spending Tomorrow's Pensions?</a><br /></span></h3>
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<span style="font-weight: normal;"> </span><b>Spain's Recovery Is Real</b></h3>
The most striking and obvious thing about the Spanish recovery is the way in which real (inflation adjusted) GDP growth rates have steadily accelerated. The country's economy - with a quarterly increase of 0.8% -had one of the fastest growing Euro Area economies in the first three months of 2015. The annual rate accelerated to 2.5%, while full year 2014 growth rate (as compared to 2013, when it shrank by 1.2%) was 1.4%.
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These are good results, but it is worth bearing in mind that everything is relative and that there is still a long hard road to travel. GDP levels still remain around 4.5% below the pre-crisis level. And while the (possibly optimistic) Bank of Spain forecasts are for robust growth in the near future - 2.8% in 2015 and 2.7% in 2016 - even their achievement will mean the pre-crisis level will not be attained before 2017, which gives a very concrete and precise meaning to the term "lost decade". The real debate is about the following decade, whether or not that one will be lost too, as deflation and secular stagnation steadily take hold in the context of an ageing and declining population (see <a href="http://www.imf.org/external/pubs/ft/survey/so/2015/new040715a.htm">the latest IMF report on this</a>, and Larry Summers on Secular Stagnation <a href="http://larrysummers.com/2015/04/01/on-secular-stagnation-a-response-to-bernanke/">here</a>) . Is Spain not at risk of becoming Japan 2.0?<br />
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Certainly there are many in Spain who would deny that possibility, among them Economy Minister Luis De Guindos, who recently <a href="http://www.wsj.com/articles/spains-economic-growth-accelerates-in-fourth-quarter-1422606139">told the Wall Street Journal</a> that he expected growth of between 2.5% and 3% for the next two to three years with the trend simply continuing thereafter. Bank of Spain governor Luis Maria Linde would be another. He <a href="http://www.bloomberg.com/news/articles/2015-04-10/ecb-s-linde-says-negative-yields-won-t-last-as-economy-recovers">recently told Bloomberg reporters</a> that negative interest rates would be a temporary phenomenon which would disappear as the "recovery tales hold" and that it was much easier to "assert there was no deflation risk" in Spain than it had been some months earlier (when he was also saying there was no risk). Such assertions are hard to either agree with or dispute, since no one really knows the future. Words are easy while economic models simply mindlessly churn out predictions based on past performance. The only thing we can be sure at this point is that the future will look less like the past than it ever did, so forecasts based on old data have less validity than ever. At the same time simple economic theory suggests that as work forces decline economic growth rates will do too. <br />
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Still, were the most optimistic forecasts to be confirmed the resulting growth rates over a sustained period would clearly turn the country into the Euro Area's most efficient and fastest growing economy, and it is hard to see where the basis for such confidence comes from. When Spain's economy grew at rates of 3% or more a decade or so ago it was on the back of excessive and unsustainable debt increases, and that isn't going to happen again, even were it desirable. Spain's economy may well grow by more than 2.5% this year (although with deflation nominal GDP will grow by less), but - failing something unexpected like Grexit - it is hard to imagine a more positive growth environment. As for when we get to 2016, as they say, it depends......... <br />
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<h3>
<b>Employment Growth Is Strong As Unemployment Falls</b></h3>
The second area where it is possible to see a strong positive side to Spain's recent performance is on the employment front.According to the latest labour force survey Spain created 434,000 jobs in 2014.<br />
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To put some flesh on these numbers it should be said that many of the new jobs are part time (40% of new indefinite contracts are p-t), while many others are temporary and not well paid (the economy is increasingly becoming a low value added services one, lead by tourism), but still, Spain's economy is once more creating employment, and that is good news.<br />
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A similar picture emerges when it comes to unemployment which is now steadily falling back, with the seasonally adjusted rate falling to 23.2% in February.<br />
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And the positive news continued in March: registered signings fell by 7.17% year on year.<br />
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A similar picture emerges from the data for affiliations to the country's national insurance system, which were up 416,000 (or 2.3%) in 2014.<br />
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In fact - as can be seen in the following chart showing numbers of social insurance affiliates - the rate of job creation continues to accelerate. <br />
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And this better employment situation is also confirmed by the fact that the economically active population rose in the last three months of 2014, although it was down over the previous December by 44,000. The participation rate rose from 58.03% in Q3 to 58.24% during the last quarter.<br />
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Naturally, putting all this in perspective, the number of unemployed - almost 5.5 million - remains unacceptably high, and the increase in employment needs to be seen in the context of more than 3 million jobs having been lost since the start of the crisis, but still, things are manifestly improving.<br />
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<h3>
Consumer Confidence Hits A Record High in March</h3>
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<h3>
<b>Household Consumption Driving Recovery</b></h3>
As employment has risen and real (inflation adjusted) wages and pensions have increased (since consumer prices have fallen) spending has naturally rebounded: indeed we seem to be in the midst of a mini consumption boom driven by what is perceived as a short term reduction in prices (which look to many shoppers like very welcome discount offers).<br />
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According to the National Statisics Office retail sales rose (in price adjusted terms) by 1% in 2014 as compared with 2013. I stress price adjusted since with consumer falling an annual 1.1% in December and 0.2% across the year the actually increase in cash in the till was less. Perhaps such an increase is not a game-changer, but after a 30% drop any improvement is welcome.However 2015 sales did not start on such a strong footing, with retail sales falling for a second month in Feb. They were down 0.7% vs Jan (when down 0.4% vs Dec). Still due to the strong autumn surge they were still up 2.6% y-o-y.<br />
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Household consumption - which includes a broader range of spending than retail sales, including the government subsidized car sales - had a very strong 2014, and was up 3.9%. It is not clear that this pace can be repeated in 2015, especially if inflation starts to rebound following the Euro devaluation.<br />
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<h3>
<b>Construction Activity Growing Again</b></h3>
Construction activity has also been rising. Output was up 14.4% year on year in January. Quite what is driving this isn't clear, since with a large stock of unsold houses the demand for more at this point (see below) must be limited, but surely there is activity involved in completing unfinished buildings, of which there are more than a few. Again, this is (in theory) election year so infrastructure spending is probably increasing.Well again, peak to trough was something like 60%, so the rebound could have been anticipated.<br />
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<br />
<b>IBEX on a Roll?</b><br />
<br />
The financial sector has been one of the principal beneficiaries of the
Spanish recovery, thanks largely to the hard work of Mario Draghi at the
ECB. Many will remember <a href="https://www.youtube.com/watch?v=F1OoNOU0_QY" target="_blank">the immortal words of the late Emilio Botín</a>:
"Es un momento fantástico para España, llega dinero de todas partes."
("This is a fantastic moment for Spain, it is literally raining money
from all corners of the globe" October 2013). As a result the IBEX had a
very good 12 months from July 2013 to July 2014 (up maybe 35%) but in
the second half of last year struggled to stay over the 10,000 level. QE
from the ECB will likely be a positive for the index in 2015.<br />
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<h3>
Negative Bond Yields Arrive</h3>
The Draghi QE effect has long been making itself felt right across the Euro periphery, and Spain's bond yields are now constantly breaking historic lows. The 10 year yield has more than halved over the the last 12 months and is now at 1.39% (and falling). Naturally these lower yields will make government interest payments lower (and indeed due to seigniorage repayment will even become zero on those bonds purchased as part of the ECB programme). This benefits everyone, but beyond this the IBEX boom and the increase in bond values which accompanies the drop in yields has made a lot of money for some people, even though these people are a small minority of the Spanish population (indeed they have often been external investors). This means on the one hand that the Spanish net external debt has risen, while on the other those who have suffered most during the crisis feel even more aggrieved that they have been left out of this particular party (the Podemos effect). <br />
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<br />
It's possible every time Mariano Rajoy opens his mouth to declare "victory" he probably only ends up alienating yet another group of people who feel they are missing out on the "good times". Certainly this is what the government opinion surveys suggest. In March 41.8% of those asked thought the economic situation was "bad", and 33.8% thought it "very bad", while only 1.8% replied it was "good", and 21.6% "passable". So I think it is reasonable to say that ordinary Spanish citizens do not buy the very bullish arguments being offered by the government at this point, and this is also being reflected in the opinion polls. As most political observers note, economic recovery should help the PP, but first the PP have to convince a skeptical populous that this recovery is real, and that talk about it is not simply another attempt to lead them up the garden path.<br />
<br />
<h2>
Now For The Glass Half Empty Part</h2>
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<h3>
How "Good" is Spain's Deflation?</h3>
In my opinion deflation is one of the serious problems potentially clouding the economic outlook in Spain, as I explain in my <a href="http://spaineconomy.blogspot.com.es/2015/02/spains-good-deflation.html" target="_blank">Spain's "Good" Deflation</a> post. Since I have gone through all the arguments in great detail there I won't repeat myself here.<br />
<br />
I would just note that the argument that Spain is simply suffering the impact of a negative oil price shock doesn't hold up, since as the chart below suggests, once you strip out tax impacts and energy, Spain has been flirting with deflation since the start of 2012.<br />
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It is also clear that there is no short term purchase postponement effect, in fact we can see evidence across countries that as prices fall people buy more. This is largely because they do not expect deflation, and simply take advantage of what they see as "temporary" sales offers and discounts to buy. As very low to negative inflation extends across time the risk is that people come to expect constant and renewed discounts, forcing prices even further down. This is the short term self-reinforcing component.<br />
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It is also the case that up to now prices have fallen, but wages and pensions have not been reduced proportionally. If and when this starts happening the impact on consumer confidence may be the opposite of the one we are now seeing.<br />
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In general, as long as incomes don't fall the growing debt burden problem isn't operative, since debt to income levels don't change, it's only as incomes fall, and over extended periods of time, that this impact starts to make its presence felt. <br />
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<h3>
Is There a Recovery In The Housing Market?</h3>
Spanish housing offers us a clear example of something whose price has fallen considerably, around 40% since the 2007 peak, and whose price continues to fall (in the 3% to 5% per annum range).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhT8tws9WpT3LlzG0v8V1lOmWJEqWRGYzmXdhhr0P7Te0c57Kt0JkhuBWkjAL92E8sTtSI8_jPf7Jf4ZXtBkOhwNmtiTawmtSAsLx8W6LubIwGhqgGH7EshVsSSqRKT6y060Hg8/s1600/2015-01-15_091856.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhT8tws9WpT3LlzG0v8V1lOmWJEqWRGYzmXdhhr0P7Te0c57Kt0JkhuBWkjAL92E8sTtSI8_jPf7Jf4ZXtBkOhwNmtiTawmtSAsLx8W6LubIwGhqgGH7EshVsSSqRKT6y060Hg8/s1600/2015-01-15_091856.png" height="175" width="320" /></a></div>
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Yet far from this fall in prices having stimulated demand we are witnessing the opposite effect: demand has collapsed, and is not recovering significantly (see my piece from April 2014, "<a href="http://edwardhughtoo.blogspot.com.es/2014/04/firmly-anchored-expectations-no.html" target="_blank">Firmly Anchored Expectations, No Postponement of Purchases?</a>"). The number of new house purchased in December was just over 7,000. That was the lowest monthly level in more than a decade.<br />
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True, the number of second hand houses is rising, but even the combined total is far from showing a sharp rebound.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAIaZId0sXspaiLtpSUpJvPKRutanuJI1bjnf3wBde7R1rJx6XuIjefXmNKuN0qQAEQOCwxQO3jV_G0e5PGgajr3qyN7yJBC_rhg3nA4DMM3VWvRgl28m7jZIV1nu_N5vTI78h/s1600/2015-02-10_093425.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAIaZId0sXspaiLtpSUpJvPKRutanuJI1bjnf3wBde7R1rJx6XuIjefXmNKuN0qQAEQOCwxQO3jV_G0e5PGgajr3qyN7yJBC_rhg3nA4DMM3VWvRgl28m7jZIV1nu_N5vTI78h/s1600/2015-02-10_093425.png" height="187" width="320" /></a></div>
Perhaps the most worrying thing about the fact that second hand purchases are improving while new ones aren't is that part of the explanation for this is that properties become reclassified as "used" 2 years after completion (so some of the second hand houses are in fact new), but this makes the situation with new houses deeply preoccupying since there are nearly half a million unsold housing units still classified as "new" (see <a href="http://www.idealista.com/news/inmobiliario/vivienda/2015/01/12/733817-la-realidad-de-por-que-se-venden-menos-viviendas-nuevas" target="_blank">this article</a> on the Spanish property website Idealista) which means they have - by and large - been built within the last two years. According to the construction manufacturers association Cepco the number of new housing units which had been neither sold nor let at the end of 2014 stood at 439,617.<br />
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The housing market is obviously stabilizing but that is not the same thing as returning to real growth, especially as far as house prices are concerned. There are two reasons for thinking that the recovery will be very weak. The first of these is the growing custom among young people to rent rather than buy. But the second is even more important: Spain's population, especially in the 25-40 age group is falling and each generation is now smaller than the previous one. <br />
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<h3>
<b>From an Export Lead to an Imports Driven Recovery?</b></h3>
<b></b>Exports went through a "soft spot" in the middle of 2014, but recovered towards the end of the year. Price deflated goods exports were up 4.7% in the year to December in comparison with the same period in the previous year. Deflation in Spain (export prices were down an annual 1.1% over the same period) and the weakening Euro are obviously helping. Tourism is also doing well, and income from this activity rose by about 3.4% in the year to January (when compared with the previous 12 months).<br />
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Nonetheless, it is no longer true to speak of Spain's recovery as "export driven" since the growth in domestic consumption has lead to a surge in imports, and the goods trade balance has weakened accordingly, meaning that when it comes to GDP levels net trade is now a negative factor (see below). This issue will come back to haunt us, since with the population falling, the government reducing the fiscal deficit and the private sector not increasing its appetite for credit domestic demand cannot continue to drive the economy indefinitely.<br />
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<h3>
External Balances Worsening?</h3>
While external demand had been making a positive contribution to Spanish economic growth from early 2010, the second quarter of 2013 saw a major shift, with net trade becoming negative, at the same time as domestic demand became a positive factor. Thus the recent recovery is almost entirely due to growth in domestic demand (and growing imports) despite the fact that exports have held up well, and continue to grow to new highs.<br />
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The level of Spanish exports is constantly higher, but exports only contribute to GDP growth insofar as they grow, and this rate has been falling steadily since the post crisis peak. As such the contribution of exports to growth becomes less and less.<br />
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On the other hand the current account balance, after deteriorating in 2013/14 has been improving since mid 2014 thanks largely to the drop in oil price and the impact of the falling Euro on income Spanish residents (including corporates) derive from their non-Euro overseas holdings (USD investments are worth more in Euros after the devaluation). <b></b><br />
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However the fund inflow that has accompanied the boom in Spanish bonds and stocks has meant that the net external debt balance has again deteriorated. In fact the Net International Investment Position now stands at nearly 100% of GDP negative. This is not a good development, or sustainable. Spain cannot both deleverage and have positive net fund inflows. The long term numbers don't add up. In the short run the inflows are financing the government's fiscal deficit.<br />
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But since interest rates are lower in Europe than in many other parts of the world, the net income stream has actually improved since foreign investors earn relatively little on their Spanish asset holdings, and mainly are benefiting from capital gains. Nonetheless Spain has clearly made a massive improvement in its current account balance which is a big positive for the economy.<br />
<h3>
Industrial Output Lags Behind GDP</h3>
Spain's economic recovery
is no longer export lead, and it isn't industry based either. Industrial
output, as can be seen from the chart, has hardly budged since the
return to growth began, and was only up 0.6% compared with a year
earlier in February. To get a sustainable recovery Spain needs industrial (and not just services) growth.<br />
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<h4>
<b>And Let's Not Forget the Fiscal Deficit</b></h4>
Spain's leaders are very proud of the country's recent growth performance, they also like to claim that it is largely due to their ongoing austerity policy. What they don't mention so often is that the country ran the largest fiscal deficit in the EU in 2014 (5.7% of GDP) and will do the same in 2015 (around 4.5% of GDP). In fact Spain's deficit objectives have been relaxed a number of times in recent years, so far from the outcome being a victory for austerity it is more like a victory for leaving extra stimulus.<br />
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Between falling prices, high fiscal deficit, ultra low interest rates and strong external fund inflows it would be surprising if Spain weren't doing well at the moment. A bigger test will come as all these positive tailwinds start to change direction. Spain probably be running a primary (before interest payments) budget surplus before 2017 - Greece, it will be remembered, is being asked to run one of between 3% and 4% of GDP. If Spain does eventually manage to run a primary surplus it will indeed be interesting to see what the growth rate is. In the meantime the sovereign debt level will pass 100% of GDP this year, and will continue to increase.<br />
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<h3>
<b>Economic Consequences of Demographic Decline</b></h3>
<h4>
The Price Of Doing Nothing</h4>
<br />
The social and political risks associated with Spain having conducted a far from complete economic adjustment are now becoming apparent, but there are also long term economic consequences, ones which may not be very evident at this point. People are often too busy celebrating a short term return to growth to ask themselves the tricky question of where all this is leading.<br />
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The most obvious result of having such a high level of unemployment over such a long period of time - Spain's overall rate won't be below 20% before 2017 at the earliest - is that people are steadily leaving the country in search of better opportunities elsewhere. Initially this new development was officially denied, and since there is little policy interest in the topic we still don't have any adequate measure of just how many young educated Spaniards are now working outside their home country. Anecdotal evidence, however, backs the idea that the number is large and the phenomenon widespread. All too often articles in the popular press are misleading simply because journalists have no better data to work from than anyone else. On the other hand work like this from researchers at the Bank of Spain (Spain: From (massive) immigration to (vast) emigration? - 2013) only serves to illustrate how little we know, especially about movement among Spanish nationals.<br />
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On the other hand, when it comes to migration flows among non Spanish nationals we do have a lot better quality information due to the existence of the the municipal register electronic database. Everyone who wishes to be included in the health system needs to register with it (whether they are a regular or an irregular immigrant), and non Spanish nationals need to re-register with a certain frequency (so the authorities know if they leave). <b>For a fuller discussion of the economic issues raised by Spain's population decline see my post "<a href="http://spaineconomy.blogspot.com.es/2015/03/why-is-spains-population-loss-economic.html" target="_blank">Why Is Spain's Population Loss An Economic Problem</a>".</b><br />
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<h3>
<b>Current Level of Pensions Not Sustainable</b></h3>
The average pension paid is also rising. In February 2015 the total amount paid out by the system in pensions was up 3.1% year on year. But the number of pensioners was only up 1.3%, so the average pension went up by 2.1% due to the fact that the most recent retirees have been earning more than earlier cohorts and are thus entitled to higher pensions. We don't have data on this year's pension system income yet, but at the end of last year it was rising at about 1.5% a year, leaving a growing shortfall for the system to cover.<br />
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As I said, under the former PSOE the shortfall was funded out of the general government budget, and possibly 1.5 percentage points of the 9.6% 2011 fiscal deficit were the result of this financing. With the arrival of the PP in government this policy changed, and pension financing moved over to the Reserve Fund.<br />
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The attrition has been constant and the Fund is now starting to dwindle. In 2012 7 billion euros were withdrawn, in 2013 it was 11.6 billion euros and in 2014 15.3 billion euros (or 1.5% of GDP). If you want to compare apples with apples and pears with pears, you would need to add this 1.5% of GDP to the 5.6% fiscal deficit, giving a 7.1% deficit using the same accounting criteria as 2011. Put another way the deficit has really been reduced from 9.6% to 7.1% in 3 years, hardly dramatic austerity. Instead of paying the pensions gap out of current income the government are using a credit card issued by "future pensions" to keep payments up even though the situation is obviously getting worse, meaning it will be even more difficult to pay current pension levels in the future than it is As a result of all these withdrawals the size of the Reserve Fund has fallen from its 66.8 billion euro peak in 2011 to the current level of 41.6 billion euros. At the moment the government have budgeted for another 8.4 billion euro withdrawal this year, but this number could easily turn out to be larger. So 2015 should close with around 30 billion euros outstanding - about 3 years more money at the current rate. It is clear that soon after the election changes will have to be made. Even though the number of contributors to the system is growing as the employment situation improves the rate of spending is rising faster.<br />
<h3>
<b>Financial Sector Deleveraging or Less Solvent Demand for Credit?</b></h3>
<b><br /></b>Mario Draghi understands that falling inflation expectations raise
real interest rates by influencing the perceived cost of credit into the
future. If consumers anticipate inflation, then that makes borrowing
cheaper and people tend to advance purchases. Conversely expected price
falls make the cost of borrowing greater, make the desirability of
advancing purchases via credit less, and in this sense constitute
monetary tightening. I am aware of an ongoing debate about whether
interest rates really are a key factor influencing investment decisions,
but I have never seen an argument suggesting that the cost of credit
does not influence consumption. And so it is in Spain, since the demand
for household borrowing is not surging, even though the country's banks
keep telling us they are now "<a href="https://twitter.com/bloombergtv/status/558180122055176192" target="_blank">ready to lend</a>".<br />
<br />
I am aware of an ongoing debate about whether interest rates really are a key factor influencing investment decisions, but I have never seen an argument suggesting that the cost of credit does not influence consumption. And so it is in Spain, since the demand for household borrowing is not surging, even though the country's banks keep telling us they are now "ready to lend".<br />
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In fact lending is still falling, and was down an annual 3.2% to the private sector in February. There may be many reasons beyond the strength of bank balance sheets which may explain why we are not seeing an increase in private sector credit in Spain. Some may simply not be able to get loans because they already can't pay their existing debt. The 4 million Spaniards currently on the credit blacklist run by credit consulting firm ASNEF will have a hard time joining in the current consumer "boom" even if they have a job. Spain's Economy minister Luis De Guindos put quite graphically when he said: "It’s hard not to defer purchases when you’ve got no money for them in the first place. In the case of Spanish unemployed I think they’ve got more worries than waiting for a new sofa suite to drop by €50."<br />
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So part of the reason for the "no credit expansion" is the high level of existing debt and the large number of unemployed or people working in low pay short-term contract jobs. Many corporates are also still heavily indebted, and those that aren't are still facing comparatively low levels of demand for their products, which means they will not be engaging in large scale investment projects, which anyway they would probably finance via the bond markets.<br />
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<h3>
Political Uncertainty Ahead</h3>
When the IMF said last year that Spain's unemployment level was unacceptably high, I was pretty critical of the fact that they didn't spell out the consequences of this, or offer any substantial policy alternative. The most obvious impact of this failure to find an alternative is being seen right now, with the emergence of political movements which could well turn the country's two party system completely upside down, and the steady flow of talented young people out of the country in search of work.<br />
<br />
According to the latest Metroscopia opinion poll carried out for the newspaper El País ( April 12 2015), four parties (Podemos 22.1%, PSOE 21.9%, PP 20.8%, and Ciudadanos 19.4%) are in close competition for first place in the forthcoming election. The lastest arrival on the national political scene is Citizens (Ciudadanos), a movement which despite being difficult to pin down in terms of specific policy, seems to lie somewhere to the centre right, between PP and PSOE in terms of its political ideology. It is very hard to predict what the outcome of the coming general election (due at the end of this year) will be, but it seems clear that no one party will have a majority. So governmental arithmentic is about to get complicated.<br />
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The first indication of what the political landscape might start to look like should come in Andalusia, which has regional elections on March 22. Then in May there will be regional elections in Madrid and Valencia, and municipal ones in large cities like Madrid, Valencia and Barcelona. Such elections will, however, only give a vague impression, since personality factors and local loyalties will also be important.<br />
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As for the concerns which are driving this earthquake, these are clear enough from the opinion surveys: unemployment, corruption and the issues related to their current economic situation are by a long way the most important issues in voters minds, indeed despite all the talk of recovery the vast majority of them continue to think the current economic situation is either bad (41.8%), or very bad (33.8%).<br />
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Forthcoming alliances are hard to predict. Ideologically Podemos and Citizens may seem far apart, but the voter concerns which are driving their rise are often surprisingly similar, even if the solutions they offer are quite different. Over the corruption issue, for example, the possibility must exist of a de facto alliance between the two movements to force major reform on the two "traditional" parties.<br />
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Another issue which will probably unite them is that of debt. Many of Spain's citizens are badly indebted, and many still have difficulty paying their mortgages despite very low interest rates. In addition there is the notorious "full recourse" rule, which means people who can't pay can't simply return their home and liquidate their debt. There is a wide feeling of injustice associated with the fact that property developers received limited liability mortgages (many of which have now ended up with bad bank Sareb, with losses being met by taxpayers) while ordinary citizens were given no such "escape clause". "Rescue the citizens not just the banks," is a slogan you often hear these days.<br />
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It is unclear what Citizens propose to do about the issue, but Podemos's opinion is clear enough, and on this stance they enjoy widespread popular support, going well beyond those who will actually vote for them: they will revoke full recourse. It's not a mere detail that the point Pablo Isglesias stressed in his interview with CNBC's Michelle Caruso-Cabrera was, "we can have governments that work for people and not for the banks," As the interviewer commented, "One thing he's really got going for him is ... that in Spain they can kick you out of the house and you still keep paying the mortgage. It's a recourse loan".<br />
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The other big issue is austerity. Spain still runs a large fiscal deficit - 5.6% of GDP in 2014 - the largest in the Euro Area. At first glance, with so many elections taking place it doesn't seem likely this will come down that much this year, and in 2016 it is hard to imagine there won't be a parliamentary majority in favour of prioritizing bringing down unemployment over reducing the deficit, making some sort of clash with the EU commission not improbable. Nevertheless, as long as ECB QE stays in place investors are hardly going to worry too much so yields wouldn't necessarily be affected. But what if the ECB wanted to taper?Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-86962861303678055552015-03-12T14:59:00.002+01:002015-03-12T14:59:38.225+01:00Spain - Fuelling Today's Retail Sales By Spending Tomorrow's Pensions?Spain's pension system is on the rocks. Before the crisis it was running constant surpluses, but now the trend has reversed, and it is in constant deficit, and the shortfalls look set to stretch forwards as far as the eye can see. The curious detail about this situation is that even as the crisis deepens the government keeps raising the real value of pensions being paid. (This post is an edited extract from my larger piece, <a href="http://edwardhughtoo.blogspot.com.es/2015/03/why-is-spains-population-loss-economic.html" target="_blank">Why Is Spain's Population Loss An Economic Problem?</a>).<br />
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On the other hand household consumption is surging: it was up an annual 3.9% in the last three months of 2014, a phenomenon which is leading many to talk of "<a href="http://edwardhughtoo.blogspot.com.es/2015/02/spains-good-deflation.html" target="_blank">good deflation</a>" in Spain. But what proponents of this argument tend to forget is that someone if paying for this "deflation boost" party. I the case of salaried workers the cost is carried by their employers, but in the case of pensioners the "fiesta" is being charged directly to the account of future generations of pensioners, as Spain's mini boom becomes increasingly consumption driven.<br />
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<span style="font-size: large;"><b><br /></b></span>
<span style="font-size: large;"><b> Shifting The Burden Onto The Reserve Fund</b></span><br />
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The fact that Spain's pension system was going to have problem maintaining the level of payments has long been known. In fact in recent years there have been two reforms which have tried to address different aspects of the problem. But it is really the huge loss of employment during the crisis that has really highlighted the chronic nature of the underfunding the system is being subjected to. Initially the then socialist government plugged the growing funding gap out of general government finances, but as financial markets started to focus on the size of the country's fiscal deficit this practice became increasingly problematic. <br />
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With the arrival of the PP there was a change in strategy and since 2012 the pensions deficit has been funded by drawing down on the Reserve Fund. This was established in 2000 and was meant to ensure the long term sustainability of the system, especially as demographic pressure mounted towards the end of this decade. The Fund had been accumulating the surpluses generated in the 2000 - 2007 boom years.<br />
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The financing switch has helped the headline fiscal deficit number, but the decline in the Reserve Fund that has been the result is starting to make a growing number of Spaniards increasingly nervous.<br />
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One part of the problem the system is having is simply the result of population ageing: the balance shifts as the number of pensioners rises and the number of contributors for each pensioner falls. Another part is the result of the recent economic crisis (since with so much unemployment less people contribute) while a third contributing factor are the recent changes in the labour market structure which mean that young people now earn a lot less than those retiring, leading average contributions to fall, while average pensions rise.<br />
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Some of the results of this sea change can be seen in the chart below (sorry about the Spanish, but I think the main points are easily grasped). The number of contributors for each pensioner hit a high of 2.71 in 2007, since then it has been falling and was at 2.25 in 2014. The number of pensioners has risen from 7.6 million in 2007 to 8.4 million in 2014. <br />
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<br />
The average pension paid is also rising. In February 2015 the total amount paid out by the system in pensions was up 3.1% year on year. But the number of pensioners was only up 1.3%, so the average pension went up by 2.1% due to the fact that the most recent retirees have been earning more than earlier cohorts and are thus entitled to higher pensions. We don't have data on this year's pension system income yet, but at the end of last year it was rising at about 1.5% a year, leaving a growing shortfall for the system to cover.<br />
<br />
As I said, under the former PSOE the shortfall was funded out of the general government budget, and possibly 1.5 percentage points of the 9.6% 2011 fiscal deficit were the result of this financing. With the arrival of the PP in government this policy changed, and pension financing moved over to the Reserve Fund.<br />
<br />
The attrition has been constant and the Fund is now starting to dwindle. In 2012 7 billion euros were withdrawn, in 2013 it was 11.6 billion euros and in 2014 15.3 billion euros (or 1.5% of GDP). If you want to compare apples with apples and pears with pears, you would need to add this 1.5% of GDP to the 5.6% fiscal deficit, giving a 7.1% deficit using the same accounting criteria as 2011. Put another way the deficit has really been reduced from 9.6% to 7.1% in 3 years, hardly dramatic austerity. Instead of paying the pensions gap out of current income the government are using a credit card issued by "future pensions" to keep payments up even though the situation is obviously getting worse, meaning it will be even more difficult to pay current pension levels in the future than it is now.<br />
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As a result of all these withdrawals the size of the Reserve Fund has fallen from its 66.8 billion euro peak in 2011 to the current level of 41.6 billion euros. At the moment the government have budgeted for another 8.4 billion euro withdrawal this year, but this number could easily turn out to be larger. So 2015 should close with around 30 billion euros outstanding - about 3 years more money at the current rate. It is clear that soon after the election changes will have to be made. Even though the number of contributors to the system is growing as the employment situation improves the rate of spending is rising faster.<br />
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There was a pension reform in 2013 which was intended to address the problem by making the system self financing. A complicated formula was introduced whose intention was to ensure that more money didn't go out - on a structural basis - than came in. But this was in the era when Spaniards still expected inflation as their economic default setting. As a result - and as a way of selling the reform - a minimum increase of 0.25% was set. Last December consumer prices were down 1.5% over a year earlier, and as a result the minimum rise was a generous "vote winning" increase of 1.75% at a time when the system itself was running at a huge loss. Something similar will happen this year, giving at least one part of the explanation as to why retail sales are doing better - in part these increased sales are being paid for with future pensions.<br />
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-17239675124972094982015-03-10T17:06:00.001+01:002015-05-02T23:01:16.358+02:00Why Is Spain's Population Loss An Economic Problem?<i>"Growth theory was invented to provide a systematic way to talk about and to compare equilibrium paths for the economy. In that task it succeeded reasonably well. In doing so, however, it failed to come to grips adequately with an equally important and interesting problem: the right way to deal with deviations from equilibrium growth……..if one looks at substantial more-than-quarterly departures from equilibrium growth……….. it is impossible to believe that the equilibrium growth path itself is unaffected by the short- to medium-run experience…….So a simultaneous analysis of trend and fluctuations really does involve an integration of long-run and short-run, or equilibrium and disequilibrium.</i> "<br />
Robert Solow, <a href="http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1987/solow-lecture.html" target="_blank">Nobel Acceptance Speech</a> <br />
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When the IMF said last year that Spain's unemployment level was unacceptably high, <a href="http://spaineconomy.blogspot.com.es/2014/07/spain-and-imf-round-bend-or-out-of-woods.html" target="_blank">I was pretty critical of the fact that they didn't spell out the consequences of this</a>, or <a href="http://spaineconomy.blogspot.com.es/2013/09/doing-nothing-is-not-option.html" target="_blank">offer any substantial policy alternative</a>. The most obvious impact of this failure to find an alternative is being seen right now, with the emergence of political movements which could well turn the country's two party system completely upside down, and the steady flow of talented young people out of the country in search of work.<br />
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According to the latest Metroscopia opinion poll carried out <a href="http://elpais.com/elpais/2015/03/07/media/1425753123_358981.html" target="_blank">for the newspaper El País</a> ( March 7 2015), four parties (Podemos 22.5%, PSOE 20.2%, PP 18.6%, Ciudadanos 18.4%) are in close competition for first place in the forthcoming election. The lastest arrival on the national political scene is Citizens (Ciudadanos), a movement which despite being difficult to pin down in terms of specific policy, seems to lie somewhere to the centre right, between PP and PSOE in terms of its political ideology. It is very hard to predict what the outcome of the coming general election (due at the end of this year) will be, but it seems clear that no one party will have a majority. So governmental arithmentic is about to get complicated.<br />
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The first indication of what the political landscape might start to look like should come in Andalusia, which has regional elections on March 22. Then in May there will be regional elections in Madrid and Valencia, and municipal ones in large cities like Madrid, Valencia and Barcelona. Such elections will, however, only give a vague impression, since personality factors and local loyalties will also be important.<br />
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As for the concerns which are driving this earthquake, these are clear enough from the opinion surveys: unemployment, corruption and the issues related to their current economic situation are by a long way the most important issues in voters minds, indeed despite all the talk of recovery the vast majority of them continue to think the current economic situation is either bad (41.8%), or very bad (33.8%).<br />
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Forthcoming alliances are hard to predict. Ideologically Podemos and Citizens may seem far apart, but the voter concerns which are driving their rise are often surprisingly similar, even if the solutions they offer are quite different. Over the corruption issue, for example, the possibility must exist of a de facto alliance between the two movements to force major reform on the two "traditional" parties.<br />
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Another issue which will probably unite them is that of debt. Many of Spain's citizens are badly indebted, and many still have difficulty paying their mortgages despite very low interest rates. In addition there is the notorious "full recourse" rule, which means people who can't pay can't simply return their home and liquidate their debt. There is a wide feeling of injustice associated with the fact that property developers received limited liability mortgages (many of which have now ended up with bad bank Sareb, with losses being met by taxpayers) while ordinary citizens were given no such "escape clause". "Rescue the citizens not just the banks," is a slogan you often hear these days.<br />
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It is unclear what Citizens propose to do about the issue, but Podemos's opinion is clear enough, and on this stance they enjoy widespread popular support, going well beyond those who will actually vote for them: they will revoke full recourse. It's not a mere detail that the point <a href="http://video.cnbc.com/gallery/?video=3000355396#." target="_blank">Pablo Isglesias stressed in his interview with CNBC's Michelle Caruso-Cabrera</a> was, "we can have governments that work for people and not for the banks," As the interviewer commented, "One thing he's really got going for him is ... that in Spain they can kick you out of the house and you still keep paying the mortgage. It's a recourse loan".<br />
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The other big issue is austerity. Spain still runs a large fiscal deficit - 5.6% of GDP in 2014 - the largest in the Euro Area. At first glance, with so many elections taking place it doesn't seem likely this will come down that much this year, and in 2016 it is hard to imagine there won't be a parliamentary majority in favour of prioritizing bringing down unemployment over reducing the deficit, making some sort of clash with the EU commission not improbable. Nevertheless, as long as ECB QE stays in place investors are hardly going to worry too much so yields wouldn't necessarily be affected. But what if the ECB wanted to taper?<br />
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<span style="font-size: large;"><b>The Price Of Doing Nothing</b></span><br />
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The social and political risks associated with Spain having conducted a far from complete economic adjustment are now becoming apparent, but there are also long term economic consequences, ones which may not be very evident at this point. People are often too busy celebrating a short term return to growth to ask themselves the tricky question of where all this is leading.<br />
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The most obvious result of having such a high level of unemployment over such a long period of time - Spain's overall rate won't be below 20% before 2017 at the earliest - is that people are steadily leaving the country in search of better opportunities elsewhere. Initially this new development was officially denied, and since there is little policy interest in the topic we still don't have any adequate measure of just how many young educated Spaniards are now working outside their home country. Anecdotal evidence, however, backs the idea that the number is large and the phenomenon widespread. All too often articles in the popular press are misleading simply because journalists have no better data to work from than anyone else. On the other hand work like <a href="http://www.iza.org/conference_files/mhc2013/jimeno_j141.pdf" target="_blank">this from researchers at the Bank of Spain</a> (Spain: From (massive) immigration to (vast) emigration? - 2013) only serves to illustrate how little we know, especially about movement among Spanish nationals.<br />
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On the other hand, when it comes to migration flows among non Spanish nationals we do have a lot better quality information due to the existence of the the municipal register electronic database. Everyone who wishes to be included in the health system needs to register with it (whether they are a regular or an irregular immigrant), and non Spanish nationals need to re-register with a certain frequency (so the authorities know if they leave). <br />
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More than an economic phenomenon, Spain's property boom was a demographic one. Since births only just exceeded deaths, between 1980 and 2000 Spain's population rose slowly, by just over 2 million people. Then between 2000 and 2009 it suddenly surged by 7 million. This was almost entirely due to immigration, with workers coming to the country from all over the globe attracted by the booming jobs market. Then in 2008 the boom came to an abrupt end, and unemployment went through the roof causing the trend to reverse. Since 2010 more people have left the country every year than have arrived, with the consequence that the population is now falling. Given that in 2015 the statistics office forecast that for the first time deaths will exceed births, it is most likely that this decline will continue and continue.<br />
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In fact the overall migration number - a net 251 thousand people emigrated in 2013 according to official data - only tells part of the story. The majority of young Spanish people working abroad are not included in these numbers (unless they have explicitly informed the Spanish authorities they are leaving, and few do this, partly because they do not consider themselves "emigrants"), but just as importantly the net balance masks very large movements in both directions. According to the national statistics office over half a million people (532 thousand to be precise) emigrated from Spain in 2013, while 285 thousand people entered the country as immigrants. So the net migration statistic covers over what are really very large flows.<br />
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The number of annual births in Spain has been steadily falling since the mid 1970s. They accelerated again slightly in the first years of this century, partly due to the shadow effect of an earlier boom in the 1970s, and partly because the incoming immigrants had a slightly higher birth rate. Coinciding with the outbreak of the crisis births peaked again in 2008 (after an initial peak in 1976 - ie 32 years later, average age at first childbirth is now just above 30) , and now the statistics office forecast a continuous decline.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijmznFX1iHy82oikQlq_y-Dkc57nA-p_-fdEcog4RtccGyuwgG8n9KmZo1owahGrDik_Fsysf-MhEsqH_uQT4FSBJEmt_ufFjrHX0zcierfAK6B6gVpKARs5FyUmMgY91zFRO1/s1600/2015-03-08_203250.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijmznFX1iHy82oikQlq_y-Dkc57nA-p_-fdEcog4RtccGyuwgG8n9KmZo1owahGrDik_Fsysf-MhEsqH_uQT4FSBJEmt_ufFjrHX0zcierfAK6B6gVpKARs5FyUmMgY91zFRO1/s1600/2015-03-08_203250.png" height="190" width="320" /></a></div>
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The statistics office estimate there were just 2,280 more births than deaths in the first six months of 2014, which suggests that for 2015 as a whole the balance will probably be negative, as it will be in the years to come since the birthrate is around 1.35 children per woman of childbearing age. The drill-down effect means that since every generation is smaller, and there is only a replacement rate of about two thirds, the base of the population pyramid gets smaller and smaller over time.<br />
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The current data we have for Spain show the share of the population aged 65+ currently stands at 17% (or something over 7 million people, Instituto Nacional de Estadística-INE, 2008), of whom approximately 25% are aged over eighty. Furthermore, INE projections suggest the over-65s will make up more than 30% of the population by 2050 (almost 13 million people) and the number of over-eighties will exceed 4 million, thus representing more than 30% of the total 65+ population.<br />
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International studies have produced even more pessimistic estimates and the United Nations projects that Spain will be the world’s oldest country in 2050, with 40% of its population aged over 60. At the present time the oldest countries in Europe are Germany and Italy, but Spain is catching up fast.<br />
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In their most recent long term population projections the national statistics office suggested that Spain's population would fall to 41.6 million by 2052 (a 10% drop over current levels). While the number of over 80s rises sharply the number of people under 15 is forecast to fall to just over 5 million, a drop of about 25%.<br />
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But these long term projections only give an us an indication of what might happen given that there could be major changes in trend. Population movements are governed by two factors: the birth/death difference and by net migration. Since we are unlikely to see any substantial movement in the birth rate, migration becomes the critical variable. And what does migration depend on? Evidently the job market. This is why this issue is so important.<br />
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At present the rate of outward migration from Spain seems to be slowing as the economy starts to create jobs. But just how stable and sustainable is this trend? This is why the issue of whether or not Spain has taken enough measures to ensure a better longer term growth rate (a growth outlook which moves beyond picking the low lying fruit after the recession) becomes important. In the short term population projections published in November 2013 by the statistics office, Spain's population was forecast to fall by 2.6 million (5.6% of the present population) over the 2013-2023 decade. The largest population decline was expected to be in the 20 to 49 age group, which was expected to fall by 4.7 million (or 22.7%).<br />
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These are dramatic numbers, but it must be emphasized that they are very sensitive to emigration rates. For the moment the improving job market means the outflow numbers (while remaining large) are decreasing, although again it must be emphasized once more that we have very little knowledge about the actual migration rates of young educated Spanish citizens.<br />
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Whatever way you look at it this state of affairs is highly undesirable, and raises serious questions about the sustainability into the medium term of Spain's current economic recovery. If the level of unemployment is "unacceptably" high, this is partly because of the damage it will do to Spain's economic outlook in the longer term.<br />
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But won't they all come back? This is the answer I get time and time again. Such an outcome is far from guaranteed, even if it is what policymakers implicitly assume. As I am trying to suggest, whether those who are leaving come back or not depends on the state of the Spanish job market, and despite the fact jobs are now being created the size of the problem means the situation on the ground will remain difficult for many, many years to come. Some point to surveys, like the one shown in the chart below carried out by recruitment experts Hays, which show that a large majority of those leaving want to return. But wanting is not the same as being able. Few want to leave their home countries and their families to start a new life in a distant land, but many are now being forced to do so. Most initially don't see themselves as emigrants, but as time passes there is a growing possibility that that is exactly what they will become.<br />
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<span style="font-size: large;"><b>So What Are The Probable Economic Consequences of Doing Nothing?</b></span><br />
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What matters in Spain is not the fact that the economy is recovering. More important is how it is recovering, and how quickly the jobs market could get back to normal. Otherwise the risk exists that the longer run growth potential could fall even as the unemployment rate remains high.<br />
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It is a simple fact that as Spain's working age population falls so will the long term potential growth rate also fall. And if growth is lower, then new jobs will be less. As can be seen in the diagram below (which illustrates how EU Commission calculates potential growth rates). There are three inputs which matter a) the existing capital stock, b) labour force growth (which is a function of working age population), and productivity. <br />
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Now it is clear that as working age population turns negative (which basically happened in Spain around 2012) the dynamic also becomes negative for potential economic growth, and the only real hope of sustaining it in the longer term is via (total factor) productivity growth. But this - the "oh well, we'll raise productivity" argument - isn't as easy as it seems. The following chart which was <a href="http://blogs.ft.com/gavyndavies/2014/10/26/is-economic-growth-permanently-lower/" target="_blank">produced by Fulcrum research</a> based on Conference Board and IMF data and shows clearly how the trend towards lower productivity growth in developed economies is now decades long. It simply isn't credible to imagine that this trend is going to be turned around at the click of a finger.<br />
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So one of the obvious consequences of this population loss is a permanent fall in the long run trend growth rate. This situation is concealed at the moment as the very high unemployment rate means that in the short term an above trend rate of growth is possible, but this favorable situation won't last forever.<br />
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<span style="font-size: large;"><b>Housing Issues</b></span><br />
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The most obvious area of the economy to be affected by population decline is the housing sector. Spain has a very large stock of empty houses (well over a million, possibly two, between new and second hand), and the rate of home sales while rising is still very low.<br />
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During the boom years the fact that a very large "boom" cohort was in the household formation a group and then that a large number of immigrants arrived to set up their homes was a key factor in fueling the boom.<br />
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During 2007 474,000 new households were set up. In 2014 the equivalent figure was 117,000. Given this new dynamic it is very difficult to see how the outstanding stock of houses can be sold, how prices can recover, and how new building construction activity can take off again.<br />
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<span style="font-size: large;"><b>And Then, What Happens To Pensions?</b></span><br />
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Spain's pension system is on the rocks. Before the crisis it was running constant surpluses, but now the trend has reversed, and it is in constant deficit, and the shortfalls look set to stretch forwards as far as the eye can see. The curious detail about this situation is that even as the crisis deepens the government keeps raising the real value of pensions being paid. <br />
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On the other hand household consumption is surging: it was up an annual 3.9% in the last three months of 2014, a phenomenon which is leading many to talk of "<a href="http://edwardhughtoo.blogspot.com.es/2015/02/spains-good-deflation.html" target="_blank">good deflation</a>" in Spain. But what proponents of this argument tend to forget is that someone if paying for this "deflation boost" party. I the case of salaried workers the cost is carried by their employers, but in the case of pensioners the "fiesta" is being charged directly to the account of future generations of pensioners, as Spain's mini boom becomes increasingly consumption driven.<br />
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<span style="font-size: small;"><b> Shifting The Burden Onto The Reserve Fund</b></span><br />
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The fact that Spain's pension system was going to have problem maintaining the level of payments has long been known. In fact in recent years there have been two reforms which have tried to address different aspects of the problem. But it is really the huge loss of employment during the crisis that has really highlighted the chronic nature of the underfunding the system is being subjected to. Initially the then socialist government plugged the growing funding gap out of general government finances, but as financial markets started to focus on the size of the country's fiscal deficit this practice became increasingly problematic. <br />
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With the arrival of the PP there was a change in strategy and since 2012 the pensions deficit has been funded by drawing down on the Reserve Fund. This was established in 2000 and was meant to ensure the long term sustainability of the system, especially as demographic pressure mounted towards the end of this decade. The Fund had been accumulating the surpluses generated in the 2000 - 2007 boom years.<br />
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The financing switch has helped the headline fiscal deficit number, but the decline in the Reserve Fund that has been the result is starting to make a growing number of Spaniards increasingly nervous.<br />
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One part of the problem the system is having is simply the result of population ageing: the balance shifts as the number of pensioners rises and the number of contributors for each pensioner falls. Another part is the result of the recent economic crisis (since with so much unemployment less people contribute) while a third contributing factor are the recent changes in the labour market structure which mean that young people now earn a lot less than those retiring, leading average contributions to fall, while average pensions rise.<br />
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Some of the results of this sea change can be seen in the chart below (sorry about the Spanish, but I think the main points are easily grasped). The number of contributors for each pensioner hit a high of 2.71 in 2007, since then it has been falling and was at 2.25 in 2014. The number of pensioners has risen from 7.6 million in 2007 to 8.4 million in 2014. <br />
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The average pension paid is also rising. In February 2015 the total amount paid out by the system in pensions was up 3.1% year on year. But the number of pensioners was only up 1.3%, so the average pension went up by 2.1% due to the fact that the most recent retirees have been earning more than earlier cohorts and are thus entitled to higher pensions. We don't have data on this year's pension system income yet, but at the end of last year it was rising at about 1.5% a year, leaving a growing shortfall for the system to cover.<br />
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As I said, under the former PSOE the shortfall was funded out of the general government budget, and possibly 1.5 percentage points of the 9.6% 2011 fiscal deficit were the result of this financing. With the arrival of the PP in government this policy changed, and pension financing moved over to the Reserve Fund.<br />
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The attrition has been constant and the Fund is now starting to dwindle. In 2012 7 billion euros were withdrawn, in 2013 it was 11.6 billion euros and in 2014 15.3 billion euros (or 1.5% of GDP). If you want to compare apples with apples and pears with pears, you would need to add this 1.5% of GDP to the 5.6% fiscal deficit, giving a 7.1% deficit using the same accounting criteria as 2011. Put another way the deficit has really been reduced from 9.6% to 7.1% in 3 years, hardly dramatic austerity. Instead of paying the pensions gap out of current income the government are using a credit card issued by "future pensions" to keep payments up even though the situation is obviously getting worse, meaning it will be even more difficult to pay current pension levels in the future than it is now.<br />
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As a result of all these withdrawals the size of the Reserve Fund has fallen from its 66.8 billion euro peak in 2011 to the current level of 41.6 billion euros. At the moment the government have budgeted for another 8.4 billion euro withdrawal this year, but this number could easily turn out to be larger. So 2015 should close with around 30 billion euros outstanding - about 3 years more money at the current rate. It is clear that soon after the election changes will have to be made. Even though the number of contributors to the system is growing as the employment situation improves the rate of spending is rising faster.<br />
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There was a pension reform in 2013 which was intended to address the problem by making the system self financing. A complicated formula was introduced whose intention was to ensure that more money didn't go out - on a structural basis - than came in. But this was in the era when Spaniards still expected inflation as their economic default setting. As a result - and as a way of selling the reform - a minimum increase of 0.25% was set. Last December consumer prices were down 1.5% over a year earlier, and as a result the minimum rise was a generous "vote winning" increase of 1.75% at a time when the system itself was running at a huge loss. Something similar will happen this year, giving at least one part of the explanation as to why retail sales are doing better - in part these increased sales are being paid for with future pensions.<br />
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<span style="font-size: large;"><b>Madrid Fiddling While The Future Disappears Under Its Feet?</b></span><br />
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In principle, the fact that people are moving around looking farther afield for work is a good thing isn’t it? Simple economic theory suggests it should be. Indeed one of the habitual criticisms made by outside observers about the way in which the Euro currency union operated during the first decade of its existence concerned the absence of labour mobility within the region. Labour mobility as an adjustment mechanism in the face of economic shocks has been a leading topic in the economic literature on currency unions, both in the United States and in Europe. More than 50 years ago, in his seminal paper on optimum currency areas, Robert Mundell stressed the need for high labour and capital mobility as a shock absorber within a currency union: he even went so far as to argue that a high degree of factor mobility, especially labour mobility, is the defining characteristic of an optimum currency area – i.e. one that works well. Thus, a key question when evaluating whether the Eurozone is an optimal currency area has always been: how important is labour mobility as an adjustment mechanism in Europe compared with, say, the United States?
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So now that people are finally moving from one Euro Area country to another in search of work the currency union is working better, isn't it?<br />
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If only life were so simple. Two issues arise in the case of labour migration within the EU that make the situation different to that of movement from one US state to another. In the first place US states are inside one and the same country. This is important when we come to think about things like unemployment benefits, health systems and pension rights. In the second place US fertility still hovers round about population replacement level (2.1 total fertility rate). In most of the countries on the EU periphery fertility levels are significantly below 1.5 children per woman of childbearing age (Tfr), and have been for decades. <br />
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More recent evidence, however, suggests that things are now changing even there with 2011/2012 marking a turning point in migration patterns and population momentum all across the southern rim. The number of newly registered migrants into Germany from Italy and Spain, for example, rose by about 40% between the first half of 2012 and the first half of 2013. The number from Portugal rose by more than 25% over the same period and since then the process has accelerated. Numbers for London and Paris reveal a similar pattern.<br />
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Since unemployment in the Euro Area currently ranges from about 5% in Austria and Germany to over 25% in Greece and Spain there is plenty of potential for imbalance adjustment. Half-a-century after Mundell’s original article was published, the most ambitious attempt yet to create a single currency spanning a wide variety of national boundaries is about to see “optimal” labour mobility. But is it really so optimal? Is it as desirable as many assume to correct imbalances between countries through working age population flows rather than through devaluation? Is there any way to evaluate outcomes? Are there hidden costs in doing it in the former rather than the latter way?<br />
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As Nobel economist Robert Solow puts it in the quote with which I start this post, it is impossible to believe that the longer term path of an economy is unaffected by the trajectory taken during periods of deviation from trend - whether upwards or downwards. Emigration, and with it negative working age population dynamics, are being promoted by the ongoing labour market crisis in the worst affected countries. The question is just how far the longer term future of these countries is being put at risk by the form in which the adjustment is taking place. In allowing this to happen instead of addressing excessive indebtedness issues, are we simply replacing short term debt defaults with longer term pension and health system ones?<br />
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Young people are moving from the weak economies on the periphery to the comparatively stronger ones in the core, or even out of an ever older EU altogether. This has the simple consequence that the fiscal deficit issues in the core are reduced, while pressures on those on the periphery are only liable to get worse as welfare systems become ever less affordable. Meanwhile, more and more young people could follow the lead of Gerard Depardieu and look for somewhere where there isn't such a high fiscal burden, preferably where the elderly dependency ratio isn't shooting up so fast.<br />
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What impact are the migration trends within the Euro Area going to have on trend GDP growth and structural budget deficits in the respective member countries in the longer term? These questions are just not being asked.<br />
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As often happens in economic matters, solutions to one problem are inadvertently promoting the creation of another. Avoiding radical debt restructuring on the periphery, and going for a "slowly slowly" correction doesn’t necessarily mean that all other things remain equal. The Euro is being held together by allowing unemployment rates to adjust towards a narrower range via population flows.<br />
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The question is, is this good news? Obviously in one sense it is, if this is needed to make the Euro work it has to happen. But there is a downside: changes in the political process are lagging well behind developments in other areas, and especially in the migration one. It has been clear since the Euro debt crisis that a common treasury was a necessity for the good functioning of the currency union, that all participants would need to make sacrifices in this regard, yet progress towards this objective has been painfully slow, and full of bitter recrimination. At the end of the day the migration problem might just the issue that brings this simmering problem right to a head.
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<b>Postscript</b><br />
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Many of the above arguments are developed in detail and at greater length in my recent book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-69482049980610368592015-02-16T20:55:00.001+01:002015-02-22T16:44:58.027+01:00Spain's "Good" Deflation?Spain's domestic economy is booming, or so the story goes, and in no small part this boom comes thanks to the arrival of what is being termed the "good kind of deflation", the sort everyone would like to have, a world where prices fall, real incomes rise, jobs are created, and everyone gets to live happily ever after. Let's not worry that in the process the boom is steadily transforming an export lead recovery into a domestic consumption - or import driven - one.<br />
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"Deflation is like cholesterol", Economy Minister Luis De Guindos <a href="http://www.cnbc.com/id/102363479#.">told CNBC at the WEF in Davos</a>, "There are two kinds.....The bad one and the good one. In Spain, you know, we have the good kind," So appealing was the story he told I'm surprised many of those in his audience didn't immediately get on a plane to visit the country to try to discover what the secret was. After all, sounds like the next best thing to a free lunch. Wouldn't anyone want some of that?<br />
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Or again, we have Bloomberg's Maria Tadeo, who temptingly <a href="http://www.bloomberg.com/news/articles/2015-02-11/madrid-ready-to-party-as-spain-s-recovery-bolsters-spending-mood">informed her readers last week</a> that "Madrid is ready to party again". "A strengthening economy and a pickup in consumer spending," she said, "are energizing nightlife in the Spanish capital after a perfect storm of record unemployment, tax increases and a smoking ban put more than 400 venues out of business since 2008."<br />
<blockquote class="tr_bq">
“<i>Madrid is a great place to be,” said Javier Bordas, owner of Opium, which he plans to open seven days a week. “You’ve got the football players, celebrities, and people love to party. We’re optimistic.</i>” </blockquote>
It makes you wonder why on earth support for the radical Podemos party is surging at the polls. Surely there must be a catch here somewhere?<br />
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Of course, Maria is only covering a story, an upside-bullish Spain-recovery one, and she does point out that Spain's 23.7% unemployment rate is the second highest in Europe after Greece, but still, it couldn't be that all the intense talking-up of Spain's recovery in domestic demand is also helping to sell some of that <a href="http://www.wsj.com/articles/recovery-has-investors-stocking-up-on-spanish-malls-1423594281">3.34 billion Euros worth of retail commercial property that went under the hammer in 2014</a>, now could it?<br />
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Certainly the story must be a lot more palatable to the clique of property consultants who are currently doing the selling than it is to one of the 4 million Spaniards currently on the credit blacklist run by <a href="http://“Madrid is a great place to be,” said Javier Bordas, owner of Opium, which he plans to open seven days a week. “You’ve got the football players, celebrities, and people love to party. We’re optimistic.”">credit consulting firm ASNEF</a>, who normally can't get hold of credit under any circumstances and will have a hard time joining in the current consumer "boom" even if they have a job. Spain's Economy minister Luis De Guindos <a href="http://www.forexlive.com/blog/2014/11/26/spains-guindos-says-there-is-no-deflation-in-spain-26-november-2014/" target="_blank">put it even more graphically</a>:
"It’s hard not to defer purchases when you’ve got no money for them in
the first place. In the case of Spanish unemployed I think they’ve got
more worries than waiting for a new sofa suite to drop by €50."<br />
<br />
Nor is the "good deflation" argument especially convincing to anyone with sufficient economic common sense to understand that deflation in a heavily indebted economy can NEVER be unequivocally "good". I doubt there are too many mortgage holders out there busily applauding the ongoing fall in house prices.<br />
<br />
If there is such a thing as "good deflation" it surely comes from falling prices in the wake of productivity gains rather than from "downward stickiness" in wages and pensions. But this is not the Spanish case since employment is growing faster than output. Spain's economy grew by 1.4% during 2014, yet employment was up 2.5%, suggesting that labour productivity actually fell during the year. So Spain's drift downward in prices is being fueled more by a demand shortfall than by supply side improvement: it's hard to see what is so "good" about that.<br />
<br />
My intention here, however, is not to argue that Spain's economic recovery has been hopelessly one
sided, which it has, but rather to try and pick my way through the
ideologically-loaded minefield of arguments which are currently being
advanced about the significance and meaning of the deflation phenomenon in Spain.<br />
<br />
<span style="font-size: large;"><b>So, Is Deflation A Problem? </b></span><br />
<br />
<blockquote class="tr_bq">
<i>"Deflation is a protracted fall in prices across different commodities, sectors and countries. In other words, it is a generalised protracted fall in prices, with self-fulfilling expectations. Therefore, it has explosive downward dynamics." - Mario Draghi</i></blockquote>
One of the reasons the arrival of deflation in Spain has generated so much controversy, I think, is that many doubt the country is actually suffering the phenomenon at all (see <a href="http://www.teinteresa.es/dinero/BANCO-ESPANA-DESCARTA-DEFLACION-RECESION_0_1255075857.html" target="_blank">Bank of Spain Governor Mario Linde</a>, "deflation risk in Spain continues to be low - November 2014 - or <a href="http://www.channelnewsasia.com/news/business/spain-not-sliding-into/1528816.html" target="_blank">Economy Minister Luis De Guindos</a>, "Spain is not at risk of sliding into deflation" - December 2014). Beyond policy makers and those whose job it is to "talk up" the Spanish recovery there is also little perception that it is a real issue, possibly because many have come to doubt so many of the things the administration says that they aren't even sure yet prices are falling. Beyond petrol and house prices the fall is so small it's not easy to perceive, especially when reductions are not shown in the form of like for like changes, but in the form of more complex "offer" and "discounts".<br />
<br />
In fact statistics show that consumer prices were down in January by 1.5% over January 2014, while the GDP deflator for the whole of 2014 (the figure that is used to estimate the impact of inflation on overall output) was estimated at minus 0.7%, meaning that the inflation corrected rise in GDP of 1.4% was only half that number, so, statistically speaking at least, it is important.<br />
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<br />
But beyond those who simply - perhaps for definitional reasons - doubt that Spain is experiencing deflation rather than simple disinflation there are those who doubt falling prices really constitute a problem. This is the so-called "good deflation" argument. The FT's Tobias Buck sums up many of the arguments in his article "<a href="http://www.ft.com/intl/cms/s/0/aa1c7bbe-a159-11e4-bd03-00144feab7de.html#axzz3QgTQz9Hp" target="_blank">Spanish Consumers Defy Deflationary Gloom</a>",and economist/blogger Shaun Richards <a href="https://notayesmanseconomics.wordpress.com/2015/01/29/falling-prices-are-providing-an-economic-boost-for-the-ukspain-and-ireland/" target="_blank">has a more theoretical version of the argument here</a>.<br />
<br />
The gist of the "good deflation" case is pretty simple: on the one hand countries like Spain need falling prices and some kind of "internal devaluation" in their ongoing attempt to restore international competitiveness, and on the other consumers aren't "so" rational as to engage in long and complex calculations across infinite time just to work out whether it is better to purchase now-or-later products whose price is falling by only 1% a year. <br />
<br />
At this point it is perhaps worth noting what Mario Draghi says deflation is. Deflation, he tells us, "<i>is a generalised <b>protracted</b> fall in prices, accompanied by <b>self fulfilling expectations</b> which has explosive downward dynamics</i>".<br />
<br />
Well in this sense little in the way of conclusions can be drawn from Spain's initial contact with falling prices, since hasn't been that protracted (yet) and certainly has not developed self-fulfilling expectations: most people in Spain regard the situation as transitory. The self fulfilling part of the definition relates to the possibility of a downward wage-price spiral which mirrors the kind of spiral we see under inflationary dynamics but in the opposite direction. As prices fall, then wage reductions can be offered - as we have seen in Japan - to maintain real wages constant and these wage cuts then fuel further drops in prices. None of this is very evident in Spain so far, even if wages have fallen at some points in the crisis, and with this being election year, the process is unlikely to take hold in 2015.<br />
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As for the "explosive dynamics", I presume the explosive part refers to the impact of a wage price downward spiral on debt affordability, since debt to income ratios are constantly pushed up.<br />
<br />
The idea that economies move into an outright contraction spiral simply because a small fall in prices is repeated over a number of years is a curious one, whose origin isn't clear, and whose reality is to some extent denied - as FT Alphaville's Matthew Klein points out in a post entitled "<a href="http://ftalphaville.ft.com/2014/12/04/2059371/did-japan-actually-lose-any-decades/" target="_blank">Did Japan Actually Lose Any Decades</a>" - by the fact that Japan's economy is widely believed to have performed "tolerably well" all through the deflation years, with weaker consumption growth being more due to declining population (a problem which may also affect Spain in the future) than it is to a supposed phenomenon of "purchase postponement". It's only when you start to look at Japan's 245% debt to GDP level that you get to see where there might be a problem.<br />
<br />
Even in the case of technological products, where price falls are constant and significant, people seem more likely to look for a combination of price and performance, since improvements are ongoing and unending, yet people do buy.<br />
<br />
So if people are largely agreed that small but constant price falls don't, in and of themselves, produce widespread purchase postponement, and recognize in addition that Spain needs weaker inflation than Germany, then, you might ask yourself, why on earth are policymakers worried by the phenomenon? Yet worried about it they are, since if they weren't why would the German government be acquiescing in sovereign bond purchases at the ECB (which in principle it is opposed to) to try to stop it digging in for the long haul? <br />
<br />
Assuming you don't write this institutional concern off as yet another example of things only economists worry about, and go on to ask the question you are likely to encounter three basic explanations: i) not all price falls are small, ii) there is an interest rate impact and iii) those who are burdened by debts become even more burdened as time passes.<br />
<br />
<span style="font-size: large;"><b>Purchase Postponement in Housing </b></span><br />
<br />
Spanish housing offers us a clear example of something whose price has fallen considerably, around 40% since the 2007 peak, and whose price continues to fall (currently in the 3% to 5% per annum range).<br />
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<br />
Far from this fall in prices having stimulated demand - the deflation "consumption boom" argument - we are witnessing exactly the opposite effect: demand has collapsed, and is not recovering significantly (see my piece from April 2014, "<a href="http://edwardhughtoo.blogspot.com.es/2014/04/firmly-anchored-expectations-no.html" target="_blank">Firmly Anchored Expectations, No Postponement of Purchases?</a>"). This is not surprising, since housing is a special sort of good (combining both use and investment) and the market is one where price movements tend to be self re-inforcing.<br />
<br />
The Spanish housing market is still far from functioning normally - the number of new houses purchased in December was just over 7,000 - the lowest monthly level in more than a decade.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtahJh4D2OOzROkvCrLis7irZTCkWRYoMTm3aUQc_5s_9abk_zeK8ljdJ7eQ4dHzX4IKc6hV2ESWw67XyiqBYVDa4lOUl-unL_AsQqyKzgR_syto7wRmYIzoA2ONMARInFQrZ9/s1600/2015-02-10_092736.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtahJh4D2OOzROkvCrLis7irZTCkWRYoMTm3aUQc_5s_9abk_zeK8ljdJ7eQ4dHzX4IKc6hV2ESWw67XyiqBYVDa4lOUl-unL_AsQqyKzgR_syto7wRmYIzoA2ONMARInFQrZ9/s1600/2015-02-10_092736.png" height="189" width="320" /></a></div>
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True, the number of second hand houses being purchased is rising, but even the combined total is far from showing a sharp rebound.<br />
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Perhaps the most worrying thing about the fact that second hand purchases are improving while new ones aren't is that part of the explanation for this is that properties become reclassified as "used" 2 years after completion (so some of the second hand houses being sold are in fact new), but this makes the situation with new houses deeply preoccupying, since there are more than half a million unsold housing units still classified as "new" (see <a href="http://www.idealista.com/news/inmobiliario/vivienda/2015/01/12/733817-la-realidad-de-por-que-se-venden-menos-viviendas-nuevas" target="_blank">this article</a> on the Spanish property website Idealista) which means they have been built within the last two years.<br />
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The problem with the arrival of deflation in Spain is this is going to create an environment where it becomes even more difficult for the housing market to really recover. In the meantime, constantly falling prices have had one consequence: Spaniards now prefer renting to buying, they have become more aware of the risk involved in owning a property. So perhaps rather than simple purchase postponement process what we should be looking for are a broader set of behavioral changes over the longer term.<br />
<br />
In any event, given the importance of the Spanish housing market to the economy in general - 75% of the country's household wealth is tied up in property - the situation cannot be ignored: ending deflation in Spain would help push house price movements back into positive territory, and in so doing would give a significant boost to the Spanish economy.<br />
<br />
<b><span style="font-size: large;">Then There Are Borrowing Costs</span> </b><br />
<br />
Moving beyond the issue of the supposed "purchase displacement effect", Mario Draghi has a rather more powerful argument: the interest rate impact. Consumption growth in modern economies is as much about credit as it is about spending from current income. Too many people are still thinking about economic dynamics in terms of confidence and money stored under the mattress, or as some whit of a Bloomberg journalist put it, <a href="http://www.bloomberg.com/news/articles/2015-02-03/greeks-spooked-by-debt-clashes-put-cash-under-bathroom-tiles">burying it beneath bathroom tiles</a>. Credit matters to modern economies, as we have seen during the recent "credit crunch". As consumer credit accelerates, economies grow, and normally when this happens central bankers started raising interest rates to slow credit growth. In general I think it is fair to say that those who think there is "good deflation" in Spain and those who think Spanish deflation is "not so good" agree about this. <br />
<br />
Yet credit, curiously, is all about the temporal displacement of purchases. When credit is cheap, and inflation is expected to be present, consumers tend to advance purchases. I don't know whether anyone wants to challenge this, but it is the cornerstone of any kind of interest rate policy. It is what gives the central bank, under normal conditions, the ability to apply counter cyclical policies in the face of recession. If this mechanism doesn't work, then there is a problem in the whole way we have been thinking about things.<br />
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Once interest rates reach the zero bound (I think it is impossible to separate discussion of deflation from the issues which arise in the context of a zero bound) then this mechanism hits a limiting factor, since while prices are in negative territory conventional central banking theory makes bankers reluctant to follow by taking interest rates even deeper into negative territory (although, it should be said, we are now increasingly seeing the negative nominal interest rate phenomenon in countries like Sweden, Denmark and Switzerland). As Mario Draghi put it <a href="http://www.ecb.europa.eu/press/pressconf/2014/html/is141204.en.html" target="_blank">answering questions at the ECBs December 2014 press conference</a>: <br />
<blockquote class="tr_bq">
<i> "Now, let me make absolutely clear that we won’t tolerate prolonged deviations from price stability, and the main reason is that if these deviations feed into inflation expectations, they’ll cause a drop on medium to long-term inflation expectations, which by the way still are within a range consistent with medium-term price stability. But if these were to feed into inflation expectations, these lower outcomes of inflation, were to feed into lower inflation expectations, we would have a zero lower-bound nominal interest rate. This would be tantamount to an increase in the real interest rate." </i></blockquote>
Here we find some key word expressions:<b> prolonged deviations from price stability</b>, <b>lower long-term inflation expectations</b>,<b> increase in real interest rate</b>. This situation is rather different from the one described by the Spanish economist Javier Andrés in <a href="http://www.ft.com/intl/cms/s/0/aa1c7bbe-a159-11e4-bd03-00144feab7de.html#axzz3RWzTKDkb" target="_blank">the Tobias Buck article</a> I mentioned earlier: “The fall in prices", Andrés argued, " is not strong enough, nor is it perceived to last that long, as to make it worthwhile for consumers to postpone the purchase of goods.” In Spain at the moment the deviations from price stability have not been strong enough or perceived to have lasted long enough to have an impact on consumer expectations.<br />
<br />
In fact deflation has been settling in for a lot longer than people in Spain think it has. Many still believe that the recent negative inflation is simply the result of a negative oil price shock, but if we look at the EU HICP rate excluding energy it is clear that the deflation issue started a lot earlier.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVkdrNmU7Q3AlstupN4vtIguDA3z7mUfWY4mNa1M5uur6dUb-tdaHgOwfrlhIlKgsumglqHv6JewhkLHOleZJLMXVaIsSNeOcVT9TFtS0i7RkRUYbX1j-4m7dAxDr-9z8_6kFO/s1600/2015-02-20_122151.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVkdrNmU7Q3AlstupN4vtIguDA3z7mUfWY4mNa1M5uur6dUb-tdaHgOwfrlhIlKgsumglqHv6JewhkLHOleZJLMXVaIsSNeOcVT9TFtS0i7RkRUYbX1j-4m7dAxDr-9z8_6kFO/s1600/2015-02-20_122151.png" height="167" width="320" /></a></div>
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<br />
Another issue which has clouded the Spain deflation issue has been the use of consumption tax increases as a deficit reduction measure.The national statistics office maintain an ex-tax estimated EU HICP inflation rate, rather like the one the Bank of Japan maintains following the consumption tax rise in that country. Obviously if you raise a consumption tax you raise inflation, but this kind of inflation is not thought to be positive (as we are seeing in Japan, the country fell back into recession after the increase) as it weakens consumption (as the various VAT rises have in Spain). <br />
<br />
The ex-tax consumer price index tries to estimate underlying inflation without the tax, and - as the chart below reveals - if we use that measure Spain has been hovering in deflation territory since late 2012. However Spain's citizens seem to have a kind of "inflation bias" after many years of highish inflation, and simply refuse to believe that prices really have started falling.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVQxFJOZZFLSBdcJRhKF7LJylhJNFLSmwkZ60oZG58Dq_Hlo_h8A7Clm4htqSuNmENrb5-U-IRmpGGg_KDmkSzY_8aOaOAQhFTPzYCdoar49qwo8wENYgrgwadUSQBmQFw7482Mw/s1600/2015-02-15_134228.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVQxFJOZZFLSBdcJRhKF7LJylhJNFLSmwkZ60oZG58Dq_Hlo_h8A7Clm4htqSuNmENrb5-U-IRmpGGg_KDmkSzY_8aOaOAQhFTPzYCdoar49qwo8wENYgrgwadUSQBmQFw7482Mw/s1600/2015-02-15_134228.png" height="200" width="320" /></a></div>
In fact if we now adjust that earlier HICP excluding energy data and produce a constant tax version, we get a chart which looks like this.<br />
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<br />
This suggests that Spain has been near to deflation ever since the global financial crisis struck, but that the initial recovery produced an inflation surge as wages and prices across the economy reacted upwards (price rigidity, things going back to normal in terms of expectations). Now that shock has passed and the underlying trend towards deflation becomes obvious.<br />
<br />
Mr Draghi is worried (although NOT Mr Linde, or Mr De Guindos, as we have seen) that if the current trend is not corrected Spain's citizens might eventually begin to believe and expect it, which is why he gives more importance to the issue and is taking measures accordingly. Indeed, such is the importance which EU - as compared to Spanish - policymakers give to the issue they are taking the measures even though their mere announcement has started causing a great deal of difficulty for central banks in countries like Switzerland, Sweden and Denmark. Again, it is noteworthy how by and large these central bankers are accepting such difficulties without protesting too much since they understand why Mario Draghi feels forced to implement them.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjG0mehr-6t8RkJN-3h4AzZJha62P5scE-vpw7kCc-3ISfJIWdm0tMDZyQa1ayRokt2lu9sbCjJbf6L4Y6ZsqYFcX1kDbnybj-P4VICGXPy2WFjSi2ii8Es94YwB-io7n9tM3NorA/s1600/2015-02-17_093856.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjG0mehr-6t8RkJN-3h4AzZJha62P5scE-vpw7kCc-3ISfJIWdm0tMDZyQa1ayRokt2lu9sbCjJbf6L4Y6ZsqYFcX1kDbnybj-P4VICGXPy2WFjSi2ii8Es94YwB-io7n9tM3NorA/s1600/2015-02-17_093856.png" height="168" width="320" /></a></div>
<br />
Mario Draghi argues that falling inflation expectations<b> raise real interest rates</b> by influencing the perceived cost of credit into the future. If consumers anticipate inflation, then that makes borrowing cheaper and people tend to advance purchases. Conversely expected price falls make the cost of borrowing greater, make the desirability of advancing purchases via credit less, and in this sense constitute monetary tightening. I am aware of an ongoing debate about whether interest rates really are a key factor influencing investment decisions, but I have never seen an argument suggesting that the cost of credit does not influence consumption. And so it is in Spain, since the demand for household borrowing is not surging, even though the country's banks keep telling us they are now "<a href="https://twitter.com/bloombergtv/status/558180122055176192" target="_blank">ready to lend</a>".<br />
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<span style="font-size: large;"><br /></span>
<span style="font-size: large;"><b>Deflation Favors Savers Not Debtors</b></span><br />
<br />
Deflation obviously favors those with money in the bank (unless <a href="http://www.wsj.com/articles/danish-lenders-take-unprecedented-steps-to-combat-negative-interest-rates-1423576590">the banks start charging negative rates on time deposits</a>) since the value of money steadily goes up. It is not so kind on those with debts, since as prices and incomes go down, debts remain unchanged and the burden of paying them increases.<br />
<br />
Spain is an endebted country - the net international investment position (NIIP) is negative to the tune of around 100% of GDP - so it isn't the first place that comes to mind when you think of some kind of "good deflation" process. Japan, in comparison, has a positive NIIP of around 50% of GDP, making it a very different case.<br />
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The various sectors in Spain's domestic economy are also very highly indebted, and the combined debt of government, households and the business sector comes to about 275% of GDP, not that much less than it was at the start of the crisis. This is because while household and corporate debt has reduced, government debt has increased considerably. All of this means that if deflation sets in it will be a serious problem for Spain.<br />
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<br />
Spain's external correction still has some way to go in terms of price competitiveness, but having so called "good" competitiveness recovering deflation is not the way to do it at this point, due to the debt impact. This is why ECB policy is directed towards trying to stimulate Euro Area inflation, since obviously if countries like Germany had 2% annual inflation and Spain and others had 0.5% the correction would be a lot less fraught with problems.<br />
<br />
<span style="font-size: large;"><b>Why Is It Likely Deflation Will Continue In Spain?</b></span><br />
<br />
There are basically two theories why Eurozone countries are suffering from deflation at the moment. One of these is the idea of <a href="http://en.wikipedia.org/wiki/Debt_deflation">debt deflation</a>, whereby over-indebtedness creates a consumption drag leading to a shortage of consumer demand while countries deleverage. This is certainly part of the problem that Spain is experiencing.<br />
<br />
But there is second theory going the rounds ever since it was put into circulation by US economist Larry Summers <a href="https://www.youtube.com/watch?v=KYpVzBbQIX0">at an IMF research conference in the autumn of 2013</a>. The hypothesis Summers advances is based on ideas developed by <a href="http://conversableeconomist.blogspot.com.es/2013/12/secular-stagnation-back-to-alvin-hanson.html">Alvin Hansen in the 1930s</a>, and the essential point is that countries like Japan and those in the Euro Area are experiencing some kind of demographically driven secular stagnation. This is not the place to go into this theory in any depth, but basically the idea is that as working age population growth slows, comes to a halt and then turns negative consumer demand starts to weaken and eventually decline. This affects the investment process, and it is the structural "underinvestment" which produces the demand shortfall which means there is constant downward pressure on prices.<br />
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Paul Krugman provides a useful summary of the argument in his blog post - "<a href="http://krugman.blogs.nytimes.com/2014/05/19/demography-and-the-bicycle-effect/?_php=true&_type=blogs&_php=true&_type=blogs&module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&actio&_r=0">Demography and the Bicycle Effect</a>" - and I offer a summary <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">here</a>.Of course, at this point it is only a hypothesis - the worrying thing is that in Spain the possibility that this might be happening hasn't even been considered, let alone rejected.<br />
<br />
<span style="font-size: large;"><b>So What Is It - Good or Bad Deflation?</b></span><br />
<br />
At the moment Spain's citizens have mainly seen only the good side of deflation: wages and pensions were up while prices fell. Spanish hourly wages rose an annual 0.6% year on year in October 2014 (last date for which we have available data) according to Eurostat, Spain's pensions were up 0.25% (despite the pension system running a loss of 1.3% of GDP) while consumer prices were down 1.1% year on year in December. In addition 400,000 new jobs were created during the year. It is little surprise then to discover that the statistics office report that price corrected retail sales were up 1% on the year in 2014.<br />
<br />
The question is, what happens next? Do workers and pensioners continue to receive above cost-of-living wage and pension increases? This being election year the chances are they do, which means more pressure on profit margins and more withdrawals from the pension reserve fund. And in the longer run, is this sustainable, or will wages and pensions start to fall in line with prices, producing the so called "spiral"?<br />
<br />
To get answers to these questions we will need to wait to see in the years to come, but in the meantime important changes may be occurring in consumer behaviour, not only in attitudes towards house purchase, or in terms of any supposed "postponement" activity, but simply in the way people are becoming more sensitive to price movements and bargains. In this context, Justin McCurry's New York Times article on the Japanese experienece - "<a href="http://www.theguardian.com/world/2015/jan/11/japan-deflation-consumers-falling-prices-gyudon">Spectre of deflation horrifies bankers, but Japan now has a taste for it</a> - makes interesting
reading. In particular his conclusion:<br />
<blockquote class="tr_bq">
<i>"Spending habits honed over 20 years die hard. And if Japan’s experience can teach Europe anything, it is that government attempts to haul consumers out of the deflationary abyss are fraught with difficulty. An entire generation has come to embrace the deflationary devil they know. For the population at large, what started life as a reluctant thrift habit borne of necessity has quietly become the economic version of the Stockholm syndrome."</i></blockquote>
And <a href="http://moneymorning.com/2010/07/08/real-housewives/">here's another piece</a> of evidence from Japan (The Real Housewives of Japan: Shopping for Bargains … Driving Deflation?) highlighting how years of deflation have lead customers to expect price discounts, and have come to leverage online and social media in the search for ever better bargains.<br />
<blockquote class="tr_bq">
<i>Could 70,000 Japanese housewives tip this Asian giant into a deflationary spiral?
As farfetched as that sounds, it's become a major cause for concern in this nation of 128 million, which has been in an economic funk for two decades. These "real housewives" are part of a user-driven, social-networking site called Mainichi Tokubai, which delivers the best prices on specific grocery-store items to the fingertips of Tokyo-region consumers.
To hear frustrated Japanese policymakers and retail executives tell it, these bargain-minded consumers and their equally frugal social-networking site are almost-single-handedly undercutting the Japanese economy.</i></blockquote>
The above article particularly caught my attention since<a href="http://blogginzenith.zenithmedia.es/rebajas-y-compras-online/"> this is a phenomenon which is increasingly to be seen at work in Spain</a>: people shopping around and expecting bargains, and using online media to help them in their search. In deflationary times the evidence suggests the rise of a kind of "consumer power" where people come to expect permanent sales and discounts and virtually force these on retailers, to the great disadvantage of the small, local shop. This kind of behaviour obviously fuels deflation and when entrenched it is hard to change as Stanley White noted<a href="http://www.nytimes.com/2012/12/18/business/global/deflation-a-determined-foe-in-japan.html?_r=1&"> in a 2012 Reuters article</a>.<br />
<blockquote class="tr_bq">
<i>"A bargain-hunting psychology is so entrenched in Japan — after two decades of stop-start economic growth, 15 years of falling wages and nearly 15 years of deflation — that the government will struggle to convince people that their incomes will improve enough for them to buy more expensive goods.</i></blockquote>
Spanish policymakers take note, and think twice in future before you say Spain is simply suffering from "good deflation".
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-23159260589683746162014-10-18T10:23:00.001+02:002014-10-18T12:43:22.979+02:00Open Letter to the Economist on Catalonia - J'accuse<b>Those who have interest in neither Catalonia nor the issue of journalistic standards will probably find this posting long, tedious, and not especially interesting. Perhaps you might like to stop at this point. Those of you who are interested in one or other of these, well, I invite you to read on..... </b><br />
<br />
<span style="font-size: large;"><b> To The Editors Of The Economist</b></span><br />
<br />
I am writing this missive addressed to you as I am outraged, nay scandalized, by the level of your reporting on the Catalan question. The source of my discontent are two recent pieces - both signed by one GT - the first of which appeared on the Charlemagne Blog (<a href="http://www.economist.com/blogs/charlemagne/2014/09/catalonias-referendum" target="_blank">Getting to “sí”</a>, 19 September 2014), while the second was published under the rubric The Economist Explains (<a href="http://www.economist.com/blogs/charlemagne/2014/09/catalonias-referendum" target="_blank">Catalonia’s independence movement</a>,14 October 2014.) <br />
<br />
Of the two, I consider the second much more reproachable since it purports to be an informative document, and not a mere opinion piece. My issue with your journalist is not his opinion - to which any journalist is entitled - but that he attempts to pass off opinion as fact. My view is the that the level of journalism being demonstrated is not what you should be seeking in a publication with your high level of international prestige.<br />
<br />
At the end of the day, of course, whether this is the case or not is an editorial decision on your part. I fully understand why the Economist originally took the decision to publish non-editorial unsigned articles, but in the modern age I think this be a double edged sword as it leads to confusion about what is an Op-ed and what isn't. Personally I think the practice is now more trouble than it's worth, but again that's for you to decide.<br />
<br />
In order to try and demonstrate my case I have gone to the rather tedious lengths of re-reading the two offending articles and identifying what I consider to be factual inaccuracies (see below). <br />
<br />
In a personal mail addressed to me, GT says he admires President Mas, and even describes the new Catalan "consulta" as a brilliant move. It is a pity he couldn't have brought himself to express such opinions in the articles. My reproach is not related to any one phrase or statement, but to a long history of the same over many years.<br />
<br />
My feeling is that in the present context, and with so much for the whole of Europe at stake here in Spain both politically and economically in the coming years, what GT does verges on the irresponsible, especially in an article with the header The Economist Explains. Curiously for an article with such ambitions it is striking that the ANC (Assemblea Nacional Catalana) which is the key civil society organisation promoting the independence drive) doesn't get even a mention.<br />
<br />
In his mail GT tells me he is critical of Mr Rajoy, but frankly in his last two pieces this criticism is hardly noticeable. My "j'accuse" is based not on this factual inaccuracy (or superficial assessment) or that one, but on the fact that quantity eventually becomes quality. Despite claiming to admire Artur Mas the sum total of GT's "comedy of errors" makes the Catalan President look more like a character from Hotel Faulty, a sort of mediocre, run of the mill politician who was busying himself "ploughing another furrow" when the indy movement snuck up on him and forced him to try to "regain control". He is seen as a politician who is almost permanently under threat from the "Manuel" (or Sancho Panza) type character (Oriol Junqueras, leader of the openly separatist ERC - "my name is Oriol and I come from Barcelona") who is constantly threatening to wreak havoc with his best laid plans. Funnily enough there is a popular weekly satire programme on TV here which does something similar, but that programme, evidently, is just that, satire.<br />
<br />
<span style="font-size: large;"><b>Getting to “sí</b>”</span><br />
<br />
<b>"On Friday Catalonia's parliament passed a so-called “law of consultations”, with a view to allowing Mr Mas to call a referendum on November 9."</b><br />
<br />
This - that what the Catalan Parliament intended to enable under the "law of consultations" was the holding of a referendum - is just plain wrong. The law enables only popular consultations, and this was always its intention. Whether the vote called under the initial decree issued under the law was in fact a referendum is disputed, and vigorously so. The Catalan side argue it was an opinion-sounding vote, with no legal consequences, and have appealed to the Constitutional Court on just these grounds, against the Spanish government submission that it is de facto a referendum. The court has not yet ruled on this issue. When it does it is quite possible that it rule the law as such (possibly with some amendments) falls within the competences assigned to the Catalan Parliament under its charter, but that the question that was to be put is not covered by the law since it may be considered to constitute a referendum. But since the "with a view to" words constitute an opinion about what was in the heads of the members of the Catalan parliament at the time of voting, all I can say is that there is no evidence to support this view.<br />
<br />
Now, there is no harm in putting both sides of the argument, but I do think it is incumbent to put BOTH sides of the case. Also, it would be quite legitimate for GT to take the view it was a referendum by another name, but I do think he should make clear that this is his opinion. If you don't mention that the Catalans considered their attempted vote a "consulta" not a referendum - one without any evident legal consequences - then it's hard to make sense of everything that has taken place subsequent to the suspension, and especially it is difficult to explain how the new vote that has been called for the same day with the same questions differs from the suspended one. Apart from the legal framework in which it is to take place, to all appearances it doesn't.<br />
<br />
<b>"If Mr Mas obeys and cancels the referendum, his minority nationalist government, propped up by the separatist Catalan Republican Left (ERC), may fall."</b><br />
<br />
Again, GT refers to "referendum" as if it was clear that this is what it would have been. As can be seen, President Mas cancelled the order authorizing the vote but his government didn't fall. It was never going to, and I think only people in Madrid ever believed this to be a possibility. In order to understand why this was always going to be a highly improbable outcome maybe you do need to be familiar with some very simple "game theory". <br />
<br />
<b>"In the most extreme one, Mr Mas could stage an illegal referendum, with police moving in to remove urns and Madrid suspending the Catalan regional government's right to rule."</b><br />
<br />
Well let's imagine that President Mas was to call an illegal "referendum" (not totally ruled out, but unlikely since he has continually insisted on his desire to work within the existing legal framework, or at least within his legal advisers' interpretation of it). The scenario GT depicts leaves me with one very basic question: where would these police come from? The number of Guardia Civil and Policia Nacional in Catalonia is very, very small. The vast majority of police in Catalonia are either local (municipal) police or belong to the body known as the Mossos de Esquadra, a Catalan police force under orders to the Generalitat de Catalunya. So this was a silly, unrealistic scenario. If the government in Madrid do move against the Catalan government, in my opinion, it will be through the courts and through cutting-off finances. Maybe even trying to suspend the Statute of Autonomy under which the Catalan Parliament operates.However legal experts here question whether - despite the threats to do so that have on occasion been made - they in fact have the power to do this under the terms of the Spanish constitution. So it is possible that any hypothetical suspension of the "right to rule" may in practical terms need to involve some sort of suspension of the very constitution Mariano Rajoy declares he is determined to defend. That would be ironical, wouldn't it?<br />
<br />
<b>"Catalonia cannot negotiate to win more such powers from Madrid, for the simple reason that it already has them."</b><br />
<br />
Well, again this is just an empty silly argument, since it is obvious there will eventually - as in the Scottish case - be third way proposals (maybe even a West Lothian question) as GT admit in his second article. There is no theoretical limit to the amount of devolution that can take place within a federal state. Especially if we start talking here about bi-lateral federalism for Catalonia. Again, he later points out, maybe many Catalans would vote for a new type of arrangement along these lines, and indeed this is why the consultation question is framed in two parts, so people can vote for the option of a (federated) Catalan state within Spain. If GT were to argue that maybe Artur Mas is ambiguous on this point, I would say that view is legitimate. As a democrat I suspect President Mas would go along with what he felt a majority of Catalans wanted. On the other hand I'm not sure I've seen any reference to the fact that there are to be two questions, or any analysis of the significance of this fact in any of his published material.<br />
<br />
<span style="font-size: large;">Catalonia’s independence movement</span><br />
<br />
<b>"The regional government of Catalonia ..... was planning to hold a non-binding referendum on independence on November 9th."</b><br />
<br />
Well again, this is a one side way of putting it (see above) the continual repetition of which brings into question GT's independence on the matter.<br />
<br />
<b>"On October 14th the Catalan prime minister, Artur Mas, announced that some form of "consultation", involving "ballots and ballot boxes", would go ahead anyway on November 9th, regardless of the Court's decision."</b><br />
<br />
Well exactly, this is simply the earlier consultation without any decree behind it, since President Mas is gambling that without a decree the Madrid government can't go to the constitutional court to get a decree which doesn't exist suspended. As GT says in his mail to me, it's a brilliant stroke. Since the Catalan Parliament never considered the 9N vote a referendum, neither version could be considered to have legal consequences, the only force they can have is political, in demonstrating people's opinions. At the international level these political effects should not be underestimated, hence, I venture to suggest, Mariano Rajoy's desire that it not take place.<br />
<br />
<b>"The two motors of the new wave of separatism are Spain's economic woes and a 2010 Constitutional Court decision to strike out part of a renewed charter of self-government that had been approved at referendum."</b><br />
<br />
This is undoubtedly true, but maybe it would have been helpful to have mentioned WHICH part of the charter was struck down - the declaration that Catalonia is a nation. This is especially relevant since it is at the heart of the current issue, and also in the light of his next comment. The fact that this little word was struck out following an appeal from the Partido Popular to the constitutional court after a "popular participation" protest which involved the collection of a large number of signatures is possibly also relevant. President Mas is simply repeating this performance in reverse.<br />
<br />
<b>"Many Catalans, who speak their own language as well as Spanish, believe their taxes pay for poor, lazy southerners to live off government hand-outs."</b>
<br />
<br />
As well as the fact that they speak that language maybe he could have said a bit more, especially about how the Catalans now feel their language - which was of course banned during the Franco years - is once more under threat. Recent developments in Valencia, the Balearic Islands, Aragon (where there are significant Catalan speaking communities) are seen as a clear sign of an intention to limit use of and familiarity with the language. The most recent Spanish educational reform which attempts to influence the quantity of teaching in Catalan in Catalan schools is also highly contentious and important in understanding the current strength of feeling.<br />
<br />
In addition, the second part of his sentence is little better than an Andy Capp type caricature. The quantifier "many" often hides a multitude of sins. Many Germans think something of the kind about Spaniards in general, but I doubt it is a majority. The same is true of Catalans. What Catalans want is to be able to decide what to do with their own resources.<br />
<br />
They also want to be recognized as a nation and not continually told there is only one nation - the Spanish one - of which (under the terms of the constitution) they are all compelled to form part (whether they like it or not). <br />
<br />
<b>"Mr Mas has been caught unprepared by this wave of separatist enthusiasm. He responded first by demanding new tax-raising powers from Madrid."</b><br />
<br />
Well, this is one of the issues where I feel GT has things totally back to front. Artur Mas, like the ANC - who he somehow manages to avoid mentioning even once in what is supposed to be a background information article - and everyone else, was as he says surprised by the *size* of the 2012 demonstration, and this undoubtedly encouraged him to move forward more quickly with a project he was already working on - the Catalan "national transition" - and recognise the leaders of ANC and Omnium Cultural as legitimate leaders of Catalan civil society.<br />
<br />
No man is an island, and President Mas himself had been evolving as part of this growing separatist feeling since 2006. It was around that time he first started talking about moving towards a "national transition". This transition was already conceptualized as creating the institutions necessary to move towards independence. A declaration of some kind of statehood was always going to be the end point. So he was himself fanning the flames. He was not simply a late opportunistic add-on to the developing idea that Catalonia had gone as far as it could within the terms of the 1978 constitution.<br />
<br />
On the isssue of the tax proposal GT is just plain wrong: President Mas's tax proposal was not a hasty response to the arrival of a wave of separatism. It was an idea he had been working on all through his years in opposition. Certainly he seems to have been quite happy when Rajoy (perhaps foolishly) greeted this proposal with an outright "no", since this meant he could then move on to the next stage in the project. I think the size of the separatist movement lead him to accelerate his plans, and shorten the time scale of the "national transition".That is all.<br />
<br />
<b>"When they [the tax powers] were refused he called a referendum, knowing it was likely to be banned. It has not been enough to convince voters:"</b><br />
<br />
What is the insinuation behind "knowing it was likely to be banned"? That it was all part of a carefully calculated plan - just another step towards the "elections as a referendum move"? Mas as Machiavelli? Or is GT suggesting that he was simply trying to throw sand in the voters eyes, to stall for time. The general gist of his argument leads towards the latter conclusion, so if he wanted to make the former point may I suggest that there are better ways of doing so. Like saying "this was also brilliant".<br />
<br />
<b>"Spain's conservative prime minister, Mariano Rajoy of the Popular Party (PP), has refused to call a referendum, which has only stoked support for one"</b><br />
<br />
Mariano Rajoy, to my knowledge, has not been asked to call a referendum at any point, so he has not refused to call one. The Catalan parliament in the spring of this year asked the Madrid one to authorize them to hold one - as had happened with the earlier referendum which was held over the new charter in 2006 - but this time the Madrid parliament refused. Once a referendum became impossible the Catalan parliament decided to go for a "popular consultation" - the legal aspects of the two - as I keep saying - are rather different. I suggest that the fact that GT didn't distinguish between referendum and "consulta" in the first instance leads to this kind of confusion. maybe he himself was confused.<br />
<br />
<b>"It [the Spanish government] also refuses to countenance the opposition Socialist Party's “third way” approach, which would involve constitutional reform to give Catalonia still more power and make Spain more federal. Polls show such reforms could bring support for independence below 50%."</b><br />
<br />
See my point above, this is the reason more autonomy could clearly be offered, as happened in the Scottish case. And is indeed one of the few occasions on which GT criticizes Mariano Rajoy.<br />
<br />
<b>"Mr Mas's pseudo-referendum is still due to go ahead on November 9th, though it will have no legal consequence."</b><br />
<br />
Well, we're back to the same old issue. What would have been the legal consequence of the suspended vote? None. What will be the legal consequence of the new vote? None. What's the real difference? None.<br />
<br />
Essentially the two votes are one and the same - same questions, same date, same ballot papers, same ballot boxes - and serve the same purpose, to find out what those who want to vote think. "No" supporters would not vote in either case, so we are only talking about getting a rough idea of who would vote "yes-yes" in a full referendum. <br />
<br />
The use of the expression "pseudo referendum" irks somewhat here, since it sounds remarkably like the Catalan PP leader Alicia Sanchez Camacho's disparaging "refèrendum de costellada" (Sunday afternoon barbeque referendum). Pseudo (unlike say surrogate, or placebo) is normally used very negatively in English.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsG56-5EUX0BZeeb6sidPNiSGR5j3Pf6ig1EWyzAr77HA-G37-MsAn4KHf8LKuuR1qS9uNk1IXciuZgLOD06-DwCT0IkdJA85pXAbOIgSA0XLxRhsfyiLIY6MtgiPhOSl4qxDE/s1600/2014-10-17_140551.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsG56-5EUX0BZeeb6sidPNiSGR5j3Pf6ig1EWyzAr77HA-G37-MsAn4KHf8LKuuR1qS9uNk1IXciuZgLOD06-DwCT0IkdJA85pXAbOIgSA0XLxRhsfyiLIY6MtgiPhOSl4qxDE/s1600/2014-10-17_140551.png" height="222" width="320" /></a></div>
<br />
<br />
<b>"The “no” side has either refused to engage or, where it has spoken up, been drowned out."</b><br />
<br />
I dispute this. Both parts. Plenty of people have come to Catalonia from Madrid and other areas of Spain to argue in favour of "no". Both putting the constitutional case for "no" vote (rather than "no" in the vote) and arguing Catalonia is better off inside Spain. What hasn't existed is a "better together" campaign since there has been no third way offer to campaign for, and an assumption that there will be no vote. I also see no evidence of people being "drowned out". Plenty went to the Plaça Catalunya on 12 October (maybe 50,000) to show their support for staying in Spain. If people think that more than a small minority actively oppose independence, then the best way to find out is to have a real referendum and see. Constant insinuation achieves nothing.<br />
<br />
GT also misses the key point about the elections as referendum proposal: this - in President Mas's opinion - is the only way to get the "no" side to actually campaign and vote - a key point in his international legitimization strategy.<br />
<b><br /></b>
<b>"Mr Mas may now be forced to call early elections."</b><br />
<br />
President Mas is not going to be FORCED to call early elections, as GT obviously knew since he explained to me he watched a video of the relevant press conference. The Catalan president is actively promoting them and sees these as the best way forward. In fact he is struggling with the other parties to get them to accept this idea and join a common list.<br />
<br />
<b>"The likely winner would be the radical ERC, which would lead a regional government encouraging civil disobedience, if the party sticks to its current position."
</b><br />
<br />
So again no, the likely winner wouldn't be ERC but the "yes-yes" vote. Mas has said he won't call early elections unless a common platform is agreed to. His mandate extends to November 2016. He doesn't even need the support of any other party to pass the 2015 budget since he can simply extend the validity of this year's in the same way he did this in 2011 with the 2010 ones he inherited when he came to office.<br />
<br />
You could, like Oriol Junqueras suggest he has electoral purposes in taking this stance. That is a matter of opinion. Think again about game theory and the prisoner's dilemma. The outcome of those elections wouldn't, in his opinion, be an immediate UDI, but hey, guess what, Artur Mas's blessed national transition - which it is suggested would last 18 months - during which time an attempt would be made to create the institutional infrastructure necessary for UDI. In fact he has has an advisory body on the national transition at work since the November 2012 elections preparing all the documentation and strategy precisely with this in mind. <br />
<br />
Naturally Madrid would probably not stand idly by - see comments above - but that is not what we are talking about here.<br />
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-78288675072501966342014-09-16T14:17:00.001+02:002014-09-16T14:17:35.765+02:00What Is The Risk The Euro Crisis Will Reignite?The euro zone crisis is not back -- at least not yet. <br />
<br />
Recent movements in global markets following concerns about Portugal’s Banco Espirito Santo really had as much to do with market nerves after a long spell of repressed volatility as it did with the state of the bank’s balance sheet. Despite the current calm, everyone knows that volatility will return one day, and no one wants to be caught on the back foot when it does arrive. So the initial response is to hit the “sell” button and then ask questions.<br />
<br />
Beyond this context, there is a lack of certainty in the market about which way bond yields for the so-called “peripheral” euro zone countries are heading in the near term -- and what exactly the risks associated with holding them really are. Riding the yield compression, in the case of the Portuguese 10-year bond from over 7 percent to under 3.5 percent was a one-way-bet no-brainer once the impact of Draghi’s July 2012 speech became crystal clear.<br />
<br />
But now yields have started to tick up again, so the advantages of holding in anticipation of further declines become less obvious, while the risks continue to mount. In many ways, the situation is analogous to yen depreciation and the Bank of Japan. The first leg was easy, as the yen fell into the 100 to 105 to USD range. But now it is stuck there, and the debate has become a “will she, won’t she” on further BoJ easing.<br />
<br />
It is clear the recent European Central Bank decision to launch Targeted Long-Term Refinancing Operations has disappointed. TLTRO's may do something to help ease access to credit in the south in the mid-term, but they will hardly be effective in combating deflation. In particular, we may need to wait more than six months to see any net liquidity impact, since the September and December allocations coincide with earlier LTRO repayments, leaving what Pantheon Macroeconimcs’ Claus Vistesen calls “a potentially worrying ‘air-pocket’ over the next six months where the central bank’s balance sheet continues to contract, making the verbal commitment to easing increasingly difficult to rely on as a sole back-stop."<br />
<br />
Will we really have to wait till 2015 to see any significant step to try to stop the deflation rot?<br />
<br />
Digging deeper, and beyond fears about what the coming ECB bank stress tests may turn up, the simple passage of time in itself could complicate things. The recent round of numbers has had everyone busily revising down their 2014 growth forecasts, and it is obvious that even if outright deflation is avoided inflation will be very, very low. In fact whether or not the Euro Area slumps back into outright recession or not seems to depend more on Vladimir Putin than on the ECB at the moment,<br />
<br />
But the key point to take away from all this is that nominal GDP over the next couple of years may barely increase, with the knock on consequence that sovereign debt levels in the most indebted countries will surely be jolted onwards and upwards. This is important since all official sector projections have these levels peaking either this year or next, but now these estimates will surely need to be revisited.<br />
<br />
Second quarter GDP data was horribly bad. France's economy stagnated, but more worryingly for policymakers Germany relapsed (minus 0.2 q-o-q), leaving Spain as the only one of the "big four" to put in a positive growth performance (0.6 q-o-q). While the immediate drag on short-term growth may well be the impact on sentiment of a crisis on the frontier between Ukraine and Russia, the Euro Area is now clearly stuck in some form of longer term <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">secular stagnation</a>. The daylight just around the next recovery corner argument rings hollower and hollower with each successive loss of momentum.<br />
<br />
"Europe is becoming Japanese" is an expression you hear more and more. People saying this normally point to the fact that German 10 year bund yields have now gone under 1% (and hence have started to look like 10 year JGBs). <br />
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<br />
But behind this argument lies some sort of version of "reverse causality". In Japan JGB yields have been driven to very low levels by central bank intervention, with the BoJ now buying a very large share of all new issue. The ECB isn't buying Euro Area sovereigns, the markets are in anticipation of QE. So to talk about the Japanification of Euroa Area yields is a little misleading. Bond purchasers and their models are PROVOKING this downward lurch, not weak growth or deflation. To push Mario Draghi into QE markets would need to move back into risk-off mode on periphery assets.
As long as the bond markets remain well behaved Draghi will do as little as possible, as I will discuss below.<br />
<br />
Another argument used to justify the "Japanisation" of the Euro Area idea carries much more clout, and that is the one being used by <a href="http://krugman.blogs.nytimes.com/2014/08/13/whats-the-matter-with-europe/?module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blogs&region=Body">Paul Krugman based on working age population dynamics</a>.<br />
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<blockquote class="tr_bq">
"If you’re worried that secular stagnation might be depressing the natural real rate of interest — the rate consistent with full employment — and you think that demography is a big factor, Europe looks really terrible, indeed full-on Japanese."
</blockquote>
The basic idea is that working age population dynamics play a big part in determining movements in aggregate demand and hence inflation (see my secular stagnation summary <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">here</a>). This idea received support from <a href="https://www.imf.org/external/pubs/cat/longres.aspx?sk=41812.0">a research paper published at the start of August</a> by a group of IMF economists - "Is Japan’s Population Aging Deflationary?" (authors Derek Anderson, Dennis Botman and Ben Hunt). The first part of the abstract runs as follows:<br />
<blockquote class="tr_bq">
"Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need."</blockquote>
Bottom line, despite all the denials from Mario Draghi that the Eurozone is not another Japan there are plenty of grounds for thinking that it will be.<br />
<br />
<b>So Which Way For The ECB?</b><br />
<br />
Evidently members of the EU Commission, ECB governing council members, and senior political leaders in Berlin, Amsterdam or Paris are neither theoreticians nor intellectuals. The secular stagnation hypothesis is at this point more akin to a theoretical research strategy than a workable template for policy-making, and policymakers are understandably reluctant to take decisions on the basis of what is still largely a hypothesis. <a href="http://www.voxeu.org/article/secular-stagnation-facts-causes-and-cures-new-vox-ebook">As the editors of a recent book on the topic</a> put it in their introduction: "Secular stagnation proved illusory after the Great Depression. It may well prove to be so after the Great Recession – it is still too early to tell. Uncertainty, however, is no excuse for inactivity. Most actions are no-regret policies anyway". As they suggest the risks here are far from evenly balanced. If countries like Japan, Italy and Portugal are suffering from some local variant of one common pathology, then normal solutions are unlikely to work, and matters can deteriorate fast.<br />
<br />
Naturally the ECB can go down the Abenomics path, and institute large scale sovereign bond purchases even while the Commission turns an increasingly blind eye to higher deficit spending at the country level. But it is far from clear that Abenomics works (see <a href="http://edwardhughtoo.blogspot.com.es/2014/08/abenomics-what-could-possibly-go-wrong.html">here</a>) and if it doesn't what happens to all the accumulated debt?<br />
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<br />
<br />
On the other hand time always has a cost. Letting things drift further means letting debt levels rise, and risking testing market patience and this becomes especially important in the cases of Italy and Portugal. The longer time passes the more difficult it is going to be for anyone to convince themselves that the debt of these countries is sustainable.<br />
<br />
So there may come a point after which the Germans simply will not allow Draghi to buy Italian bonds without a prior haircut (see my "Italian Runaway Train" <a href="http://italyeconomicinfo.blogspot.com.es/2014/08/the-italian-runaway-train.html">here</a>). OK, they've said they won't do more PSI, but they've said a lot of things, and the cost of irritating investors is limited when you have a regional current account surplus and a central bank buying bonds.<br />
<br />
Maybe the costs of the Euro "widowmaker" trade will be borne by all those eager bond purchasers who thought nothing could possibly go wrong. I am sure German politicians would decide a loss of credibility on PSI would be less costly to them than getting German taxpayers on the hook for current Italian debt levels. Especially in a country <a href="http://in.reuters.com/article/2014/08/14/germany-economy-debt-idINL6N0QK1PN20140814">where they are now proudly announcing</a> they have reduced government debt for the first time in more than 50 years. So in this case, maybe the turkeys just did vote for Xmas.<br />
<br />
The thing is, despite the meeting between Draghi and Renzi (who may also be a turkey by Xmas) nothing substantial is going to happen in Italy. The government is under no pressure to ask for help (and doesn't even feel it needs it), and Draghi won't act before things change. Gridlock - with rising debt. <br />
<br />
Naturally in the short term the “Mario Draghi ultimately has my back” feeling will still prevail, but with markets continuing to finance debt levels that any official study will soon have to recognize as unsustainable lack of proactive policies from the ECB will only fuel concerns that the size of the pill may become just too big for the bank to persuade Germany comfortably swallow, leaving the specter of private sector involvement to once more rear its ugly head. How do you tell people who have just sacrificed hard to get their debt under control that they are now about to help "pardon" 50% of someone else's. It simply doesn't make sense.<br />
<br />
************************************************************* <br />
<br />
These arguments are developed at greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really 0ver?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-85548817846116487602014-09-11T11:31:00.000+02:002014-09-12T08:48:54.259+02:00The Catalan Vote: Why It's Time To Start Getting Worried About Complacency In MadridWhen Barack Obama told a CNBC interviewer last autumn that Wall Street ought to be "genuinely worried about what is going on in Washington" in reference to the US government shutdown he raised more than a few eyebrows. Normally political leaders try to calm and reassure markets, so this attempt to stir them up on the part of the US President was, in its way, something of a first. <br />
<br />
Last May the Financial Times <a href="http://www.ft.com/intl/cms/s/0/619a8200-d201-11e3-8ff4-00144feabdc0.html#axzz3CzXTdlND">issued a similar warning</a> in an editorial with a clear message: right now you should be more worried than you are about what is happening in Madrid. According to the newspaper, “secessionist demands have created a rolling crisis involving Catalonia and the national government in Madrid,” a crisis which it warns could end in a “head on collision” if the issues being raised are not addressed.<br />
<br />
The issues have not been addressed, and there is now a provisional date for that woeful collision to occur: the 9 November this year, the date chosen by the Catalan parliament for the holding a popular (non binding, not a referendum) consultation under a new law which will receive parliamentary approval on 19 September. The original intention of the Catalan parliament was to hold a referendum on the region’s future authorized by Madrid. With that intent parliamentary representatives took a proposal last spring to the Spanish parliament. The reply was a polite but near unanimous “no” since Spain’s parliamentarians took the view any such vote could be considered “unconstitutional”.<br />
<br />
As Mariano Rajoy pointed out, given the way the Spanish Constitution is currently worded neither he, nor even the Spanish parliament, have the power to authorize such a vote. The Spanish prime minister’s view was also endorsed recently by the country’s constitutional court, who ruled that the proposed referendum would be unconstitutional under the terms of the constitution as it stands. The court however added an important rider to the judgment, a rider to do with the political problem of legitimacy. If in a discrete part of the national territory, the court suggested, a significant majority of the population are not satisfied with the current arrangements, and these arrangements are not changed, then a constitutional crisis ensues.<br />
<br />
Thus the issue moves from being a purely juridical one to a political one, and any eventual solution - even if this means accepting Catalan independence - needs in essence to be political. Effectively the court threw the ball back into the politicians’ court: if the constitution doesn’t permit a vote it can be changed, if there is the political will to do so. Amending the constitution didn’t seem to be such an insurmountable obstacle at the height of the sovereign debt crisis, when agreement was reach between the various parties in a matter of days to place constitutional limits on the level of government debt, a fact which does not escape the attention of those Catalans who feel themselves in urgent need of the right to a vote.<br />
<br />
This is also what the FT had in mind when the editorial argued “it is disingenuous” for Mariano Rajoy “to hide behind the Spanish constitution”. Sooner or later democracy will out. This is why the newspaper argues the Spanish government needs to urgently formulate some sort of counter proposal, along the lines of the so called “third way”: an approach going beyond the current arrangements but falling short of full independence. The core of such a proposal, the paper argues, would be an improved fiscal arrangement, and more autonomy. <br />
<br />
In the opinion of the present author these proposals look fine on paper, but arriving at any sort of agreement on them seems highly unlikely. In the first place, Spain’s ongoing economic issues make the financing of any new fiscal agreement extremely problematic. The economy may be showing signs of recovery, but it is a weak and fragile one, and the aftermath of the country’s property bust will cast a shadow of at least a decade over the country’s economic future. In addition there is no easy “win-win” solution available, since letting the Catalans keep more of their own money will undoubtedly mean someone else will receive less. Who will that someone else be? A glance at the political arithmetic shows that the major Spanish party closest to considering the third way is the socialist PSOE. But PSOE relies on votes from the country’s most populous region – Andalusia – and this would surely be one of the areas most negatively affected any substantial fiscal change.<br />
<br />
More autonomy sounds nice, but what exactly would it look like? Would it allow the region, for example, to opt out of laws which are highly unpopular in Catalonia like the recent abortion one or the proposal to make bullfighting form part of the national heritage? And what about the identitarian issues which are really what lie at the heart of the current tension? From the Spanish point of view, the most contentious of the Catalan demands is their claim to have their identity as a nation included in any rewritten constitution. Any addressing of this long standing grievance would seem to open the door to solving another, that of having national sports teams to compete in international competitions. Are Spaniards – not simply Madrid politicians – ready for this? <br />
<br />
Then there is the language. Far from the impression being given that Spaniards are getting more and more comfortable with linguistic coexistence the situation seems to be quite the opposite, with moves to restrict the use of the language in schools having taken place in the regions of Valencia, the Balearic Islands, and Aragon, in each of which there are significant Catalan speaking communities. Even in Catalonia proper the central government is currently trying to implement an education reform which restricts the autonomy of the Catalan education minister to decide matters of language policy. It is hard to see in any of this a reflection of a will to improve relations.<br />
<br />
It seems to me that such feelings of national identity affect both Spaniards and Catalans. They are strong and deep seated, on both sides, and far more important than the economic ones. The difficulty is they cannot be changed either in committee or overnight. I repeat, is there any real sign of a desire among the Spanish population to make the sort of attitude changes which a successful implementation of a third way would imply? President Mas visited Prime Minister Rajoy in the Moncloa in July to discuss the situation. He presented a list of 23 issues about which they could talk. To date the Spanish Prime Minister has not replied. He seems content simply to chant the mantra "there will be no vote". But as the Constitutional Court pointed out you cannot generate political legitimacy by only explaining what won't happen.<br />
<br />
Naturally this "no" to the possibility of voting has come to the forefront in recent days with the publication of an opinion poll showing that the "yes" vote might win in Scotland. <br />
<br />
As for the Catalans, we have yet to discover what it is they really want. This is what the demand for a vote is all about, so that the wishes of Catalans can be registered in a fashion which goes beyond the innumerable opinion polls. Determining what people actually want is a basic prerequisite so that the democratic process can then go to work. In the meantime they will simply look on in envy on the 18 September as Scots exercise their basic right.<br />
<br />
What then happens next? The Catalan parliament will on 19 September pass into law a formula which will allow opinion seeking, non-binding consultations to be held under Catalan rather than Spanish law. It is not clear at this point whether the Madrid government will challenge this law. Possibly they won't, since it is probably not unconstitutional. Then the Catalan parliament will pass as second decree law convening a consultation with an already announced question for the 9 November. Madrid have already made clear that they will not permit this question to be asked and will take the matter to the Constitutional Court.<br />
<br />
Which brings us to 9 November itself: if it is not possible to have a vote then Catalonia’s President Mas has suggested he might call plebiscitary elections. The purpose of these elections would not be – as some suggest – to authorize the parliament to declare UDI, but to establish the size of the majority in favor of a vote. The newly constituted parliament will then have the responsibility for deciding what to do next.It would be a mistake to think that these elections - if held - would be the end of the matter. They will take the collision onto a new level and generate a very high degree of uncertainty about where things are going from that point on.<br />
<br />
So although the world will not change on November 10, and even if there are elections instead of a vote on independence the outcome could well produce a definitive sea change about how Catalans view their relations with Spain. They may well mark a “point of no return”. So to go back to where we started. Right now global markets and most of the international press are being pretty sanguine about the situation, when – as President Obama suggested in the case of the US government crisis – perhaps they shouldn’t be. Perhaps they should be worried about the complacency in Madrid, and remember that one of the principal ways of letting something unexpected happen is to assume it won’t. Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-88119623605815292262014-07-15T15:36:00.001+02:002014-08-14T19:59:42.121+02:00Spain and the IMF: Round the Bend or Out of the Woods?"Spain has turned the corner". With this stark statement the IMF opened it's annual <a href="http://www.imf.org/external/pubs/ft/scr/2014/cr14192.pdf" target="_blank">Article IV consultation report for 2014</a>. Naturally the statement rankled, with this author among others, because at first sight it seems to be saying something which on closer reading of the report you find it isn't. At best it's misleading, possibly from a PR point of view intentionally so, but then Article IV reports are supposed to be more sober, measured assessments. One Spanish journalist summed up the surprise many felt <a href="https://twitter.com/claudiperez/status/487527958023004160" target="_blank">in the following tweet</a>. <br />
<blockquote class="tr_bq">
Dear IMF,
You can't say "Spain has turned the corner" and "the unemployment remains unacceptably high" in the same paper
It's silly
Yours,
C</blockquote>
What I suppose the authors of the report were trying to convey was the feeling that an important turning point had been passed along the long winding road out of the mess that was generated in Spain in the first seven years of the Euro's existence. Personally I can't help feeling the expression would have been none the less prosaic and much more complete had they added the line from a well know Jimmy Cliff song - yet there are still "many rivers left to cross". Equally, "not through the rapids yet" comes to mind.<br />
<br />
The danger of putting things in the way the IMF Spain team just did is that you open yourself up to the accusation of being complacent, even self-congratulatory, and almost lacking in the necessary even handedness since it could be seen as lending a helping hand to a struggling government which is about to ramp up its 2015 election campaign. Indeed more than one journalist took it this way. <br />
<br />
There's a danger here, one of institutional credibility, should the economy once more succumb and fall back into a triple dip. Indeed the downside risks detailed in the report offer plenty of arguments as to why just that might well happen. In any event this wouldn't be - as Landon Thomas <a href="http://www.nytimes.com/2012/06/27/business/global/spanish-officials-hailed-banks-as-the-crisis-built.html?pagewanted=all&_r=0" target="_blank">pointed out in this article</a> - the first time the Fund has gotten things badly wrong on Spain.<br />
<br />
<b> Fair And Balanced?</b><br />
<br />
The thing is, once you get past that troublesome first phrase, much of the report - leaving aside one or two topics I will draw attention to - seems remarkably unobjectionable. The opening paragraph continues, "Growth has resumed, labor market trends are
improving, the current account is in surplus, banks are healthier, and sovereign yields are at record lows", most of which is unquestionably true.<br />
<br />
And then those positive evaluations are suitably and appropriately counterbalanced by a string negatives, "But unemployment is unacceptably high, incomes have fallen,
trend productivity growth is low, and the deleveraging of high debt burdens—public and private—is weighing on growth".<br />
<br />
So actually the fund isn't at all saying that all is well in Spain, and that the level 5 alert is now all but over - far from it. Perhaps an opening phrase more in tenor with the general drift would have been "Spain's recovery continues to gain traction".<br />
<br />
<b>Export Lead Recovery?</b><br />
<br />
As I say, most of the positive assessment offered is valid. Most, but not all. There is one exception: the state of the current account. It is no longer positive.<br />
<br />
Surely it is true to say, as the authors do, that "Spain has managed a remarkable improvement in its current account". During the last 5 years the balance improved by 11 percent of GDP, moving from a deficit of 10 percent in 2007 to a 1 percent surplus in 2013. But that was then, and this is now, and as the recovery has progressed part of the improvement has been lost. During the 8 months between May and December 2013 the account was in positive territory. 8 months in something like the last 150. For each of the five months of 2014 however - just as the economy has been accelerating - it has been consistently negative. Indeed the fact this might happen was expressed as a constant concern in earlier editions of the report (namely, that as things improved the CA balance would once more turn negative). Now it has, which is perhaps one of the reasons why they were ill-advised to use that "corner turning" phrase.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4WV6RDbOSbazb9iLx2X-LPI4Db-DtgFjiGIDe7vF9_abPfErFVAygkb2VFSYDYkK-paC_-lRv__kqCPDwJUCB6J4Z0OJwp71BoPqyafyYgFCbEHuBQ-MwhTPfzSR40jKnUoke/s1600/current+account+balance.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4WV6RDbOSbazb9iLx2X-LPI4Db-DtgFjiGIDe7vF9_abPfErFVAygkb2VFSYDYkK-paC_-lRv__kqCPDwJUCB6J4Z0OJwp71BoPqyafyYgFCbEHuBQ-MwhTPfzSR40jKnUoke/s1600/current+account+balance.png" height="171" width="320" /></a></div>
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As the Fund points out, only one other advanced large non-commodity exporting country has managed to achieve a current account improvement of a similar order, and that was South Korea in 1997–98 (so comparisons and precedents here are few and far between), and the key factor in the Korean case was the ability to devalue the Won. As the Fund says:<br />
<blockquote class="tr_bq">
"Spain’s current account improvement is particularly notable given that it was achieved without nominal depreciation. South Korea’s adjustment was facilitated by a large nominal exchange rate depreciation, an option that was not available to Spain. While Spain’s real effective exchange rate (REER) did depreciate significantly based on unit labor costs, it largely reflected labor shedding. The CPI-based REER has not depreciated much."</blockquote>
What the authors are getting at here is that Spain's nominal internal devaluation was very small, and indeed the overwhelming majority of Spanish experts have consistently argued that more wasn't needed since the economy hadn't lost as much competitiveness as "outsiders" claimed. On the other hand there was a large improvement in Unit Labour Costs produced by the comparatively small fall in GDP output (roughly 7%) and the very large drop in the number of those working (about 20%), but this way of doing things always left the concern that as the economy started creating jobs again the average Unit Labour Cost would start to rise again, as we have seen happen in Ireland (see chart below).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5KE2m7A-VXi3TcwkTwm9rigctodO_SpOIyWtscAphqKWtnG7iudB4Hse6vWzg0378AggE2AJCeTalNr_vW5u0Hn2e301s6XWefc9B6N7LPTNs_0Gu1l3RkVsSSFp6enxGhXg7/s1600/2014-07-13_115057.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5KE2m7A-VXi3TcwkTwm9rigctodO_SpOIyWtscAphqKWtnG7iudB4Hse6vWzg0378AggE2AJCeTalNr_vW5u0Hn2e301s6XWefc9B6N7LPTNs_0Gu1l3RkVsSSFp6enxGhXg7/s1600/2014-07-13_115057.png" height="229" width="320" /></a></div>
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In fact there is even some indication that this may already be happening. In the 12 months to March the economy grew by 0.6% while the number of those paying national insurance contributions (a reasonable proxy for employment) rose by 115,000 (or 0.7%). As a result the rate of productivity improvement has declined sharply.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaPONloa-mUfo-G1798nl8snS_rXnKNabvzdWdhQea4J-VUdt5iAp6V4DxXs8httGU9SLRewSGUrGN8ENtOfCEWPv7RLGowoHv1he52TCAtQvN4MjQQe-FOnJLk6RdNf31tBK9/s1600/Spain+productivity.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaPONloa-mUfo-G1798nl8snS_rXnKNabvzdWdhQea4J-VUdt5iAp6V4DxXs8httGU9SLRewSGUrGN8ENtOfCEWPv7RLGowoHv1he52TCAtQvN4MjQQe-FOnJLk6RdNf31tBK9/s1600/Spain+productivity.png" height="180" width="320" /></a></div>
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The danger thus is that many of the hard won gains of the crisis years are unwound during recovery. The current account deficit fell sharply on the back of the drop sharp drop in employment which accompanied the crisis as consumption collapsed (retail sales are still down 30% from 2007 peak) and imports followed suit. Little by little this process is now reversing, imports are once more rising as domestic consumption starts to recover and the goods trade surplus is once more deteriorating.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-o_ivdT-iAQNccOTl5klBhqkF0CTu1MxpIW8tw1Lrd9I5TWEdlDO7mejQNcDZFmcQXf7K1zmK46auyiWZRK2udsjgryFBA-Pdtrw4SEB9j08U9r0Ejphg8XeJJKGrX6PYWCt8/s1600/W+Bank+of+Spain+Goods+deficit.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-o_ivdT-iAQNccOTl5klBhqkF0CTu1MxpIW8tw1Lrd9I5TWEdlDO7mejQNcDZFmcQXf7K1zmK46auyiWZRK2udsjgryFBA-Pdtrw4SEB9j08U9r0Ejphg8XeJJKGrX6PYWCt8/s1600/W+Bank+of+Spain+Goods+deficit.png" height="182" width="320" /></a></div>
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So the correction is far from complete at this point and the risk the corner has been not been completely turned is not negligible. Which bring me to another minor quibble with this section of the report. "Exports are performing well," the authors tell us. Well perhaps the best thing that can be said about this statement is that it is a little bit out of date. In the three months to May Spain's goods exports were up by 2.75% over the same period a year earlier. In comparison in 2013 they were up by 6.5%. Spain's export machine has been losing momentum, and - <a href="http://edwardhughtoo.blogspot.com.es/2014/04/spain-land-where-incipient-deflation.html" target="_blank">as I argue in this post</a> -exports are now roughly stuck at the level they were at in June last year. Naturally there are reasons for this, emerging markets who were strong Spanish customers last year have had their own crisis, and now tensions in Eastern Europe surrounding Ukraine may be leading the Euro Area itself to loose momentum. But this is just it, a fragile and tenuous recovery is easily knocked off balance.<br />
<br />
The current position can perhaps be best summed up by the situation described in the chart below. Between 2010 and 2013 the economy was re-balancing nicely with external demand doing the heavy lifting while the current account moved towards balance, but over the last twelve months things have changed and external demand is now, once more, a negative drag on the economy as imports rise. This is obviously a worrying development, and naturally a cause for concern.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfXxvbEJJ8ZbN0HX7FuDEAChw_bKywVgvpNErxpMqKh3scnjyijUtJsVK-Lb1xN8zFzwvS4X0Nwh1l5eIqbl_bhXazKSgentjzFVsleJsSzYZioqdgPgVhe2I1M1wUovTTx-ao3Q/s1600/2014-05-29_093847.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfXxvbEJJ8ZbN0HX7FuDEAChw_bKywVgvpNErxpMqKh3scnjyijUtJsVK-Lb1xN8zFzwvS4X0Nwh1l5eIqbl_bhXazKSgentjzFVsleJsSzYZioqdgPgVhe2I1M1wUovTTx-ao3Q/s1600/2014-05-29_093847.png" height="176" width="320" /></a></div>
<br />
Indeed the authors of the IMF report more or less implicitly accept that the external correction is far from complete when they say:<br />
<blockquote class="tr_bq">
"Model-based and historical REER analysis suggests the real effective exchange rate is some 5–
15 percent above the level consistent with medium-term fundamentals and desirable policies. However,
achieving significantly lower unemployment rates closer to international peers in the medium term may
require an even larger adjustment in the exchange rate".
</blockquote>
<b>What Does Unacceptably Mean?</b><br />
<br />
I think we are all in agreement on one thing: Spain's unemployment remains unacceptably high. But what does "unacceptable" mean? Well normally it means you don't continue to accept it and do something about it. And this is just the part I find missing from this year's IMF report.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzq35MZ7KlHY_kjSTY78wDBl_gncI1kQ5gMNlRItyNjVB35Dv5OzPke5n119b4AVuBCFqVqaKiOkzQOsJwfiIkr_QuJtvpuE2rj40J3lI8Tra7rRpwWkFRgypEx3IZrEzGYR1l/s1600/unemployment+one.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzq35MZ7KlHY_kjSTY78wDBl_gncI1kQ5gMNlRItyNjVB35Dv5OzPke5n119b4AVuBCFqVqaKiOkzQOsJwfiIkr_QuJtvpuE2rj40J3lI8Tra7rRpwWkFRgypEx3IZrEzGYR1l/s1600/unemployment+one.png" height="172" width="320" /></a></div>
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If we go back twelve months, and take a look at last years report, then it's easy to notice a clear difference: the IMF offered a proposal for <b>doing</b> something. Essentially the proposal, which naturally was not at all popular in Spain, was to move towards a wage cut in return for job sharing (indeed I myself agreed with this proposal - see my "<a href="http://spaineconomy.blogspot.com.es/2013/09/doing-nothing-is-not-option.html" target="_blank">Doing Nothing Is Not An Option</a>", and even wrote a chapter arguing for it in my <a href="http://www.amazon.es/%C2%BFAdi%C3%B3s-crisis-superado-recesi%C3%B3n-recuperaci%C3%B3n/dp/8423418510/ref=sr_1_1?ie=UTF8&qid=1395218690&sr=8-1&keywords=edward+hugh" target="_blank">Spanish book on Spain</a>).<br />
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Another possibility, which I have personally advanced inside Spain, would be to temporarily change the retirement regulations to allow people to retire from 60 onwards on the condition that their employer replaces them with someone previously unemployed and under 30 (not obviously job for job) on a long term contract.<br />
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Now, you will say, doesn't this roll back the 2010 pension reform which tied retirement ages to life expectancy and saw a progressive increase in retirement age from 65 to 67? This reform was much applauded at the time, and was indeed a core part of the Zapatero government's attempt to regain market credibility. My response to this objection is, indeed it would, but lets think about the situation for a moment, and in particular about the meaning of Keynes's oft over-cited phrase, "in the long run we are all dead". What Keynes is getting at here is that we need to be "nimble of thought" enough to be able to distinguish between the different time horizons involved in economic policy. (And not simply shrug our shoulders because "in the long run it will all sort itself out). Simply because something is advantageous in the long run, doesn't mean that a policy to promote it is what is needed in the shorter term. There can be a trade-off of interests, and doing something which might be harmful in the longer run (running up government debt), could be not only a palliative in the short run but could lead to a superior long run outcome if it is done wisely. The dilemma we face in Spain was summed up in more theoretical terms by the founder of modern growth theory - Robert Solow - when he admitted in his <a href="http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1987/solow-lecture.html" target="_blank">Nobel acceptance speech</a>, that "the problem of combining long-run and short-run macroeconomics has still not been solved".<br />
<br />
In the long run, despite the fact that we will all die, we are all living longer, and having longer working lives makes sense. But in the short run, in a country with 5.9 million people unemployed (half of them for over a year) and over 50% of those between 16 and 24 who are looking for work unable to find it, asking people to work longer doesn't seem to make that much sense. <br />
<br />
Letting people retire to be replaced by people with a younger mindset makes obvious economic and productivity sense, but what about the implications of such a decision for the pensions system? Wouldn't this be moving backwards? Well this is where the second (2013) pension reform comes in. That reform introduced the principle of "sustainability" into the Spanish pension system. Sustainability means - across the economic cycle - as much money needs to come in as goes out. I think this is a good reform, indeed a vital one, since it turns Spanish pensions from being a defined benefits system (which would be unable to live up to its promise) into an easy to understand defined contributions one. The pension system becomes an implicit contract between those working and those receiving benefits and takes the government (and most importantly its finances) out of the middle. There is a formula to decide how much can be paid in any given time period, so if more people suddenly start claiming pensions naturally pensions will go down proportionately, but there is no system to collapse, and there will be no knock on effect on government finances.<br />
<br />
What both these proposals have in common is that they involve solidarity and they involve sacrifice, and neither of these seem to be very much in fashion at the moment. But people need to be aware of the <b>longer run consequences of doing nothing</b>. And this is just where expressions like "Spain has turned the corner" don't really help, since they don't put people in the right frame of mind. If unemployment <b>is</b> unacceptably high then it is an urgent matter to do something more about it, and not just sit there with our arms folded to see if the IMF forecast of unemployment moving under 20% in 2019 is fulfilled or whether it happens in 2018, or 2020. These kind of outcomes simply won't do, and as we will see below they will have long run consequences for Spain.<br />
<br />
<b>Long Run Growth Potential</b><br />
<br />
I think virtually everybody agrees that the Spanish economy will grow this year at a rate lying somewhere between 1% and 2%. Naturally a lot of debate and energy has been invested in arguing about just which end of the range will be nearer the final mark. The end result, whatever it is, will be better than expected six months or so ago but at the same time it will hardly constitute an economic revolution. No game changer to see here, please move along.<br />
<br />
The issue is really what we can expect from Spain in the years ahead, well beyond 2014 and 2015, and in approaching that tricky question there is no piece of current economic data that can help us decide. We need a different approach: growth analysis.<br />
<br />
To put things into some sort of perspective on this account it is worth perhaps noting Spanish retail sales were up a mere 0.3% in the three months through May over the same period a year earlier, while industrial output was up around 2.5% over the same time horizon. The notable difference between these two numbers reflects the fact that at the end of the day the future of Spain's economy is now more linked to the sale of industrial products abroad than it is to the level of shop sales at home. But the second thought to take away is the sobering one that both of these indicators are still down around 30% since 2007, and that at current rates the economy will need over a decade to get them back to earlier levels, if it ever does.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFNuJPXYLozHFdOCkz1VU0PNqXCD9mbB7j03C-Jb-KJfEaoUdyz1HeggJvTmjv9Yz8E_chpYXhzhLZixzigzkxO1Dbuma-EkREVm2IjJPk5UGsicaG8qwsEe4bCAlVHnizpIgJ/s1600/retail+sales.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFNuJPXYLozHFdOCkz1VU0PNqXCD9mbB7j03C-Jb-KJfEaoUdyz1HeggJvTmjv9Yz8E_chpYXhzhLZixzigzkxO1Dbuma-EkREVm2IjJPk5UGsicaG8qwsEe4bCAlVHnizpIgJ/s1600/retail+sales.png" height="192" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMGtIwPuUU08aqRNZCQAvfl9oHwDsVHCGfORvMAMpZwXHODoIsqg0Ms2G_HfITfcEGzRGVYKcFQ1o2j9oiKPIGtJk6RLfk0qDUBTlC3kD4NaLZcK9tBqf-dMuZW9xrFmuRhTBd/s1600/industrial+output.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMGtIwPuUU08aqRNZCQAvfl9oHwDsVHCGfORvMAMpZwXHODoIsqg0Ms2G_HfITfcEGzRGVYKcFQ1o2j9oiKPIGtJk6RLfk0qDUBTlC3kD4NaLZcK9tBqf-dMuZW9xrFmuRhTBd/s1600/industrial+output.png" height="178" width="320" /></a></div>
<br />
I say *if* it ever does, since a clear possibility exists we may not <b>ever</b> see Spanish retail sales activity in getting back to their earlier pre-crisis highs. The reasoning behind this idea is simple: after rising rapidly in the first decade of the century Spain's population is now falling and aging at quite a rapid rate, and if that rate isn't at least slowed then a decade from now (whatever the reform progress the country makes) it is hard to see the Spanish economy eking out a hell of a lot in the way of growth. Which means if we don't hit those pre-crisis levels soon, which we surely won't, we may never do so - a more thorough explanation of the justification for this (for many perhaps surprising) assertion can be found in my <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html" target="_blank">Secular Stagnation Part 1 - Paul Krugman's Bicycling Problem</a>).<br />
<br />
What we need to think about then are not the country's short-term economic dynamics, but its growth potential in the longer term. On this issue the recent report <b>does</b> indeed have something to say (and what it says is backed-up by a deeper analysis in the 2014 edition of <a href="http://www.imf.org/external/pubs/ft/scr/2014/cr14193.pdf" target="_blank">Spain Selected Issues</a>). The authors of the Article IV report tell us the following:<br />
<blockquote class="tr_bq">
"Longer-term potential growth prospects also appear weaker than in the boom years. Growth during 1995–2007 was sustained by large accumulation of capital (the credit-fuelled housing boom) and labor (immigration and rising participation rates) hiding a substantial decline in productivity growth. Demographic trends have now turned negative (emigration and the ageing population) and capital accumulation will likely be lower (given the large rise during the boom and falling population). Spain will also need to tackle the negative effects of very high structural unemployment. <b>In this context, potential growth may only be around 1 percent over the medium term</b>."</blockquote>
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They back up the idea that Spain's longer term growth outlook (as opposed to short term recovery-from-the-slump growth) is moving steadily lower with the help of the nice chart I reproduce below.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEid8KqgEoSA5KPqGOW7ZVJb2iA0NuQqTrgt-arBN-mmP1fzVM7nRwBIUBhNBbyde2gNFRHWhsSEIPSSYtFPNHddHdNNQz8B_AHi8T0_UZR0vwme6gLBhXg7yaKJGkP3VJ4yiMBB/s1600/2014-07-15_105701.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEid8KqgEoSA5KPqGOW7ZVJb2iA0NuQqTrgt-arBN-mmP1fzVM7nRwBIUBhNBbyde2gNFRHWhsSEIPSSYtFPNHddHdNNQz8B_AHi8T0_UZR0vwme6gLBhXg7yaKJGkP3VJ4yiMBB/s1600/2014-07-15_105701.png" height="231" width="320" /></a></div>
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Over time Spain's growth rate is falling, as it has been in most developed economies. In the Spanish case while the economy grew by an average of 3.5% a year between 1995 and 2007 there was an important structural shift taking place. The rate of per capita GDP growth slump dramatically after 2000 as the employed population surged and <b>much of the growth became labour intensive</b>, a point which is illustrated nicely by another IMF chart:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWbMKORDHcHk2lJLIU51iEH9-jxe8i80rgxKnLaiEQos5j9g9z6NvfqEiOkLqK2FZELqxxKz3pnxW626mZASQW389PAiDypHBsvIc9SZz_WCeBfNIL9IvHbKx9meDutu-B57kH/s1600/2014-07-15_110600.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWbMKORDHcHk2lJLIU51iEH9-jxe8i80rgxKnLaiEQos5j9g9z6NvfqEiOkLqK2FZELqxxKz3pnxW626mZASQW389PAiDypHBsvIc9SZz_WCeBfNIL9IvHbKx9meDutu-B57kH/s1600/2014-07-15_110600.png" height="146" width="320" /></a></div>
Before the mid 1990s a significant part of Spain's growth had come from productivity improvements. Even in the second half of the nineties this remained to some extent the case. But between 2000 and 2007 the red markers almost completely disappear from the chart and as can be readily seen from the chart growth was almost entirely explained by increases in the capital stock (the result of construction activity) and higher labour force growth. This is not the direction a country which wishes to raise its living standards by engaging in higher value added work wants to go.<br />
<br />
Now, in the wake of the crisis, the country faces an enormous challenge since it has to start raising average productivity at the same time as it tries to put 3 million low skilled workers back to work. We have noted above that Spain has been creating employment on much lower than expected GDP growth, this is only partly good news, since the other side of the coin is that productivity improvements (see the red markers in 2012/13) are now slowing. This is what many feared might happen (current again deficit turn negative, productivity gains weaken) and is a warning signal that the current recovery may not be on such solid ground as some imagine.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYpz__vkQKTqKgBMhii1k8nNcHKw7mim8l973U06NFEMi-4xMUkkpTWYcLTLhUwuN1SFgof5n42ebIVxe15eBLW09A5oRhHGVV2NmLZDsMpgeDCZisfT0GHnrM70DpzgOz-8k7/s1600/Spain+productivity.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYpz__vkQKTqKgBMhii1k8nNcHKw7mim8l973U06NFEMi-4xMUkkpTWYcLTLhUwuN1SFgof5n42ebIVxe15eBLW09A5oRhHGVV2NmLZDsMpgeDCZisfT0GHnrM70DpzgOz-8k7/s1600/Spain+productivity.png" height="180" width="320" /></a></div>
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But moving beyond the present, the reason we can expect this ongoing fall in trend growth rate to continue has to do with the composition of growth and how trend growth is estimated. Basically long term growth potential is a function of working age population dynamics and total factor productivity (TFP) growth, as shown in the diagram below which illustrates the version of the approach used by the EU commission.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_nQNXhIVYfzii-M8Zr6tuWm_XV7UwQynl-Kpzk7GhV35-TCHqfcSgcyztqUJ1PYhHeew0RN-J9HPyU-CC5Fj5CMpImmQbU3X-yG47m3tIRKQOpkT_gXeo0Kg71ItRsIKvPEArOA/s1600/Latvia+Output+Gap+Model.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_nQNXhIVYfzii-M8Zr6tuWm_XV7UwQynl-Kpzk7GhV35-TCHqfcSgcyztqUJ1PYhHeew0RN-J9HPyU-CC5Fj5CMpImmQbU3X-yG47m3tIRKQOpkT_gXeo0Kg71ItRsIKvPEArOA/s320/Latvia+Output+Gap+Model.png" height="244" width="320" /></a></div>
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Leaving immigration and emigration aside for a moment, Spain's population is now virtually stagnant, fertility is around 1.3 (tfr) and the annual balance will soon turn negative. The annual number of births had been rising before the crisis, but has now started falling again (see chart from statistics office below). <br />
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The annual balance between births and deaths also rose to a peak in the boom years only to subsequently fall back (see chart below). In fact the difference between births and deaths was a record low of 36,181 in 2013, and within a few years the balance will surely be negative. But again we need to remember, in economic growth terms it isn't the size of the population that matters, it is the age structure, and Spain's working age population will certainly shrink faster than the overall population will. So even on the best of scenarios Spain's workforce is now facing slow and steady decline and this will undoubtedly bring down the trend growth performance.<br />
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But Spain isn't facing the best of scenarios. Where once people were arriving, the dire state of the country's labour market means they are now leaving. And once we factor in immigration, things start to get a bit more dramatic. As the IMF notes (in the <a href="http://www.imf.org/external/pubs/ft/scr/2014/cr14193.pdf" target="_blank">2014 selected issues document</a>):<br />
<blockquote class="tr_bq">
"Demographics have turned negative. After expanding at a fast pace until 2007, population growth slowed significantly and turned negative in 2012. This is likely to be a new trend, as INE projects working-age population to continue to decline over the next years........Labor dynamics will make a much weaker contribution to potential output. Demographics will be a drag on growth due to declining working-age population (emigration and ageing). The Spanish statistical agency (INE) expects working-age population to fall by 1 percent a year over the medium term." </blockquote>
During the boom years over nearly 6 million immigrants came to live or work in Spain. The population - which as we have seen is nearly stationary in terms of births minus deaths - shot up from 40 to 46 million. <br />
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But now, as the IMF say, this dynamic has turned negative. Quite how many people of working age are leaving Spain every year is hard to say. This, in part, is because while the number of former immigrants leaving is known with a reasonable degree of accuracy, the number of young Spanish nationals who do so is much harder to pin down, in part because you need to go to receiving countries like the UK and Germany to obtain the data since most Spaniards who are working abroad have not registered with the national authorities.<br />
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According to the latest estimates (30 June 2014) the net number of emigrants leaving Spain in 2013 was 256,849. Of these the net number of Spanish nationals leaving was 45,913. But this latter number is confusing since during 2013 some 190,000 former immigrants obtained Spanish nationality and some of these subsequently left for other EU countries. More to the point perhaps, is that these are net numbers. The gross numbers are even more shocking: over half a million people left Spain in 2013 (547,890 to be exact), while some 291,041 new immigrants arrived.<br />
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Now I don't want to get into the issue of the enormous tragedy that is taking place daily on Europe's southern borders (and in any event many of the newcomers currently arriving in Spain are doing so as part of family regroupment processes) but the absolute number of people leaving is very large, and those leaving possess a skill set which is vastly superior to that of those arriving, so in the longer run the human capital drain on Spain is massive, again reducing the potential longer term growth rate. As the IMF point out, projections here are pretty risky, but still the Spanish statistics office (INE) have made an attempt, and the result can be seen in the table below.<br />
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The impact of this hemorrhage (if it is confirmed over time) on Spain's population pyramid will look something like this.<br />
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Basically Spain's population will suddenly have become<b> much smaller and much older</b>. The population will fall by 2.6 million, and the number of people in the 20 to 49 age group <b>will fall by 4.7 million</b> (or 22.7%). This is why it is so important to try to do something more and boost employment rapidly. Otherwise the impact on long term growth will be sizable, and the pressure to reduce pensions constant. This INE population and emigration forecast is, if you like, based on a no policy change assumption, on what will probably happen unless substantially more is done. It is the sense of urgency about this need to do something more that I - and others - do not find encapsulated in the phrase "Spain has turned the corner". If these population projections are realized then quite simply it won't have done so. Pensions, for one thing, will be set on a continuously downward path, which is why I think pensioners could be convinced of the need for them to make sacrifices now, if the situation were better explained to them. For another the debt which is currently accumulating will have fewer and fewer people left to pay it. And lets not even start talking about the impact of this sharp reduction on the value of Spanish property.<br />
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The real problem in Spain - and this issue isn't treated in the report - is the complete collapse of civic confidence in many of Spain's institutions, from the Bank of Spain, to market regulator CNMV (the Bankia IPO, Preference Shares), to politicians and political parties (the Barcenas affair, among many others), to the monarchy. It is this crisis of confidence which makes it so difficult to get the consensus to make more sacrifices.<br />
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Many say that there can't possibly be 25% unemployment in Spain since if there were there would be a revolution (referring to the existence of the underground economy but conveniently forgetting that the worst years of the 1930s depression were not years of revolution, those came later).<br />
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What people are missing about Spain is the way the credibility of the institutional structure is weakening. Voices talking about a constitutional crisis are growing. The economic crisis basically coincided with the moment when the set up established - including the return of the monarchy - during the transition from Franco's dictatorship to democracy was increasingly seen as having "run its course". Many observers recognise that major constitutional reform is needed and some kind of "rebirth" and renovation in the political system. Last months EU elections were the latest warning signal. The two main political parties (the so called institutional parties) for the first time since the transition failed to get over 50% of the popular vote between them, while the Syriza-like Podemos - who hadn't even been listed in the opinion surveys - surged from nowhere to take 5 seats and 9% of the vote. And in Catalonia a large majority of voters voted for parties who are actively campaigning for independence from Spain. A general election is coming next year, but it is hard to see either of the "old" parties getting a majority without a complex set of coalition partners.<br />
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So rather than asking whether Spain has now gone round the bend perhaps the Fund would have been better off sticking with "Getting better, but not out of the woods yet, not by a long way".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-3240912656046275432014-05-29T18:33:00.000+02:002014-05-29T13:20:07.024+02:00Spain: The Land Where Incipient Deflation Becomes Good News For Headline GDP (Updated 29/05/2014).The Spanish National Statistics Office (INE) today published the first detailed estimate of Spain's Q1 GDP. Basically they confirm the gist of the original Bank of Spain numbers (see my report of 25 March below) although there are some important nuances.<br />
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In my earlier report, I stressed that Spain's Q1 surge was as much a statistical artifact as anything else since:<br />
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a) Nominal GDP growth was virtually stagnant, and the application of the (negative) GDP price deflator (see explanation in earlier report below) explained most of the annual growth.<br />
b) Spain's strong export drive has stalled, with exports being little changed in March 2014 from September 2013.<br />
c) There was a major input from government spending. An important part of the explanation for the momentum behind Spain's recovery has been the relaxation of austerity, and the strong injection of government funded liquidity into the economy.<br />
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All these three trends are confirmed by the latest data, albeit, as I say, with significant nuances.<br />
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<b>GDP deflator</b>: Inter-annual real GDP growth was revised to 0.5% from the 0.6% in the INE flash estimate. More importantly we learnt today that nominal GDP fell 0.1% over the year, confirming the impression that despite the recovery people had less money in their pockets (this is what deflation means).<br />
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<b>Export recovery</b>: exports fell by less than originally estimated (by 0.4% quarter on quarter rather than by 0.6%) but the big change came in imports which moved from an estimated fall of 1.2% (q-o-q) to a <b>rise</b> of 1.5%. The net trade contribution to the final GDP number thus swang from being 0.2% positive to 0.2% negative. However the impression that this is no longer an export lead recovery was confirmed, as was the fear that as government-stimulus fed domestic demand imports would once more surge. This seems to confirm the idea that the economy is not as internationally competitive as the official sector claim it is.<br />
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<b>Government spending</b>: the big shocker in the latest report is the role played by government spending in arriving at the final number. The Bank of Spain only mentioned there had been an increase, giving no estimate for its magnitude. Today we learn that government spending was up 4.4% on a quarterly basis, following a 3.9% decline in the last quarter.This confirms the impression that there was a significant ending-the-budget-year-early effect (see original report below), as spending was transferred from Q4 2013 to Q1 2014. It also confirms the impression obtained from the Q1 labour force survey where we learnt that while private sector employment contracted during the first three months of the year, public sector employment <b>rose</b> by 11,100. Naturally, if the government is to comply with this years reduced deficit target this momentum cannot be maintained, suggesting we will now see some weakening in the headline GDP number.<br />
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In fact <a href="http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/InformesBoletinesRevistas/BoletinEconomico/14/May/Fich/be1405-evo.pdf">in their latest report on the Spanish economy</a> (published May 28) the Bank of Spain confirm this impression, saying that "Los indicadores coyunturales más recientes apuntan, en general, a una prolongación de la fase de recuperación de la actividad, si bien se aprecia distinta intensidad según se trate de información procedente de indicadores cualitativos o cuantitativos". Roughly translated this means that the recoverey phase has continued into the second quarter although the intensity may have reduced according to which indicator you look at (hard and soft). They cite the EU household confidence indicator, which continued to improve in April but less than in the previous three months. Also sales (both of goods and services) by large companies moderated their annual growth rates in March compared with earlier months. To me it looks like Q2 quarterly growth will be weaker than Q1. possibly in the order of 0.2%. <br />
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Construction activity is an interesting area. The INE Q1 report suggests a quarterly decline in construction activity of 2.6%, yet <a href="http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-19052014-AP/EN/4-19052014-AP-EN.PDF">data supplied by the INE to Eurostat</a> show a 9% rise during the quarter, an improvement that is consistent with other information available. Spain has something like 400,000 unfinished houses and bad bank Sareb and investment funds who have purchased distressed property loans <a href="http://www.bloomberg.com/news/2014-05-25/spain-sees-embers-glow-in-wreckage-of-property-crash.html">appear to be finishing some of these housing units off in readiness to let</a>.<br />
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All in all the argument I am pursuing here is not that Spain's economy isn't recovering - it is - but that the recovery is much weaker and much less well balanced than many think it is. Momentum going forward looks weaker than people expect, employment growth is tepid (except in the public sector), and the fall in unemployment is as much a product of people leaving the country or retiring as of anything else. Spain is already in deflation, house purchases continue to be postponed awaiting a further fall in prices, and the hard won rebalancing of the economy towards external trade is steadily being undermined.<br />
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Perhaps just one data point sums this whole problem up. According to seasonally adjusted data, nominal GDP rose by 1.432 billion euros during the quarter, while nominal government spending rose by 2.494 billion euros (or almost double). Not a very impressive bang for the buck. Go figure.<br />
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<b>Spain: The Land Where Incipient Deflation Becomes Good News For Headline GDP - 25 April original review</b><br />
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According to the bank of Spain, the Spanish economy continued to push forward with its recent expansion in the first quarter, and it do so at an accelerated rate, growing by 0.4% over the previous three months. This is certainly good news for everyone in Spain, and there is no doubt that this is the strongest expansion in economic activity (see PMI chart below) since the crisis started. The economy also grew by 0.5% over a year earlier, the first time it has done this in nine quarters.<br />
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Nonethless many of the old doubts about the durability and sustainability of the Spanish expansion remain. The labour market is still a huge problem, the housing market is gridlocked, credit is scarce and expensive, and the population is shrinking at nearly 1% a year as discouraged workers (both nationals and former migrants) pack their bags and leave. In addition, concerns are mounting that the current government, with low ratings in the polls and elections coming next year, <a href="http://www.bloomberg.com/news/2014-03-25/rajoy-wavering-brings-italy-economy-risks-to-spain-euro-credit.html" target="_blank">has lost the appetite for reform</a>. Here I will focus on three issues that strike me in connection with the latest GDP numbers: the stagnation in the export boom, the difficulties being encountered in reducing the deficit and the ongoing deflation issue. The big question still remains: is this a balanced recovery, an export lead one, or simply a government financed one?<br />
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<b>Composition of Growth </b><br />
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Here to help think about all this is the Bank of Spain breakdown of recent economic growth.<br />
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GDP is a composite, derived by aggregating a number of components. Principal among these are private consumption and investment, public consumption and investment and net trade. If we look at the composition of growth in Spain in the first three months of this year we find that private consumption grew, but less rapidly (0.3 vs 0.5) than in the preceding three months, government consumption and investment grew (vs contraction at the end of last year) but we don't know by how much because, unfortunately, the BoS don't tell us. Net trade was positive - despite the fact that both exports and imports were down (on a seasonally adjusted basis, by 0.6% and 1.2% respectively). Since imports were down by more than exports, net trade was positive and contributed an estimated 0.2 percentage points (or half) to growth. If imports had fallen by less, by say only 0.6%, then Spanish GDP would only have grown by half (0.2%), such are the quirks of GDP calculations. But it is surely not unequivocally good news if you have had to rely on a slump in imports to get that highest-growth-in-recent-years number.<br />
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Lastly Spain is officially in deflation, both of the falling expectations and purchases postponement kind - <a href="http://edwardhughtoo.blogspot.com.es/2014/04/firmly-anchored-expectations-no.html" target="_blank">see this post yesterday</a> - and this is recognised by the presence of a negative GDP deflator, which estimates a fall of 0.4% in GDP price inputs when compared with a year earlier. More on this later.<br />
<br />
<b>What is going on with exports?</b><br />
<br />
Spanish exports have been an important part of the country's recovery story, no doubt about that. Services exports (mainly tourism) have been up consistently. But if Spain is to become "the new Germany", and this is what will be needed (current account surplus and all) if the country is to return to stable growth, goods exports need to grow and keep growing at a steady rate, and this is where the evidence we have to hand is a little less than convincing.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhOsASZ5cUSUR0SkJHmwBHnr6cEjxlvdUUiMpehuF4TLU7TMydQOvNWN_By0sNshlkWWXfmURWW_i0XajlAfcPsFI6jW3TXBAD2zC0WVMuPUETnMTpu4-3DiD0_lyj9VD2GfQO4/s1600/Spain+Constant+Price+Exports.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhOsASZ5cUSUR0SkJHmwBHnr6cEjxlvdUUiMpehuF4TLU7TMydQOvNWN_By0sNshlkWWXfmURWW_i0XajlAfcPsFI6jW3TXBAD2zC0WVMuPUETnMTpu4-3DiD0_lyj9VD2GfQO4/s1600/Spain+Constant+Price+Exports.png" height="191" width="320" /></a></div>
The fact of the matter is that - according to the latest bank of Spain estimates - goods and services exports ended March at the same level they reached at the end of last September. This is surely a strange result for a country during one of its best moments in an export driven recovery. True Spanish exports are up about 7% over where they were a year ago, but almost all this growth came in the second three months of 2013, just before the impact of Federal Reserve Tapering (which hit in May) was felt in the fast growing emerging markets. Sound familiar?<br />
<br />
So in fact while the export story does continue on a modified basis, with growth in the Euro Area picking up some of the slack left by the demise of the EM customer base, it is a long way from being as vibrant as it was. This tendency is clearly revealed in <a href="http://www.mineco.gob.es/portal/site/mineco/menuitem.ac30f9268750bd56a0b0240e026041a0/?vgnextoid=2a21be5f7a965410VgnVCM1000001d04140aRCRD&vgnextchannel=864e154527515310VgnVCM1000001d04140aRCRD" target="_blank">the latest press release</a> from the Economy Ministry covering exports (for February). While in the whole of 2013 export to the Euro Area were only up 0.1%, in January and February of 2014 they were up by 5.5% from a year earlier. Meanwhile exports to non EU destinations were only up by 0.4% over last year even though exports to the US, China and Japan all increased by significant percentages.<br />
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Not only are goods exports when compared with six months earlier rather stationary at the moment, the order books suggest the situation won't be improving radically in the coming months as the following chart from the national statistics office illustrates. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-u6BTtOXzctNYFrDXpeZynoJlWdRcAH_6w8b29pGvtV6Or35nEEJuh1_eEpkPgVsgqa5MhJIXQ3nEvuLDUWtRR67UE3JN0vz8f6bNYDDVN_CZeHQRYQxCpj1jbi5Wa0gemBwp/s1600/2014-04-24_192429.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-u6BTtOXzctNYFrDXpeZynoJlWdRcAH_6w8b29pGvtV6Or35nEEJuh1_eEpkPgVsgqa5MhJIXQ3nEvuLDUWtRR67UE3JN0vz8f6bNYDDVN_CZeHQRYQxCpj1jbi5Wa0gemBwp/s1600/2014-04-24_192429.png" height="134" width="320" /></a></div>
<br />
Overall new orders were down year on year by 1% in February, with orders from the domestic market - which were down by 2.2% - dragging the aggregate with it. Export orders were positive, but the composition changed, with demand from the Euro Area up 1.6%, while orders from outside the EA were down by 4.8%. <br />
<br />
This division between improving export orders and weakening domestic ones is an ongoing story, as the following chart, again from the INE, illustrates. The interesting line is the seasonally adjusted one, and it shows that only in two months in the last two years - December 2013 and August 2012 - have industrial orders been above the level of a year earlier. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNZRGQL6Xn3JvkjeT1VLKA9b_LMeg_lbWZjYo_uqrTqq_sxQOjes7iF9nopuQ6UVg_CC-_jNy6yP4d2LeIBke7JTS4vH0F_CENebyYhJiDSkMpiFLQJYulQWe8oe6S3wNsmwjU/s1600/2014-04-24_195858.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNZRGQL6Xn3JvkjeT1VLKA9b_LMeg_lbWZjYo_uqrTqq_sxQOjes7iF9nopuQ6UVg_CC-_jNy6yP4d2LeIBke7JTS4vH0F_CENebyYhJiDSkMpiFLQJYulQWe8oe6S3wNsmwjU/s1600/2014-04-24_195858.png" height="177" width="320" /></a></div>
<br />
This phenomenon is due to the enduring weakness of domestic demand, and even
with the recovery the pattern doesn't seem to have been radically
altered. Industrial output is up, but only very very marginally, hardly noticeably even in the great scheme of things.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgo0szpM7DoJcUW8D0IdCKEcXyRDAKdran6FCLdmHu5GmWyPZ2Cvxi-o9RlePsEE3azjA61U51yLUQJEcQTiPoJ6t7PDcZDJ21gC9hHFCmfxvQpn7Rft_0B6BN6eWIgRATnDJsN/s1600/industrial+output.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgo0szpM7DoJcUW8D0IdCKEcXyRDAKdran6FCLdmHu5GmWyPZ2Cvxi-o9RlePsEE3azjA61U51yLUQJEcQTiPoJ6t7PDcZDJ21gC9hHFCmfxvQpn7Rft_0B6BN6eWIgRATnDJsN/s1600/industrial+output.png" height="177" width="320" /></a></div>
<br />
In the meantime, the fact that domestic demand is rising has been having a negative impact on the evolution of the goods trade balance, which after hitting a historic surplus high last March has been in deficit territory almost ever since.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsJNsjeC2qopSDWG4hlS81sDlaxjpv6Gfv1aAiznIOY4lsoT-9H1mK_VnBHslssbljjeK9foNJqysIqoFBRpH5rj0qJgDs4nEDRQctSHnUrMocJWOXwpP0f3ImRs59QDnAjS5F/s1600/W+Bank+of+Spain+Goods+deficit.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsJNsjeC2qopSDWG4hlS81sDlaxjpv6Gfv1aAiznIOY4lsoT-9H1mK_VnBHslssbljjeK9foNJqysIqoFBRpH5rj0qJgDs4nEDRQctSHnUrMocJWOXwpP0f3ImRs59QDnAjS5F/s1600/W+Bank+of+Spain+Goods+deficit.png" height="188" width="320" /></a></div>
<br />
<br />
Indeed if we look at the trend, after steadily reducing the deficit has once more stabilized well in negative territory. So while Spain's export sector has made considerable progress - more than most, but then the country's problems are greater than most - there is still a long road left to travel. Most importantly a net trade impact based on a sharp fall in imports is not what we should be seeing at a point where the recovery is gathering traction. It does not suggest a broadening out into steadily improving domestic consumer demand, but quite the contrary.<br />
<br />
<b>Deficit Difficulties</b><br />
<br />
Spain, as is well known, was given extra time by the EU Commission - 2 additional years - to bring its fiscal deficit down below the 3% of GDP mark. In fact the country has made enormous efforts to reduce the deficit, but the results of such efforts have often been far less than had been hoped for. After hitting a peak of 11.2% of GDP in 2009, the deficit figure has meandered from 9.7% in 2010 to 9.6% in 2011 to 10.8% in 2012, to finally reach 6.6% in 2013. Not surprisingly this deficit record has produced a rather astonishing surge in the government debt level, from 36% of GDP at the onset of the crisis in 2007 to the current level of nearly 100%.<br />
<br />
But even this 2013 6.6% number is not everything it seems to be, since the government was forced to draw down some 2% of GDP extra from the <a href="http://www.seg-social.es/Internet_1/Estadistica/FondodeReservadelaS48074/index.htm" target="_blank">pension reserve fund</a> (intended to help get the country through the difficult demographic moment that arrives at the end of the decade) and a further 1% of GDP from the <a href="http://www.cuatrecasas.com/media_repository/docs/esp/fund_for_financing_payments_to_suppliers_(fondo_para_la_financiacion_de_pagos_a_proveedores_or_ffpp)_951.pdf" target="_blank">Suppliers Fund</a> (which is to pay suppliers previously unpaid bills). Neither of these liquidity injections affects the EDP deficit, but both certainly help the government square the difference between spending and income. Even so, in order to maintain the 6.6% number (actually it should have been 6.5%) the government was forced to draw the budget year to a close on November 25.<br />
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As reported in March in the Bloomberg article - <a href="http://www.bloomberg.com/news/2014-03-27/spanish-government-ended-2013-in-november-in-bid-to-curb-deficit.html" target="_blank">Spanish Government Ended 2013 in November to Reduce Deficit</a> - Spain brought forward the deadline for approving spending in the annual budget for the second straight year in 2013 following a 2012 decision to end the year on December 3. Previously the cut-off date had been the last working day of the year. Hence the enigmatic statement from the Bank of Spain that both government consumption and investment grew in Q1 following "their marked decline in the closing months of 2013". The marked decline was partly due to the cut-off date, so for deficit compliance reasons some of the spending was transferred to Q1 2014, giving a small boost to the headline GDP number.<br />
<br />
In fact, the EDP accounting measure is becoming an increasingly blunt instrument for measuring the extent of Spain government spending and the dynamic of its debt obligations. According to Bank of Spain data there were something like 1.35 trillion euros of Spain government debt obligations in circulation at the close of 2013, as compared with the 961 billion euros worth which count as debt under EDP rules. I <a href="http://www.economonitor.com/edwardhugh/2012/03/06/homeric-similes-and-spanish-debt/" target="_blank">dealt with this issue at some length</a> a couple of years back, but leaving aside the details - groso modo - it is clear that there is much more Spanish debt out there than many are assuming. Even more surprising is the fact that total debt obligations rose by some 14.5% during 2013, and that 56% of this increase came under headings which don't count towards the EDP measure.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkOssn41ZmsEOULdsuXb6tVxFzoeWGwNkzNtOwogqbfFa1R264JLvnA-xXA07j89hsZTXgfNy9EdB04J9gbZ5saatkKlp9rUU4M5mzi5ri_tb2oe8gwRoYkK3-fpy9HUBxDZ9P/s1600/2014-04-24_181104.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkOssn41ZmsEOULdsuXb6tVxFzoeWGwNkzNtOwogqbfFa1R264JLvnA-xXA07j89hsZTXgfNy9EdB04J9gbZ5saatkKlp9rUU4M5mzi5ri_tb2oe8gwRoYkK3-fpy9HUBxDZ9P/s1600/2014-04-24_181104.png" height="200" width="320" /></a></div>
The argument here is not to suggest that Spanish gross sovereign debt is 132% of GDP (which a superficial reading of the headline number would suggest) - the reality is more complicated - but that it is certainly significantly higher than the 93.9% of GDP reported to Brussels under the EDP criteria. But even more importantly - and this is really the argument I want to get across - in order to achieve a positive GDP quarterly growth figure at this point it is almost impossible to really reduce the scale of the fiscal deficit, whatever Herculean efforts you make. The rest is simply smoke and mirrors.<br />
<br />
<b>The Role of the GDP Deflator</b><br />
<br />
Finally we come to what may well be the most important doubt that enters my head when I look at that Bank of Spain table I reproduce above: the role played by the magnitude of the GDP deflator in arriving at the headline GDP number. The GDP deflator is the measure that is used to convert nominal (current prices) GDP into real (comparing apples with apples and not with pears) GDP, since it is an attempt to remove the impact of price movements (inflation or deflation) from the final benchmark GDP reading. Let's take an example. If nominal GDP grows 5% and inflation is 3% then real GDP has grown by 2%. If inflation is then re-estimated at 2% then real GDP growth turns out to have been 3%, and so on. Compensating for deflation is when things start to get more complicated, and doing so when nominal GDP is either stationary or negative is when the world gets really wonky.<br />
<br />
Lets take the case where nominal GDP grows by 2%, and deflation is 1% - then real GDP grows by no less than 3% (you have to add the deflation number, not subtract the inflation one, if in difficulty ask the Japanese for help, they have been doing this for years). Now lets imagine a case where quarterly nominal GDP growth is zero, but the GDP deflator is estimated at minus 0.4% (aha, now you see where I am going). Then in this case real GDP grows on the quarter by 0.4% (precisely the current Spanish result). Supposing that later you revise this estimate to minus 0.2%, then GDP growth is halved at a stroke, since it also becomes 0.2%.<br />
<br />
I am not the first person in the world to to think about this issue, and especially not in connection with Spanish GDP data. Back in August last year the UK economist Shaun Richards wrote a blog post - <a href="http://www.mindfulmoney.co.uk/wp/shaun-richards/what-is-happening-with-the-national-accounts-and-gdp-of-spain/">What is happening with the national accounts and GDP of Spain?</a> - which dealt with a number of similar issues. Shaun examines the impact of a series of data revisions carried out at the end of Q2 2013 and draws some thought provoking conclusions.<br />
<br />
In particular he examines the impact of a number of statistics office revisions to the GDP deflator estimates. As he tells us, <br />
<blockquote class="tr_bq">
"we get a new view on Spain by observing that it (the estimated GDP deflator) has been effectively zero since the end of 2008. I am slightly exaggerating as in fact it adds up to 0.17% but I hope that you get the point.
The revisions here have been large as the number was previously 1.58%! Now consider GDP numbers which are sometimes poured over for 0.1% and we see one more time that such behaviour is bizarre as they are by no means that accurate. Indeed 2011 seems to be a troubled year for Spain’s accounts as implied deflator inflation was 0.96% and is now 0.02% which is much more like 1% than 0.1%." </blockquote>
Certainly then the GDP deflator plays a very central role in final Spanish GDP outcomes, and the sensitivity of the early GDP estimates to errors in the deflator value is striking. As I am suggesting here the value attributed for Q1 2014 effectively accounts for 100% of the estimated GDP growth, and the probability of subsequent revision is, going by past experience, large. Indeed in the Spanish context could it be said to be the loop which finally squares any unfortunate circular gaps in the national accounts?<br />
<br />
And when I said when nominal GDP is close to zero things get wonky, I meant it. According to data from the Spanish national statistics office, seasonally adjusted nominal quarterly GDP hasn't budged more than a decimal point from 255 billion euros since Q2 2013 (see chart below), and even then the decimal movement has been downwards. We don't have an estimate for the first quarter of this year yet, but if the 0.4% real growth and the minus 0.4% GDP deflator estimates are confirmed, then it should be just about where it was during Q4 2013.<br />
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<br />
I was surprised to find this, but then maybe I shouldn't have been since shopkeepers have been telling me for months that the takings in their tills hadn't improved. Now we know why. There has been an improvement in output VOLUME and COMPOSITION, since prices have been falling and the economy has reorientated somewhat, but not in overall turnover. Looking at these numbers one of two things are true. Either Spain has been sliding steadily into deflation over the last year, or there has been no recovery. There would seem to be no available third reading. The most probable interpretation of the data we have to date would be the former, that Spain is sinking steadily into deflation. I assume the statisticians at the economy ministry understand GDP calculations sufficiently to get this. In which case the constant denials, and references to early Easter "one offs" etc would seem to be totally irresponsible. <br />
<br />
<br />
So, the ability of the Bank of Spain to offer an early estimate (normally confirmed by the INE first estimate) of GDP growth - based on the variables included in the economy ministry's synthetic indicator - comes at a price: you need to wait 12 or 18 months to get a much more precise measure of what is going on. As Shaun says: <br />
<blockquote class="tr_bq">
One of the issues with Gross Domestic Product numbers is that they are revised over time sometimes significantly. This does not fit well with the short attention span of modern media and so leads to an obvious temptation to publish relatively optimistic figures and then revise them later once the hue and cry of the pack has died down.
<b> </b></blockquote>
<br />
<b>Conclusions</b><br />
<br />
As I state at the outset, I have no doubt whatsoever that Spain's economy is undergoing a modest recovery. Even economy minister <a href="http://uk.mobile.reuters.com/article/summitNews/idUKBREA1C0KA20140213" target="_blank">Luis de Guindos calls it</a> weak, fragile and uneven. Serious doubts exist about the extent to which we are going to see anything resembling a "classic recovery" in Spain, a recovery where solid export growth eventually broadens out into a wider improvement in domestic consumption and investment, even though this is what financial markets increasingly seem to be pricing in. Press headlines have trumpeted the country's new found growth, but when you dig under the surface and find that most of the latest growth is either accounted for by a sharp DROP IN IMPORTS, or by a CALENDAR ADJUSTMENT IN GOVERNMENT ACCOUNTING, or by the ESTIMATED ARRIVAL OF DEFLATION then the conclusions you draw are hardly reassuring ones.<br />
<br />
If in addition these highly-subject-to-later-revision initial estimates are used by the incumbent government to try to shore up its wobbly position, and also used as an justification for not carrying out deeper reform - especially in the labour market where unemployment remains over 25% - then beyond not being reassuring they start to become preoccupying.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-8322382118828113642014-04-20T13:47:00.000+02:002014-04-21T16:46:58.114+02:00Firmly Anchored Expectations, No Postponement of Purchases?<a href="http://www.ft.com/intl/cms/s/0/35e0fe3e-c318-11e3-b6b5-00144feabdc0.html#axzz2zEfPj18r" target="_blank">This article</a> from former European Central Bank board member Jürgen Stark (<i>Doomsayers risk a self-fulfilling prophecy</i>) has been occasioning a lot of commentary over the last week or so.<br />
According to Stark, the current deflation debate "lacks three important points: an in-depth analysis of the forces driving inflation down; a clear distinction between “benign disinflation” and “bad deflation”, with a spiral of decreasing prices, wages and output triggered by negative expectations; and a better understanding of the European Central Bank’s approach".<br />
<br />
Perhaps<a href="http://krugman.blogs.nytimes.com/2014/04/15/blaming-the-messengers-euro-edition/?module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blogs&region=Body" target="_blank"> the most cited extract</a> is the following:<br />
<br />
"It is likely we are living in an extended period of price stability. This is good news. It boosts real disposable income and will eventually support private consumption. Inflation expectations are well anchored, and there is no evidence households and companies are delaying purchases because of negative expectations. Warnings about outright deflation and calls for ECB action are misguided and irresponsible. The longer this discussion continues, and the more intense it becomes, the more likely the risk of a self-fulfilling prophecy".<br />
<br />
Two questionable assertions immediately struck me, the idea that inflation expectations are well anchored, and the claim there is no evidence households are delaying purchases because of negative expectations.<br />
<br />
<br />
<b>Well Anchored Expectations? </b><br />
<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNBj0uNGc2HuKDVdIohOaShr9Sg98kftbUVzjdi8Qa14PwCLXd7JUg67cTopre27IgtSVvrIOZ6-LXBZ_29NyMFjw_65DRUKS3rCZPBQZcOsMrED1s9TAPESJmdo2gzMjicPa0/s1600/2014-04-08_120156.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNBj0uNGc2HuKDVdIohOaShr9Sg98kftbUVzjdi8Qa14PwCLXd7JUg67cTopre27IgtSVvrIOZ6-LXBZ_29NyMFjw_65DRUKS3rCZPBQZcOsMrED1s9TAPESJmdo2gzMjicPa0/s1600/2014-04-08_120156.png" height="234" width="320" /></a></div>
The above chart shows implied inflation expectations as derived from the swaps market. As can be seen expectations have been steadily falling for more than a year now, and they are falling right across the 2014 - 2018 term horizon. Indeed, as of the time of writing the implied inflation rate is still (at around1.75%) below the ECB 2% inflation objective 10 years from now (see chart below).<br />
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<br />
If these are well anchored expectations, well, I'd like to see what badly anchored ones looked like..... <br />
<br />
<br />
<b>Purchase Postponement Evidence From Spain's Housing Market</b><br />
<br />
The second claim I find questionable is that we have NO evidence for
purchase postponement decisions. The phenomenon may not be widespread at this point - first of all prices actually have to start to fall - but let's take a look at what has been happening
in Spain. House prices have now been falling steadily since the end of
2007 (I use the real estate valuers TINSA index). <br />
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House prices are now down around 40% and continue to fall. There is no
reliable estimate of when the slide in house prices will come to an end,
and buyers act accordingly. New home sales, despite a massive stock of
nearly a million units (between completed and still to be completed),
remain near historic lows, and were down in February over 30% from a
year earlier.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzm4jggG3-ZMXrdcxw61Vo2fKoe_qDq9M1kRKnELxZ7LZtqwWN7ejEMO3sphiaTBsrBhUEEk4c4nPEKp-t6oRxpNa2Os0FBnXAtLjDnRPKifRDb6AfVpXwl9fpzttLrTmbmVHw/s1600/Spain+new+houses+sold.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzm4jggG3-ZMXrdcxw61Vo2fKoe_qDq9M1kRKnELxZ7LZtqwWN7ejEMO3sphiaTBsrBhUEEk4c4nPEKp-t6oRxpNa2Os0FBnXAtLjDnRPKifRDb6AfVpXwl9fpzttLrTmbmVHw/s1600/Spain+new+houses+sold.png" height="174" width="320" /></a></div>
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It's clear that people are delaying purchases in the expectation of lower prices in the future, and they will continue to do so. Why does this matter. Well, let's look at some charts for Japan.<br />
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The collapse in land prices was one of the principle underlying elements driving debt deflation in Japan. In Spain we don't have a reliable land price index (to my knowledge) but it might be worth bearing in mind that before he left the Bank of Spain former governor Miguel Angel Fernandez Ordoñez jokingly told journalists that "well, we shouldn't expect these assets to have negative value, now should we?" Not sure he continues to have a smile on his face when he talks about this. These land assets may now be largely provisioned for and valued at virtually zero, but there are a lot of them remaining on bank balance sheets and stored in the "bad bank" Sareb, and it isn't clear what the impact would be of releasing them at market value on the price of new homes. (Hint, in many urban areas the land cost was roughly 50% of the final house price before the crisis).<br />
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To some extent it is the collapse in land prices that has acted as an underlying drag on retail prices in Japan. In the EU HICP housing costs are not included. If they were Spain would already be stuck in entrenched deflation.<br />
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Naturally, the Spanish housing market can be discounted by some as an isolated phenomenon, although I would argue it is important enough to make it very difficult to see the ECB being able to raise rates over any foreseeable time horizon due to the pain this would cause to those with mortgages. But how many other examples like this may there be lurking out there? Has Jürgen Stark really run a systematic search, or is he simply repeating - as in the case of well anchored inflation claim - what could be considered to be the official mantra.<br />
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Meanwhile we simply watch and wait. Spain EU HICP consumer inflation at minus 0.2% in March over a year earlier. <br />
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While Spain's factory gate prices dropped an annual 2.9% in February. <br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-49817973134869420112014-02-27T18:50:00.001+01:002014-03-06T09:37:12.028+01:00A Simple Chart Illustrating Why Japan Style Deflation Is Now More Or Less Inevitable In SpainHere's one simple chart which illustrates why I think Japan style deflation is now more or less inevitable in Spain. Curiously it comes from the Ministry of Employment and illustrates the relation between the movement in average wages caused by actual movements in the real wage and those caused by what is known as the "compositional effect". This latter is known by this name because it is the result of movements in the composition of the workforce, whether this be in terms of the average skill level or the average level of experience (or seniority premium, if you prefer). Seniority has historically played a very important part in the Spanish wage structure - ie the longer you have worked the more you are likely to earn. <br />
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Now if you look at the data superficially, you find that in the first years of the crisis average real salaries went up sharply (the blue line). This surge in average salaries was not due to salaries actually rising to this extent, rather it was the result of the composition of the workforce having changed (the average skill level went up) as unskilled workers in construction lost their jobs. Hence the 2009 spike in the composition effect.<br />
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According to Bank of Spain data in 2008 skilled workers represented 23.55% of the total while by 2012 the proportion had risen to 28.2%. On the other hand, over the same time period unskilled workers fell from 14.8% to 10.2% of the total.This naturally had an impact on average wage levels.<br />
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Now, however, the labour market has stabilised, and unskilled workers are no longer losing their jobs (at least not in net terms). According to <a href="http://www.expansion.com/2014/02/26/economia/1393406392.html">the Spanish newspaper Expansion</a> the Spanish statistics office estimate average hourly labour costs (not unit labour costs, note) fell in Spain by 2.9% en 2012, 1.9% in 2013 and they are expected to fall another 1.7% this year.<br />
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Again, looking at the chart you can see that the green (compositional effect) line which surged in 2009 has now flattened. It has flattened but the impact is still there and has stabilised at a more or less constant rate. Subsequently it is quite possible that the compositional effect will even turn negative due to the impact of the 2012 labour market reform: average salaries are no longer falling due to labour shedding producing a changing skill composition but due to AGE CHURN. Older workers with long term contracts and lots of seniority are being steadily replaced by younger ones on less well paid contracts, thus dragging down the average wage. The line is flat and extends out in to the future. This can go on for years now, and indeed the compositional effect can even turn negative.This is exactly what has been happening over the years in Japan, and is the principal reason why Abenomics isn't working.<br />
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Incidentally, here I have been talking about average hourly labour costs NOT those famous unit labour costs. These, as we all know, fell significantly in Spain after the onset of the crisis. What isn't so well understood is that this fall wasn't due to falling hourly wage costs (these didn't really start falling till mid 2010, see blue line in chart) but due to massive labour shedding. Spain's GDP has fallen by something like 7% while employment is down by around 20%.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnFVcTP3Yk1msPN28h-YmeD0wKVOAiUmH0h8mD1BPXZE7UCj6lc7NgM35LfOV3TshjSMxlGguVsvgxOUz0cF78Y7dtUBiOU8bL1HUArsa12sRvzGhsr7sK944Z06X3w0m2dNcppw/s1600/Spain+Unit+Labour+Costs.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnFVcTP3Yk1msPN28h-YmeD0wKVOAiUmH0h8mD1BPXZE7UCj6lc7NgM35LfOV3TshjSMxlGguVsvgxOUz0cF78Y7dtUBiOU8bL1HUArsa12sRvzGhsr7sK944Z06X3w0m2dNcppw/s1600/Spain+Unit+Labour+Costs.png" height="233" width="320" /></a></div>
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On the surface this shows a large gain in productivity. Where this gain is actually coming from hasn't been sufficiently analysed yet, but part surely comes from a compositional shift in the labour force. One thing is, however, reasonably clear and that is that it hasn't come from industrial productivity, since industrial output is down by some 30% since the pre-crisis peak, even more than the reduction in employment.(I'm afraid you'll have to stare very hard at the industrial output chart if you want to see signs of the much proclaimed recovery - you'll have to stare very hard since there is so little sign of it).
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So why do I think this suggests deflation may become endemic in Spain? Well, with average real wages falling, real pensions falling, and credit still shrinking by around 6% a year it is hard to see where the demand is going to come from, especially with very little happening in the way of new employment - the shortfall is becoming structurally implanted.<br />
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For more argument on all this (in Spanish) see my book which is being published by Ediciones Deusto next week. You can find a list of chapter headings<a href="http://economicresources.blogspot.com.es/2014/02/adios-la-crisis.html"> here</a>.<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-86850834615020879762013-10-05T18:43:00.001+02:002013-10-08T09:18:42.047+02:00Can demography explain Portugal's growth slump before the crash?<br />
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The above still comes from a recent Financial Times video entitled "Portugal's Brain Drain", <a href="http://video.ft.com/2658893392001/Portugal-s-brain-drain/World" target="_blank">which can be found here</a>, and which I encourage everyone to watch. The issue being raised revolves around the current acceleration of emigration from countries on the EU periphery, largely towards the EU core. Typically the emigrants are young educated people who can't find work. There is nothing especially surprising in this, since the tendency has long existed for people to move from more depressed areas to economically more dynamic ones. The exodus from Detroit in the United States immediately comes to mind. Or Scottish people getting on the bus to make the fateful journey from Edinburgh or Glasgow to London. The Schengen accord simply extends this process which used to take place within nation states to single market zones, or currency unions. But does this extension have consequences for the participating states which were not anticipated at the outset, and are these consequences all benign?<br />
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In addition, this time round in an important sense something is different since these movements are occurring in the context of a long and difficult economic adjustment, indeed one could almost argue that <strong>the people leaving form part of that adjustmen</strong>t. What's more it is hard to accept that this is the kind of adjustment that countries like Spain and Portugal really need. Renovation in these countries implies these people and their talent are injected into the local economy to dynamise it, and not shot out the side like water from a high pressure hose with holes in it. So the big question I want to ask here is whether the economic programs which are being implemented in these countries take sufficient account of the demographic impacts they are inducing, and of the fact that the population loss involved - which most likely will become permanent - is going to cast a long shadow over the history of the countries concerned.
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In earlier generations, migrants used to leave behind them what were comparatively high fertility societies. There were more children being born than the local economy could absorb. We can still see this phenomenon in the world around us, as highlighted by the recent tragedy near Lampedusa, Italy. But the EU periphery case is rather different becuase - as the article I publish below indicates - the countries people are leaving are going to be short of working age population in a not too distant future. Again, as blogger Valter Martins argues, maybe the impact of stagnating working age populations was already being felt before the global crisis broke out. Certainly, <a href="http://fistfulofeuros.net/afoe/as-good-as-it-gets-in-latvia/" target="_blank">as I argue here</a>, a case can be made that in Latvia it was the labour force limitation which lead to the excessive overheating and then the roller coaster landing that hit the country in 2008.<br />
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True, all these countries are suffering excessive levels of unemployment. But unlike the case of, say, Nigeria or Ecuador, this is not because there are too many young people for the economy to absorb, it is because the economy is stuck in a bad place and can't grow. Structural reforms are needed, but some of the reforms simply don't make sense. What is the point, for example, in lengthening the working life of older, less productive, workers while going to the airport to wave goodbye to their innovative and educated grandchildren who are forced to leave as a result. Surely a better solution would be sustainability in the pensions system - what goes out in total can be no greater than what comes in - and no reduction in the retirement age in the short term. Yes, this will mean lower pensions, but <b>if the young leave</b> the lower pensions will be even lower in the long run. There's a problem of priorities somewhere, and a generational imbalance in how the adjustment is being implemented which is not only unfair, it will lead to far from optimal outcomes in the longer run.<br />
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As it happens, just a couple of weeks ago three IMF economists (including chief economist Olivier Blanchard) <a href="http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&ved=0CDMQFjAB&url=http%3A%2F%2Fwww.brookings.edu%2Fabout%2Fprojects%2Fbpea%2Flatest-conference%2F2013-fall-blanchard-latvia-crisis&ei=95FGUpnPC9CQhQfIroHABQ&usg=AFQjCNFaJzMEle0-sFAoMc3355xDFQrW9Q&sig2=RXegwak10p6-QM445GdHFw&bvm=bv.53217764,d.ZG4" target="_blank">presented a paper</a> to the Brookings Institute which reviewed the performance of the Latvian economy since the EU-IMF intervention. It was a kind of informal post program evaluation. Interestingly enough, during the course of that paper they raise the very point I am raising here.
“<b>The question</b>," they say, "<b>is whether this emigration [from Latvia, EH] is, in some sense, a failure of the adjustment program.</b>"<br />
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They are right. This is exactly the question we should be asking ourselves. And in Portugal, Spain and Greece too. Their answer - from an economic point of view emigration <b>raises overall welfare</b>:<br />
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"In the United States, migration rather than unemployment is the major margin of adjustment to state specific shocks ….. These adjustments are typically seen as good, indeed as the main reason why the United States functions well as a common currency area: If there are jobs in other states, and if moving costs are low, it is better for workers to move to those jobs than to remain unemployed.”<br />
<br />
This is the typical "non answer" we keep getting to this issue in the EU context. Obviously, from the point of view of optimal output, and the maximizing resources across a continent, most probably such movements are beneficial. But to whom are they beneficial? Which "collective" community is it whose overall welfare is being raised here? Arguably not those in Latvia and Portugal. EU countries are not US states, and a United States of Europe does not exist. Again, this point is obvious, and agreed on by all, but when the problem this raises in terms of emigration from countries who have been running birthrates well below the replacement level is put on the table all we get is silence.<br />
<br />
Now assuming policymakers are not simply stupid this silence suggests that the whole issue touches on some very fundamental raw nerve. There is no answer in terms of sustainability for those countries who are net losers unless there are reverse direction transfers, as under the US Federal system, and that no one wants to talk about, at least in public.
As the IMF economists admit in their paper - “<i>the largely permanent departure of the younger and more educated workers may indeed be costly for those who stay</i>”.
So the question they pose - could things be done differently? - remains, at least from the demographic point of view, unanswered.<br />
<br />
Portugal isn't Latvia, but it does have a very serious demographic problem. In Latvia the total population declined by about 14 percent (340 thousand people) between 2000 and 2011. Emigration was responsible for about two thirds of this decline while low fertility accounted for the remainder. An estimated 200–215 thousand people left, mainly young people - roughly 9 percent of the population. Obviously Latvian emigration long predates the crisis. The average net emigration rate was 0.5% from 2000-2007. It increased to an average 1.3% from 2008 to 2011, but by 2012, was roughly back to its pre-crisis average. So emigration isn’t a product of the crisis, it was simply made worse by it. But the basic underlying reality is - given the ongoing fertility shortfall - even with the pre-crisis rate of emigration the population pyramid isn't sustainable.<br />
<br />
Portugal's case is not so severe, but the pattern is similar. Between 1998 and 2008 about 700,000 Portuguese nationals left their home country <a href="http://theportugueseeconomy.blogspot.com.es/2010/06/700000-new-emigrants.html" target="_blank">according to research carried out</a> by the former Economy and Employment Minister Álvaro Santos Pereira. In the pre-crisis years the outpouring was to some extent offset by an inflow of immigrants from other countries, but now the migrants are leaving too so the country's working age and total population are both declining.<br />
<br />
Which conveniently brings me to the second guest post I would like to present from the Portuguese blogger Valter Martins. As Martin's coherently argues below, the drying up of Portugal's labour supply was already affecting sustainable trend output before the crisis set, so what I am suggesting we might like to ask ourselves is one very simple question - how is an adjustment which accelerates the longer term decline in the country's workforce, and leads some of its younger and abler members to abandon the country, possibly for good, going to help raise the country's long term growth rate? Instead of alleviating this problem it seems to me it is likely to make the long term situation worse.<br />
<br />
<br />
<b><span style="font-size: x-large;">Can demography explain Portugal's slump before the crash? </span></b><br />
<span style="font-size: large;">Is the Eurozone suffering from a “Shortage of Japanese”? </span><br />
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;">Guest post by Valter Martins</span><br />
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;">In Portugal, unlike other countries now experiencing economic difficulties in the Eurozone - Spain, Greece and Ireland, for example - anemic economic growth was all too evident well before the financial crisis of 2007-08. Accession to the Euro club brought a significant reduction in interest rates in those countries that had experienced historically high ones, triggering real estate bubbles (in Ireland and Spain), and public overspending (in Greece) this cheap money allowed these countries to maintain rates of economic growth above their long term potential and also above the European average. Portugal, on the other hand, suffered a mild housing bubble and government overspending, yet growth was much weaker and more in line with countries that have had fairly </span>lackluster<span style="font-family: inherit;"> performances in the European context:, like Germany or Italy. (See chart below)</span><br />
<span style="font-family: inherit;"><br /></span>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPcJD9S-270bdvTpMtUOBqwXUS-44m5thVAySIDmNqXzJ-zJ-2MnbxG04nNXoGam23sP3sIfAeesvIxFJZN24YyL4vKfbnNw8skx6g3ZCy1Cuvt83qiiMDgAwOm7qff2UTDiqX/s1600/Real+GDP_chart1.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="246" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPcJD9S-270bdvTpMtUOBqwXUS-44m5thVAySIDmNqXzJ-zJ-2MnbxG04nNXoGam23sP3sIfAeesvIxFJZN24YyL4vKfbnNw8skx6g3ZCy1Cuvt83qiiMDgAwOm7qff2UTDiqX/s640/Real+GDP_chart1.png" width="640" /></a></div>
<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">So what lies behind the relatively low growth that took place in Portugal when compared with other countries that are now in the same situation? To put it another way, what’s the factor that differentiated Portugal from the other countries before the crisis
of 2007-08? A number of recent </span><a href="http://www.brookings.edu/~/media/Projects/BPEA/Spring%202013/2013a_reis.pdf" style="font-family: inherit;">papers</a><span style="font-family: inherit;">
and </span><a href="http://www.theatlantic.com/business/archive/2013/06/the-mystery-of-why-portugal-is-so-doomed/276371/" style="font-family: inherit;">articles</a><span style="font-family: inherit;"> have attempted to explain the causes of this relative weak performance, but although some
of the factors mentioned surely contributed to the weak Portuguese growth they do
not fully explain it since many of them were also present in the other - higher growth - countries before the
crisis.</span><br />
<br />
So we need to look a bit deeper. Essentially, long term economic growth can be split into labor force growth and productivity growth. Invariably, the main cause cited for the Portuguese low growth has been productivity growth, or the lack of it, but although this certainly has been a problem in the last decade, it was <a href="http://www.cepr.net/index.php/blogs/beat-the-press/the-japan-story" style="font-family: inherit;">not so much of a problem before</a>, and it hardly appears sufficient on its own to explain the relative weak performance. The differences in productivity gains don't seem large enough to justify the sizable difference in GDP growth, even in the cases of Ireland and Greece (where productivity growth was higher than Portugal), and certainly not vis a vis Spain since productivity growth there was lower than Portugal, as can be seen in the chart below. In the last decade, productivity growth in Portugal was threefold that of Spain but its growth was less than half.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPTSBbnrwzIFIC5dvl-QYu9jGi9Ee-MFAZG3FXupCMNM4ehFYXL5xdt2FqvCC2ULDZBXsDn5gMyUuCAv1vPamU9aK36xxQx_dl60u5T3bozXxazb_wgTU7sIKBOmJPb4pS1hx4/s1600/Productivity_chart2.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="228" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPTSBbnrwzIFIC5dvl-QYu9jGi9Ee-MFAZG3FXupCMNM4ehFYXL5xdt2FqvCC2ULDZBXsDn5gMyUuCAv1vPamU9aK36xxQx_dl60u5T3bozXxazb_wgTU7sIKBOmJPb4pS1hx4/s640/Productivity_chart2.png" width="640" /></a></div>
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<span style="font-family: inherit;">As such, we can safely conclude, that productivity on its
own cannot explain the differences in economic growth between Portugal and the
other group of countries. On the other hand, the stagnation and decline of the
working-age population can not only help explain the weak economic growth that afflicted
Portugal, but also the GDP growth differences between several countries in the
Eurozone before the crises.</span><o:p></o:p><br />
<span style="font-family: inherit;"><br /></span>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9tySdoltBgaiC_LWOdDbrAy2cSP0y_-22jlpmwwKCBmPJ6-vV8qEs5b-59yIdTwOoxbVjcEX1PNtqdY5Eh-nLJO60Z5K3PPBj9c5XrwI2o8myOr5KVS3ta47llmOg-q9cENdm/s1600/PT+GDP_WAP_Chart3.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9tySdoltBgaiC_LWOdDbrAy2cSP0y_-22jlpmwwKCBmPJ6-vV8qEs5b-59yIdTwOoxbVjcEX1PNtqdY5Eh-nLJO60Z5K3PPBj9c5XrwI2o8myOr5KVS3ta47llmOg-q9cENdm/s640/PT+GDP_WAP_Chart3.png" width="640" /></a></div>
<span style="font-family: inherit;"><br /></span></div>
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<span style="font-family: inherit;"><a href="http://demographymatters.blogspot.com/2013_05_01_archive.html">As explained in the previous post</a><span style="line-height: 115%;">, between 2003 and 2008, working-age population
growth in Portugal was negligible and as such the “workforce effect” - contribution
of </span><span style="line-height: 16.363636016845703px;">labor</span><span style="line-height: 115%;"> force growth to GDP growth - was non-existent, as can be seen in the chart above. Starting in 2008, working-age population
growth became negative and thus the “workforce effect” began to act as a drag on
the economy. To maintain a strong rate of economic growth Portugal needed to gradually
increase its productivity growth, and/or alternatively increase its </span><span style="line-height: 16.363636016845703px;">labor</span><span style="line-height: 115%;"> participation rates - to compensate for the declining workforce - but given that this is not
easily attainable</span></span><span style="line-height: 18.18181800842285px;"> trend growth will surely steadily fall</span><span style="font-family: inherit; line-height: 115%;">. Therefore, when the </span><span style="font-family: inherit; line-height: 16.363636016845703px;">labor</span><span style="font-family: inherit; line-height: 115%;"> force starts to stagnate or
decline it is likely that economic growth begins to stall. This phenomenon may well explain the relatively weak economic growth seen in a number of European countries over the last decade. In particular, it explains why
Portugal and Spain had very different economic performances before the 2007-08
financial crises and how the two began to converge subsequently. </span></div>
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<span style="line-height: 115%;"><span style="font-family: inherit;"><br /></span></span></div>
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<span style="line-height: 115%;"><span style="font-family: inherit;">Population
change is comprised of natural growth, the difference between births and
deaths, and net migration, the difference between immigration and emigration. Natural
growth, both for Portugal and Spain, had been barely edging positive at the
turn of the century since in both countries the total fertility rate fell below
replacement level in the early 80’s. In <a href="http://www.pordata.pt/en/Portugal/Annual+population+growth+total++natural+and+migratory-657">Portugal</a>,
natural growth turned negative in 2007, the year that for the first time there
were more deaths than births. On the contrary, <a href="http://www.hazteoir.org/sites/default/files/adjuntos/Nota%20IPF_Descenso%20del%20crecimiento%20natural%20en%20Espa%C3%B1a.pdf">Spain</a>
experienced a slight recover of its natural growth in recent years, as a result
of an increase in its total fertility rate, as can be seen in the chart below, although
this is due almost exclusively to foreigners, who have a higher fertility rate
than the native-born.</span></span></div>
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<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 115%; mso-ansi-language: EN-GB; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"><br /></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiv7_hkip4PNVVXWHP7ZjfYVOiW5UDZa9w1h29SGj8Py7IVU_8H49mioQP3hEkxVF6y0G4pW5Wwacf5SWkP0OUK_KijqbQokhw2ZX5klhKkfTv-_1xC1ZvI2R7hzFvf0lRgQjBt/s1600/TFR_Chart4.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="254" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiv7_hkip4PNVVXWHP7ZjfYVOiW5UDZa9w1h29SGj8Py7IVU_8H49mioQP3hEkxVF6y0G4pW5Wwacf5SWkP0OUK_KijqbQokhw2ZX5klhKkfTv-_1xC1ZvI2R7hzFvf0lRgQjBt/s640/TFR_Chart4.png" width="640" /></a></div>
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<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 115%; mso-ansi-language: EN-GB; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"><br /></span></div>
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<span style="font-family: inherit;">As a result, both in Portugal and Spain, population growth
in the last decades depended almost exclusively on having a positive net
migration, and this resulted in a large influx of immigrants. But while in Portugal this growth started to
slow down </span>beginning<span style="font-family: inherit;"> in 2002, in Spain immigration exploded until the boom burst in 2007, as can be seen
in the chart below. "</span><a href="http://www.azcentral.com/news/articles/global-immigration-spain.html#ixzz2amQVIC8z" style="font-family: inherit;">No
modern country on Earth experienced such a massive increase in its immigrant
population as Spain. In 1990, one in 50 people in Spain was an immigrant.
Today, it's one in seven.</a><span style="font-family: inherit;">"<o:p></o:p></span><br />
<span style="font-family: inherit;"><br /></span>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9obX44TGg0Woj5BcxjlkJyuaaIKBUuuw2wlFcxV3UK1jF_PRnaNzYL_v5w7je-TfdPA-kS5mlojTMRuhZpYQOlIGHfvVS-iXt_UE-mgq96Bpp3RHgJ_VSV1B4rYQNJf4744hJ/s1600/Immigration_chart5.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="266" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9obX44TGg0Woj5BcxjlkJyuaaIKBUuuw2wlFcxV3UK1jF_PRnaNzYL_v5w7je-TfdPA-kS5mlojTMRuhZpYQOlIGHfvVS-iXt_UE-mgq96Bpp3RHgJ_VSV1B4rYQNJf4744hJ/s640/Immigration_chart5.png" width="640" /></a></div>
<span style="font-family: inherit;"><br /></span></div>
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<span style="font-family: inherit; line-height: 115%;">Portugal
not only received fewer emigrants from 2000 onwards, but also witnessed a
massive exodus of its nationals. As </span><a href="http://fistfulofeuros.net/afoe/portugal-please-switch-the-lights-off-when-you-leave/" style="font-family: inherit; line-height: 115%;">Edward
Hugh pointed out</a><span style="font-family: inherit; line-height: 115%;">, the entry in the European Union was accompanied by </span><a href="http://www.dn.pt/inicio/portugal/interior.aspx?content_id=1722201" style="font-family: inherit; line-height: 115%;">steady
emigration flows</a><span style="font-family: inherit; line-height: 115%;">, which clearly sets Portugal apart from the other countries,
</span><a href="http://www.berlin-institut.org/fileadmin/user_upload/Europa/Kurz_Europa_e_Map.pdf" style="font-family: inherit; line-height: 115%;">Spain
in particular (see map on page 11)</a><span style="font-family: inherit; line-height: 115%;">, and resembles more the path that would
be later trodden by Eastern Europeans countries when of their accession to the
European Union. Consequently, and according to the </span><a href="http://www.ine.pt/xportal/xmain?xpid=INE&xpgid=ine_destaques&DESTAQUESdest_boui=155173457&DESTAQUESmodo=2" style="font-family: inherit; line-height: 115%;">Instituto
Nacional de Estatística (Statistics Portugal)</a><span style="font-family: inherit; line-height: 115%;">, during the inter-census period,
the resident population of Portugal increased by only 1.9% while in Spain, the increase
was 12.9%. (Chart below)</span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNRKyRoC_JafH8oUAvFG79f5aPYHtMoH0Mfn5-sQ6jb5UF-7de2WLemMteT7AZriWdmjUz5MwDVoJij-DSPkO5mQDJljO9o1fUUsVsTSkwnkZnnW8vZAZr5VwTy2uLfopRmlCE/s1600/Popp+Growth+PTvsES_chart6.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNRKyRoC_JafH8oUAvFG79f5aPYHtMoH0Mfn5-sQ6jb5UF-7de2WLemMteT7AZriWdmjUz5MwDVoJij-DSPkO5mQDJljO9o1fUUsVsTSkwnkZnnW8vZAZr5VwTy2uLfopRmlCE/s640/Popp+Growth+PTvsES_chart6.png" width="640" /></a></div>
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<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 115%; mso-ansi-language: EN-GB; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"><br /></span></div>
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<span style="font-family: inherit;"><span style="line-height: 115%;">With
the accession to the European Monetary System and later the Euro, interest
rates declined significantly for both Portugal and Spain and as a result the
two increased their debt levels. According to the McKinsey report, </span><a href="https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&ved=0CDwQFjAB&url=http%3A%2F%2Fwww.mckinsey.com%2F~%2Fmedia%2FMcKinsey%2Fdotcom%2FInsights%2520and%2520pubs%2FMGI%2FResearch%2FFinancial%2520Markets%2FDebt%2520and%2520Deleveraging%2520-%2520Uneven%2520path%2520to%2520growth%2FMGI_Debt_and_deleveraging_Uneven_progress_to_growth_Report.ashx&ei=ELVAUZyLEKrhygHS-IGADw&usg=AFQjCNF1n-c0Oydmh_5CgWb8SmkGW2vgWw&bvm=bv.43287494,d.aWc" style="line-height: 115%;">Debt
and deleveraging (see page 14)</a><span style="line-height: 115%;">, in the second quarter of 2011 Portugal and
Spain had total debt of 356 and 363 (as % of GDP), respectively. The
consequence of cheap and easy credit was to create a housing bubble, both in
Portugal and in Spain, but while the </span><a href="http://www.searanova.publ.pt/pt/1717/nacional/245/" style="line-height: 115%;">Portuguese began to
deflate in 2002</a><span style="line-height: 115%;">, the Spanish continued to inflate until 2008. This outcome
was the result of the substantial increase in Spain’s population as a result of
immigration, many of them Portuguese, while the increase in immigration in
Portugal was just enough to replace the ones who were leaving. This </span><span style="line-height: 115%;">population growth allowed the housing
bubble to continue for much longer in Spain</span><span style="line-height: 115%;">, while in Portugal there were
no longer enough people to buy the excess homes being built, and so prices </span><span style="line-height: 16.363636016845703px;">didn't</span><span style="line-height: 115%;"> skyrocket; but the housing units were built regardless. As such, </span></span><span style="font-family: inherit; line-height: 18.18181800842285px;">rather than a classical bubble with inflated house prices, </span><span style="line-height: 18.18181800842285px;">i</span><span style="line-height: 18.18181800842285px;">n Portugal,</span><span style="font-family: inherit; line-height: 18.18181800842285px;"> it was more a case of oversupply, given that </span><a href="http://sol.sapo.pt/inicio/Economia/Interior.aspx?content_id=52630" style="font-family: inherit; line-height: 18.18181800842285px;">800,000 homes were built in the last decade while the population only grew by 200,000</a>. On the contrary, in <span style="font-family: inherit; line-height: 115%;">Spain,</span><span style="font-family: inherit;"><span style="line-height: 115%;"> in addition to the <a href="http://redondo.photoshelter.com/gallery/Tu-Casa-es-Mi-Casa-real-state-crisis-in-Spain/G0000ugAW_dpGmB8/">excess construction</a>, prices went through the roof, with migration pressures making a substantial </span></span><span style="line-height: 18.18181800842285px;">contribution to both. </span><a href="http://ftp.iza.org/dp4333.pdf" style="font-family: inherit; line-height: 115%;">It </a><a href="http://ftp.iza.org/dp4333.pdf"><span style="font-family: inherit;"><span style="line-height: 115%;">is estimated </span></span><span style="line-height: 18.18181800842285px;">that the immigration inflow increased house prices by about 52% </span></a><span style="line-height: 18.18181800842285px;"><a href="http://ftp.iza.org/dp4333.pdf">and was responsible for 37% of the total construction of new housing units between 1998 and 2008</a>. Between</span><span style="font-family: inherit; line-height: 115%;"> 2002 and the 2007-08 financial crises the growth of the Portuguese economy started to fall more in line with the growth of economies where the </span><span style="font-family: inherit; line-height: 16.363636016845703px;">labor</span><span style="font-family: inherit; line-height: 115%;"> force was stagnant
or declining, namely Italy and Germany, as can be seen in the chart below.</span><br />
<span style="font-family: inherit; line-height: 115%;"><br /></span>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiknKzCUil876Hs4dw7WjzZwjAYwoDqXM9BvVaHJmrp3OIGhz4yGGZh8IkjeIegcEkMl90OOfIRz4sGePVjMnAOL-zvJdrw8LnJahTta6GTk_A-9ELYpXr9fZHRpvEGAtyE_8Nv/s1600/Real+GDP_EU_chart7.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="256" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiknKzCUil876Hs4dw7WjzZwjAYwoDqXM9BvVaHJmrp3OIGhz4yGGZh8IkjeIegcEkMl90OOfIRz4sGePVjMnAOL-zvJdrw8LnJahTta6GTk_A-9ELYpXr9fZHRpvEGAtyE_8Nv/s640/Real+GDP_EU_chart7.png" width="640" /></a></div>
<span style="font-family: inherit; line-height: 115%;"><br /></span></div>
<div class="MsoNormal">
<span style="font-family: inherit; line-height: 115%;">The
chart above is easier to understand if we group countries into two groups:
countries with weak economic growth – Portugal, Germany and Italy-, and
countries with more healthy growth - Spain, Ireland and Greece. With the exception of Greece, countries with
sound economic growth before the recession were also the countries with higher </span><span style="font-family: inherit; line-height: 16.363636016845703px;">labor</span><span style="font-family: inherit; line-height: 115%;"> force growth in the same period, as shown in the graph below. By contrast, in countries where economic
growth was weaker, the </span><span style="font-family: inherit; line-height: 16.363636016845703px;">labor</span><span style="font-family: inherit; line-height: 115%;"> force growth was also more moderate or even
negative, as in Germany. (Chart below)</span><br />
<span style="font-family: inherit; line-height: 115%;"><br /></span>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmwpQI81gFe-LRMStc63KaElaYolHT9XYywRiu2Brt8fjqz06mS2zRK_NX5FRwskw7fURTVb7WqduxyY2JlbmPPCSOp-Zng3x34e0rEHH0RKT9ueHQNvBaSCXQjpM1NqABnjvL/s1600/WAP+EU_chart8.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="260" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmwpQI81gFe-LRMStc63KaElaYolHT9XYywRiu2Brt8fjqz06mS2zRK_NX5FRwskw7fURTVb7WqduxyY2JlbmPPCSOp-Zng3x34e0rEHH0RKT9ueHQNvBaSCXQjpM1NqABnjvL/s640/WAP+EU_chart8.png" width="640" /></a></div>
<span style="font-family: inherit; line-height: 115%;"><br /></span></div>
<div class="MsoNormal">
<span style="font-family: inherit;">However, the dynamics changed completely with the onset of
the 2007-08 recession. In </span><a href="http://elpais.com/elpais/2011/07/24/inenglish/1311484843_850210.html" style="font-family: inherit;">Spain</a><span style="font-family: inherit;">,
where working-age population growth depended exclusively on immigration, the
rates of </span>labor<span style="font-family: inherit;"> growth collapsed, only matched by the plunge of its GDP growth,
and its workforce has actually started to shrink. In Ireland, despite a more
abrupt fall, growth nonetheless remained positive, this was due to the fact that
its population growth did not depend only on net migration but had an important
natural component as well. In fact, </span><a href="http://epp.eurostat.ec.europa.eu/statistics_explained/index.php?title=File:Total_fertility_rate,_1960-2011_(live_births_per_woman).png&filetimestamp=20130129121040" style="font-family: inherit;">Ireland
has the highest fertility rate amongst European countries</a><span style="font-family: inherit;"> and therefore,
unless emigration returns to numbers only seen in previous centuries, growth
of its working-age population should stabilize in positive territory, although
at a level well below the pre-crisis one.</span></div>
<div class="MsoNormal">
<span style="font-family: inherit;"><br /></span></div>
<div class="MsoNormal">
<span style="font-family: inherit;">In <a href="http://algarvedailynews.com/news/8467-portugals-popluation-in-steep-decline">Portugal</a> and <a href="http://greece.greekreporter.com/2013/06/02/academic-research-on-modern-greeces-population-growth/">Greece</a>, even before the 2007-08 recession,
</span>labor<span style="font-family: inherit;"> force growth already showed clear signs of a slowdown, as growth
came to a standstill in 2005, and despite a slight recovery after, more pronounced
in Greece than Portugal, working-age population went into decline with the
onset of the recession. Italy, which had
reversed the decline of its working-age population initiated in the 90’s, appears to have once again slid back into negative territory. On the other hand</span><a href="http://www.spiegel.de/international/reversing-population-decline-germany-s-new-immigrant-influx-a-880038.html" style="font-family: inherit;">,
in Germany, the workforce began to grow for the first time since 1998 due to an
increase in immigration</a><span style="font-family: inherit;">, many of them Portuguese, Spanish, Italian and
Greek.<o:p></o:p></span></div>
<div class="MsoNormal">
<span style="font-family: inherit;"><span style="line-height: 115%;"><br /></span></span></div>
<div class="MsoNormal">
<span style="font-family: inherit;"><span style="line-height: 115%;">As explained by <a href="http://www.project-syndicate.org/commentary/the-japan-myth">Daniel Gros</a>,
when comparing economic growth performance between countries with very different rates of population growth, the best indicator is undoubtedly GDP per Working Age Person
(GDP/WAP</span><span style="line-height: 115%;">).</span></span><br />
<span style="font-family: inherit;"><span style="line-height: 115%;"><br /></span></span>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjz75repPV2yvlV3psE3o6KpjSUh1MRu6Dr8w-YzFvmbVKG-T8dx3s5ZRfQ8RKa2GWAE00hk6Ol54pBVE-m3mYVuTXEPTpN4lkTtRfaQen_vyG96G25D6HwasHcpOM_fP4mis7/s1600/GDP_WAP_chart9.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="256" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjz75repPV2yvlV3psE3o6KpjSUh1MRu6Dr8w-YzFvmbVKG-T8dx3s5ZRfQ8RKa2GWAE00hk6Ol54pBVE-m3mYVuTXEPTpN4lkTtRfaQen_vyG96G25D6HwasHcpOM_fP4mis7/s640/GDP_WAP_chart9.png" width="640" /></a></div>
<span style="font-family: inherit;"><span style="line-height: 115%;"><br /></span></span></div>
<div class="MsoNormal">
<span style="font-family: inherit;">Hence, if we compare the per working-age person GDP growth between
the various countries in the last decade, as such taking working-age population
growth out of the equation, it can be said that growth in Spain and
Ireland was not so spectacular as it looked on paper, nor was growth in Portugal, Germany and Italy so dire when taken in comparison. In fact, only Greece seems to have had a spectacular
growth, which would be in line with its productivity growth before the
recession, but Greece’s population statistics might be underestimated, as
Greece has not only a large population of illegal immigrants but some weakness
in data collection that have also been highlighted. Anyway, a part of Greek growth was probably
due to other - unrepeatable - factors, like the Olympic Games. It also should be highlighted the economic
growth which was achieved in Germany despite the decline of its workforce, proving that
growth is possible with a declining population.</span><br />
<span style="font-family: inherit;"><br /></span>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnzBQo9Pd-drVVLFbp9WOeJwJhKaozrOZCKfwJGuvABPGwD3PKE1_lhwMHxcWSRgKq5XBcaHccK3Yh4-YLpv48EEqTH6ZIyBkeTfT17BhHznF8Zq8vFEFWbW97FOk0-oR9mmOM/s1600/WAP_EU00_07_chart10.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="266" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnzBQo9Pd-drVVLFbp9WOeJwJhKaozrOZCKfwJGuvABPGwD3PKE1_lhwMHxcWSRgKq5XBcaHccK3Yh4-YLpv48EEqTH6ZIyBkeTfT17BhHznF8Zq8vFEFWbW97FOk0-oR9mmOM/s640/WAP_EU00_07_chart10.png" width="640" /></a></div>
<span style="font-family: inherit;"><br /></span></div>
<div class="MsoNormal">
<o:p></o:p></div>
<div class="MsoNormal">
<span style="font-family: inherit;">Despite some regional variation as a result of internal migration,
the reality is that working-age population in the Eurozone as a whole has now initiated a long downward trend that will have major repercussions in
terms of its economic growth, <a href="http://demographymatters.blogspot.com/2013_05_01_archive.html">as explained in the previous post</a>, and therefore,
we can also conclude that Europe is starting to suffer from a "shortage of Japanese" as
shown in the graph below.</span><br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7Gj8b7Mf6Cdkz2fvekFWEVbmG6YjpJ7K5VoAKA4WkhNPE_w1WkQ-jKNqV3eH3krzIfFByuTzcO9lVzj85KmP5GISrH41WtEFQqrlX5Gieyq8zr-Ra3R8k8Giy4i3lV49p9dIY/s1600/GDP+per+WAP_EU_chart11.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7Gj8b7Mf6Cdkz2fvekFWEVbmG6YjpJ7K5VoAKA4WkhNPE_w1WkQ-jKNqV3eH3krzIfFByuTzcO9lVzj85KmP5GISrH41WtEFQqrlX5Gieyq8zr-Ra3R8k8Giy4i3lV49p9dIY/s640/GDP+per+WAP_EU_chart11.png" width="640" /></a></div>
<br /></div>
<div class="MsoNormal">
<o:p></o:p></div>
<div class="MsoNormal">
<span style="font-family: inherit; line-height: 115%;">As
such we cannot fully comprehend the situation that Portugal, Spain and Greece
face at the moment without looking into their adverse demographics. This already exerted an disproportional role
in the last decade, namely in Spain,
whose migration-induced working-age population growth
goes a long way explaining its outstanding economic growth, while for
Portugal the contrary it’s true, as the lack of population growth made its
economy lose steam as it joined the Euro. More worryingly tough,
is that </span><a href="http://www.economist.com/news/finance-and-economics/21570752-growth-will-suffer-workers-dwindle-working-age-shift" style="font-family: inherit; line-height: 115%;">working-age
population in Europe as a whole has started a long, perhaps irreversible, path
of decline</a><span style="font-family: inherit; line-height: 115%;"> that will act as a drag on its economic growth, making the
economic recovery for these countries even more difficult.</span></div>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-33723934086297628462013-09-11T19:27:00.000+02:002013-09-11T19:27:41.631+02:00Is The Perfect Always And Everywhere The Enemy Of The Good?Against a backdrop which offers an eerie parallel with events which took place somewhat to the North more than 30 years ago, Catalonia is now threatening to separate from Spain. In so doing the region seems to be putting at risk both the future of the host country and beyond that the outlook for the Euro currency and the process of European unification.
<br />
<br />
The parallel is of course with the drive for Baltic independence and its impact on Mikhail Gorbachev’s ill-fated attempt to peacefully reform the disintegrating Soviet Union. In the words of Aleksandr Yakovlev, one of his closest associates at the time, the ideas of those seeking independence were ''out of touch with reality'' and any expectation that the Baltic republics could regain the independent status they had before Soviet annexation in 1940 was ''simply unrealistic.'' As late as February 1991 Gorbachov himself was still describing the Lithuanian vote – described by the countries leaders as simply a non-binding opinion poll - as illegal, and this a matter of days before it was actually held.<br />
<br />
Sound familiar? It should do, since these very same arguments are now being played out in another pole of Europe. Not only is the Spanish administration taking precisely the view that any vote in Catalonia on whether or not to separate from Spain would be illegal, the attitudes of those outside the country are largely being conditioned, not by the merits or otherwise of the Catalan case, but by the fear of what might happen to Spain if Catalonia left.<br />
<br />
While Catalans busy themselves assuring each other that any new state would be economically viable, few on the outside doubt that this would be the case. To give but one example, former chief economist at the IMF <a href="http://www.flickr.com/photos/34857032@N00/8030333393/in/photostream/">Kenneth Rogoff recently commented that Catalonia taken on its own constitutes one of the richest regions in Europe</a>. This is simply stating the obvious. What has external observers really worried is the subsequent viability of Spain, and with it the future of the Euro. If Spain is too big to be allowed to fail, then Catalonia is too small to have inalienable rights the argument seems to run.<br />
<br />
It is for this reason, I feel, that the Catalan cause is attracting little sympathy beyond the confines of what is often called “The Principate”. <br />
<br />
Many feel that Catalonia is being selfish – just as they felt in their day that the citizens of the Baltics were - in putting their own particularist interests (a better fiscal distribution, the right to a national football team) before those of the collective (economic recovery, closer political union in Europe, etc.). But this way of looking at things is essentially flawed, just as it was in Estonia, Latvia and Lithuania. The movement for Catalan independence is primarily, and at its core, a democratic one. So what should matter to the outside world is not whether the vote will be considered legal by the central government in Madrid, or whether the Catalans have a good case. If the Catalans vote peacefully and democratically, and by a significant majority, that they want to form a separate state, then it is clear that the region's days inside the frontiers of the Kingdom of Spain are numbered. Unless that is the Catalans be retained within those frontiers by the use of force, in which case some of the fundamental principles of the Treaty of Europe will be put in question. Hence the fundamental dilemma which the Catalan independence drive presents to the whole European Union.<br />
<br />
Under these circumstances what outside observers should focus on is what the result of the vote, when it does finally take place, will be. After all what the Catalans are demanding at the moment is “the right to decide”, and at the end of the day it is they who will decide. My country, as the saying goes, right or wrong.<br />
<br />
Nothing here is either unavoidable or inevitable. As in the case of Greek Euro exit, beyond the expedient there are no ex ante juridical limits to the bounds of the possible. What is important for everyone is that the eventual solution be an orderly one.
In this context messages that the new country, should one be created, would need to apply for membership of the European Union constitute nothing more than mere hot air, just as the suggestions from the Spanish administration that any such application would be met with a veto on their part is no more than an empty threat. Such talk is not in the realm of the real, or the realistic. It is simply an attempt to alter the outcome of the vote, and a bad and ineffective one at that. Not for nothing does Catalonia’s President Mas describe the speechwriters of the Partido Popular as running a production line for manufacturing separatists. <br />
<br />
If Spain’s sovereign debt is already on an unsustainable path, then how much less sustainable would it become if the country suddenly had its GDP reduced by 20%? Common sense dictates that negotiations would be held, negotiations in which Catalonia would be asked to accept a proportion of the legacy debt, just as common sense suggests that Catalonia’s financial system, which has assets of around 500 billion Euros (i.e. it is much larger than the Greek equivalent) would be allowed to remain in the Eurosystem. The alternatives – and their consequences well beyond the frontiers of Europe – are simply unthinkable.
Naturally sometimes the unthinkable happens, especially when a majority of the key players assume it won’t. Catalonia has now decided to hold some sort of “consultation” or “opinion poll” during 2014. As in the Lithuanian case the outcome may not be binding, but few should draw comfort from that single fact and assume that the result will not be significant and even decisive for the short term future of Europe. <br />
<br />
As I say, nothing here is inevitable, or foretold in advance. But avoiding predestination involves facing up to the facts, and not, as the IMF director general Christine Lagarde recently put it in the Greek context, engaging in wishful thinking. And the facts in this case are that dialogue between Catalonia and the rest of Spain has now broken down. Catalans feel themselves to be tired of not being listened to, while the rest of Spain feels itself tired of the Catalans and their constant demands for more autonomy. At one pole there is “Spain weariness” and at the other “Catalonia exhaustion”. Matters have now past the point where orderly solutions will be sought out and found internally. <br />
<br />
Most external observers expected some sort of offer to be made by the central government after the last Catalan elections, but reading the result as a setback and defeat for President Mas the only “offer” which has been sent in the direction of Barcelona is one which involves “Hispanicising” children via the reform of the Catalan education system, a move which has effectively united the Catalans behind their new government. That is why a decisive intervention on the part of Europe’s political leaders is now crucial. Whether they like it or not they have no alternative but to become intermediaries in the search for viable solutions, if not neglect will only produce the result everyone seeks to avoid.<br />
<br />
It is no accident that the Baltics saw their chance just in the moment of maximum Russian weakness, and that Catalans see their only realistic possibility of achieving their objective of having their own state just when Spain is effectively on the ropes, and possibly in terminal decline. Some, comforted perhaps by the writings of Francis Fukuyama, feel that what is happening to Spain is simply an unfortunate setback on the bumpy road to becoming a mature democracy, but darker readings are possible. The current economic crisis is not simply cyclical or conjunctural and there is a real possibility that the country’s problems are so complex that it will become impossible for Spain’s leaders to fix them without recourse to an Argentina style default. It is precisely the loss of confidence in the capacity of the Spanish political class to resolve the country’s dire economic situation, and the mounting frustration with their perpetual insistence that all will be well starting tomorrow that has the Catalans running for the exit door. If the building is about to burn down they don’t want to be trapped inside when it happens. As Janice Joplin once put it freedom is sometimes “just another word for having nothing left to lose”. <br />
<br />
In the critical weeks and months that are to come, I think it important that all participants bear in mind that once the Baltic vote was taken, and once the demise of Gorbatchev became inevitable, attitudes towards the new countries rapidly changed. All three are now consolidated members of the European Union, and the past is simply that, what is over. Many Catalans tell me they are doing what they are doing, not for themselves but for their children and their grandchildren. Measured on such a timescale a few years of economic turbulence seem as nothing. In the interest of the common good solutions need to be found - solutions which are able to both satisfy the aspirations of the Catalans and guarantee stability in Europe. If this search is not initiated soon, then time will ineluctably run out and the likely will steadily become the inevitable, simple application of the rules of game theory tell us that. There isn’t a day to lose. You know it makes sense.
<br />
<br />
The above is a short chapter I wrote for the book "<a href="http://www.amazon.es/Whats-Catalonia-causes-which-separation/dp/161150032X">What's Up With Catalonia</a>" published earlier this year by the Catalan Press.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-26262344567688957122013-09-11T12:07:00.002+02:002013-09-11T12:07:40.562+02:00Q&A: The Catalan Way explainedWhy are Catalans taking part in a human chain this Wednesday? The Catalan newspaper <a href="http://www.ara.cat/">Ara</a> has produced <a href="http://www.ara.cat/viacatalana/catalan-way-catalonia-independence_0_990501167.html">a series of questions and answers</a> in English which should explain everything you want to know about why the human chain is taking place today.<br />
<br />
<b>What is the 'Via Catalana'?</b><br />
<b><br /></b>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9SKVeX3mnk_bPQr7TKYT4iIpN-sILFV-FiqE44N8jPVzEUFzjThW13gea3pOHT46w9hXY8kxJ5bFqMEWs5Cs_uiRRCsasS6Wj6I1Rp7JotM3QtDxiAjsm1MBU626deXRJVYCYlQ/s1600/2013-08-16_175159.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="197" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9SKVeX3mnk_bPQr7TKYT4iIpN-sILFV-FiqE44N8jPVzEUFzjThW13gea3pOHT46w9hXY8kxJ5bFqMEWs5Cs_uiRRCsasS6Wj6I1Rp7JotM3QtDxiAjsm1MBU626deXRJVYCYlQ/s320/2013-08-16_175159.png" width="320" /></a></div>
<b><br /></b>
<br />
The<a href="http://via.assemblea.cat/ca/"> 'Via Catalana'</a> (The <a href="http://via.assemblea.cat/en/catalan-way.html">Catalan Way</a>) is a political demonstration which will take place this September the 11th. Inspired by the <a href="http://en.wikipedia.org/wiki/Baltic_Way">Baltic Way</a> — a human chain formed by up to two million people on August 23 1989 across Estonia, Latvia and Lithuania — its aim is to create<a href="http://www.catalannewsagency.com/politics/item/pro-independence-supporters-prepare-a-400-km-long-human-chain-on-catalonia-s-national-day"> a 400 km long chain</a> which will cross Catalonia from north to south. 400.000 people have signed up to take part in the human chain, although organizers hope that the actual turnout will be at least twice that figure. People will be asked to join hands at exactly 17:14 (15:14 GMT). The chain, which runs along highways, roads and city streets, will come to an end at 18:00 (16:00 GMT). If successful, it will be one of Europe's largest ever demonstrations, following in the footsteps of<a href="http://www.nytimes.com/2012/09/12/world/europe/12iht-barcelona12.html"> last year's march in Barcelona</a>, when up to 1,5 million people walked through the streets of the capital asking for independence, the country's most massive rally ever.<br />
<br />
<br />
<b>What is Catalonia?</b><br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgm6VcF8lz3qa4g_8f_ZuPrIIHoM_-RuEFLqJqPY7gA_zi8NBWcnugk3CYUTP1T22BQhRmIDKfWT6DCLYwMsAKP3DL2RfmFgPU6oE58rD78FEmtG7kbfnHOahyphenhyphenWo3gEd6PIlJZD_g/s1600/2013-09-11_113334.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="189" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgm6VcF8lz3qa4g_8f_ZuPrIIHoM_-RuEFLqJqPY7gA_zi8NBWcnugk3CYUTP1T22BQhRmIDKfWT6DCLYwMsAKP3DL2RfmFgPU6oE58rD78FEmtG7kbfnHOahyphenhyphenWo3gEd6PIlJZD_g/s320/2013-09-11_113334.png" width="320" /></a></div>
<br />
<br />
<br />
<br />
With more than 7,2 million inhabitants <a href="http://www.gencat.cat/catalunya/eng/">Catalonia</a> is a country in the northeastern corner of the Iberian Peninsula. At a crossroads between different cultures and civilisations, it once formed part of the old Crown of Aragon, which merged with the Crown of Castile to create what later became Spain. What in medieval times was a powerful nation which extended its influence across and beyond the Mediterranean, is now an autonomous region within the Spanish State posessing restricted powers, devolved as seen fit by the central state. It has its own language, <a href="http://www.theguardian.com/world/2012/nov/22/catalan-language-survived">Catalan</a>, and institutions, amongst them one of Europe's oldest <a href="http://www.gencat.cat/generalitat/eng/index.htm">Governments</a> and <a href="http://en.wikipedia.org/wiki/Parliament_of_Catalonia">Parliaments</a>.<br />
<br />
<b>Why is the Catalan Way taking place today?</b><br />
<a href="http://en.wikipedia.org/wiki/War_of_the_Spanish_Succession"><br /></a>
<a href="http://en.wikipedia.org/wiki/War_of_the_Spanish_Succession">Catalonia was a party in the War of Spanish Succession</a> (1701-1714), where the old crowns of Castile and Aragon fought, alongside their European allies, over who should be crowned as king of Spain following the death of Charles II. Catalonia, which favoured archduke Charles as successor, lost a war which ended with Europe recognising Philip V as the new king of Spain. The long war ended with a prolonged siege of Barcelona, Catalonia's capital, which was systematically bombarded by Spanish troops fighting for the Bourbon candidate, Philip V. After months of resistance Barcelona finally surrendered on September 11 1714. Modern Spain was born, but Catalonia was to pay a heavy price for its support for the Austrian candidate: Catalan language was forbidden and Catalan institutions abolished. Every year, on September 11, <a href="http://tricentenari.bcn.cat/en">Catalans commemorate the day</a> on which Barcelona fell, honouring those killed defending the country's laws and institutions [See video: <a href="http://vimeo.com/52904692">A trip to Barcelona</a>].<br />
<br />
<b>Why do many 21st century Catalans want independence?</b><br />
<br />
Since the defeat of 1714 Catalonia has never been allowed to rule itself again [<a href="http://www.theguardian.com/world/interactive/2012/nov/20/europe-spain-catalonia-history-interactive?CMP=twt_gu">a Catalan history of Spain</a>]. The old nation was forcefully transformed into a mere Spanish province. This state of affairs did not change until 1931, when the proclamation of the Spanish Republic gave Catalans the freedom to regain their old institutions. Catalan was taught in schools, the Parliament reopened, the Government was once more established... Unfortunately the situation was not to last. The end of the Civil War, with the subsequent establishment of the <a href="http://en.wikipedia.org/wiki/Francoist_Spain">Franco dictatorship</a>, meant a new blow for the country, crushed once again by a centralist state, administered directly from Madrid. <br />
<br />
Following Franco's death, and with a new democratic regime in place, Catalonia regained its old institutions, and it was once more allowed to rule its own affairs in a number of key areas. But the centralist inertia of the Spanish state, always resisting to the last all devolved powers and continually meddling in matters which are close to the heart of all Catalans — like respect for the Catalan language — has left Catalonia’s citizens with a deep sense of frustration. This frustration was brought to a head in 2010 when an appeal by the Partido Popular over some of the clauses in the newly approved Catalan Statute (which won majority votes in both the Catalan and Spanish Parliaments) lead the Spanish Constitutional Tribunal to rule it was unconstitutional to use the term “nation” to refer to Catalonia in the document’s preamble.<br />
<br />
Since that time the feeling of alienation from Spain has only grown, with many previously apathetic citizens suddenly becoming separatists. More fuel has been added by the <a href="http://www.nytimes.com/slideshow/2012/09/24/world/europe/20120925-SPAIN.html?ref=europe#1">economic crisis</a>, and the gross incompetence which has been demonstrated by Spain’s political and financial leaders. This, along with the <a href="http://edition.cnn.com/interactive/2013/02/world/spain-voices/index.html">record levels of unemployment</a> with no end in sight, has given a new impulse to Catalonia's demands, since it has left the Catalan Government in a critical financial situation, unable to access the international financial markets and totally dependent on the such funds as the Spanish Government to forward to it. This unjust situation reached its most bizarre moment when the Spanish government raised the VAT rate last year to help improve funding. The Catalan government actually lost out, since it had to pay the new rate to all its suppliers but received no refund or additional funding from the central government which was, of course, much better off.<br />
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This, in a country which <a href="http://www.elclauer.cat/canvi_idioma/en.html#.Ui9KNbzeqUc">contributes to Spain far more than it gets in return</a>: figures vary, but it is reasonable to suggest that Catalonia loses between 10,000 to 16,000 million euros per year, because of this fiscal deficit. The accumulated deficit between Catalonia and Spain for the period 1986-2010 reaches a total of 213,933 million euros, five times Catalonia's current debt. The economic imbalance between what Catalans pay in taxes to the Spanish state and what they get in return, is a major contributing factor to the sense of anger and frustration felt by many [opinion: Spanish Prisoners]. It has been very hard for Catalans see their school and hospital services deteriorate under the sever cuts that have been administered while those in other regions which are arguably subsidized from Catalan taxes go virtually unscathed. [See NYT OP-ED: <a href="http://www.nytimes.com/2012/10/03/opinion/a-new-call-for-catalonias-independence.html">Spanish Prisoners</a>]<br />
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<b>What do the Catalan political parties say?</b><br />
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Since the death of Franco all Catalonia's main parties have argued for a theoretical right to self-determination, but have never taken steps towards achieving that goal. Following slow and painstaking negotiations with Madrid, only a fragile, unstable compromise has been reached: the Spanish state has devolved powers in some key areas, from education to health or police, but it still is unable to recognise Catalonia as a nation. This has left Catalan parties divided on the issue of which course of action to take. Traditionally, Catalan parties have asked for more powers to be devolved from Madrid to Catalonia, but the recent rise in strength of the pro-independence movement — which originates in social, rather than political organizations — has taken some aback [See video: <a href="http://link.brightcove.com/services/player/bcpid1513015402001?bckey=AQ~~,AAAAmtVJIFk~,TVGOQ5ZTwJYzP5l-b5uZA0wXezQXHPxp&bctid=1825237945001">Catalonia push for economic independence</a>]. <br />
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Centre Right Nationalist CiU, Catalonia's current governing political coalition, has evolved from a pro-autonomy stance to being more clearly inclined towards independence. It is, though, a coalition of parties with different views; officially, it wants a referendum on independence, but stresses the need to reach agreement on this with the Spanish Government. The once powerful Socialist party PSC, which has strong ties with the Spanish Socialist PSOE, is torn too between conflicting approaches. In theory, it recognizes Catalans the right to self-determination, but rather than asking for independence, it wants Spain to move towards a more federal political structure. The left republicans ERC, for years the only party actively seeking independence, are the rising star in the current Parliament and, according to some surveys, could become the country's main party if elections were to take place now; they want to hold a referendum as early as 2014. <br />
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Left-wing ICV, political successors of the old communist party, support the idea of a referendum, although their views on independence are not so clear. Finally, the Popular Party, which is now in power and Spain, and Ciutadans, are both opposed not only to independence but even to an eventual referendum on the issue. However, they are a minority in the Catalan political landscape: the Catalan Parliament has passed a declaration which states that Catalonia is a country with the right to decide its own future. The declaration was passed with 104 votes in favour of a referendum, for only 27 against [See video: <a href="http://www.bbc.co.uk/news/world-19847251">Will Catalonia say adios to Spain?</a>].<br />
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<b>What does the Spanish Government say?</b><br />
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The Spanish Government bitterly opposes the organization of a referendum in which Catalans can choose whether they are in favour or against an independent Catalonia. The official position is that the government has to abide by the Spanish Constitution, which states that there is only one nation, the Spanish one, and that sovereignty is exclusively held by the Spanish people in its entirety; this means that what is seen as being simply one part of the Spanish nation cannot on its own decide on matters which affect all, effectively denying the principle of the right of peoples to self determination. Since, according to the Constitution, only the Spanish Government can organize a referendum, the Catalan demand faces an insurmountable barrier. Spanish main parties — PP, now in power, and the socialists, the main party in opposition — do not want Catalans to express their views on a referendum [See video: <a href="http://edition.cnn.com/video/?/video/bestoftv/2012/10/18/marketplace-europe-barcelona-catalonia-economy.cnn">Should Catalonia seek independence?</a>].<br />
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<b>What is the position of the EU?</b><br />
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The official position of the EU is that it is not for the institution to take into consideration hypothetical declarations of independence following the possible breakaway of part of an existing member state. The <a href="http://www.catalannewsagency.com/politics/item/the-european-commission-sends-contradictory-messages-regarding-hypothetical-catalan-independence?highlight=YToxOntpOjA7czoxMjoiaW5kZXBlbmRlbmNlIjt9">official line of the EU Commission</a> is that Catalonia's independence demand is a Spanish internal affair and, as such, they cannot comment on the issue. This has proved to be a controversial idea, though, since the Spanish Government has tried to influence the debate by assuring that an independent Catalonia would be automatically expelled from the EU, and should start from scratch new negotiations with Brussels to rejoin the institution. Some commissioners have denied this, stating that there is no precedent for a situation like this, and that Europe could not possibly deny membership to 7,2 million people who are now EU's citizens.<br />
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<b>Why is Scotland holding a referendum, while Catalonia is not?</b><br />
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Because they are both nations without a state Scotland and Catalonia have often been compared, and the fact that both countries are engaging in an open debate about their possible future as sovereign states has only increased the parallels being drawn between them. Yes, they are both old European nations, with institutions of their own, but the similarities end here. It was not until recently that Westminster Parliament devolved some of its powers to Scotland, but the UK has a tradition of decentralised power in many areas. Citizens are used to the fact that laws — from smoking to gay marriage to university taxes — are different on both sides of the border. This is not the case of Spain, which for most of its history has been a heavily centralized state. However the main and most glaring difference is to be found in the very different approach to recognizing a separate identity: whereas the UK – as a plurinational society - has no real problem in acknowledging that Scotland is a nation, Spain as a whole has been unable to move beyond the idea that Catalonia is simply just one more autonomous region. Unlike Scotland, Catalonia cannot take part in official sports competitions around the world, which leaves<a href="http://www.theguardian.com/football/video/2012/nov/22/fc-barcelona-catalonia-independence-video"> Barcelona football club</a> as the unofficial national symbol [<span style="color: #525252;">See Video: </span><a _mce_href="http://www.youtube.com/watch?v=Ggci_OQdf_Y&feature=c4-overview&list=UUhMgvszWGN3LpRcj9j_dHow" href="http://www.youtube.com/watch?v=Ggci_OQdf_Y&feature=c4-overview&list=UUhMgvszWGN3LpRcj9j_dHow" style="background-color: white; color: #007d9b; font-family: Arial, Helvetica, sans-serif; font-size: 15px; line-height: 21px; outline: none;" target="_blank">cry for Catalan independence during the 'classic' Barça – Real Madrid</a>]. The consequence of this different approach is that, while the British Government is allowing the Scottish government to organize a referendum on independence, the Spanish government is completely opposed to allowing the Catalans to be consulted about an eventual secession and has promised to fight any move by the Catalan government to organize a referendum [<a href="http://www.theguardian.com/world/interactive/2012/nov/22/catalonia-scotland-europe-separatists-interactive">Catalonia and Scotland: how they compare to EU nations and Europe's other separatists</a>]<br />
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<b>What is Catalonia's level of autonomy?</b><br />
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Catalonia has a restricted autonomy. The Catalan Parliament has the power to pass laws on all sort of issues, from education to housing, but this theoretical autonomy has many strings attached. To begin with, the Spanish Government is unwilling to hand over some key powers, from allocating student grants to administering pensions, and tries to legislate on areas of devolved power, a situation which leads to constant conflicts between the governments in Barcelona and Madrid, with the Spanish Constitutional Court deciding which of the two is entitled to legislate the disputed area. Crucially, all main taxes are collected by the Spanish Government, which is then responsible for distributing the money raised between the various receiving institutions. In practice, Catalonia's Parliament is legislating on affairs without having the money to implement its laws.<br />
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<b>How strong is the popular support for independence?</b><br />
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Surveys vary significantly, but they show two consistent trends. First, support for independence has been growing year after year. Second, from being the option favoured by a minority of Catalonia's citizens, independence is now supported by the majority of the population. The latest official figures show that, in an eventual referendum, 55,6% of Catalans would vote in favour of an independent state, with those against being 23,4% and roughly a 20% showing no clear preference or saying that they are not interested. When asked which form of relationship with Spain do they prefer, 47% favour an independent state, 22% want to maintain the current status quo, and 21% would like Spain to become a federal state.<br />
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<b>What happens next?</b><br />
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A Council for the National Transition, with academics and experts from a number different fields, is working on the establishment of a timeline for an eventual referendum. Catalonia's main political force, CiU, which governs thanks to the support in Parliament of pro-independent ERC, argues that a referendum should take place before the end of 2014. The problem is that, according to the Spanish Constitution, only the Spanish Government can authorize the referendum, something the ruling PP party is firmly opposing. Other options include organizing a referendum without Spanish Government consent — which would make it technically illegal — or dissolving the Catalan Parliament and organizing new elections, with pro-independent parties sharing part of their manifestos. After months of bitter disputes, the Catalan president, Artur Mas [<a href="http://www.nytimes.com/2012/10/06/world/europe/in-catalonia-spain-artur-mas-threatens-to-secede.html?pagewanted=all&_r=0">profile</a>], is holding discrete talks with his Spanish counterpart, Mariano Rajoy, to try to find a way out of the current deadlock.<br />
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<b>Could an independent Catalonia become a viable state?</b><br />
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As with all the other aspects of the argument, the viability of a future state is a contested issue. Those opposing independence argue that a Catalan state would inherit a huge deficit which would make it very difficult to pay pensions or salaries. Besides, they take for granted that Catalonia would be expelled from the European Union, depriving Catalan companies from the benefits of a single market. On the other side of the debate, those in favour of independence argue that, without the burden of the huge deficit which results from the difference between what Catalans pay in taxes to Spain, and what they get in return, Catalonia — Spain's most vibrant economy — would have a GDP level in line with some of Europe's wealthiest nations, and its government could reduce the current debt and improve the quality of public services. In addition they doubt that Catalonia would find itself outside the frontiers of the EU, pointing among other precedents to the fact that the EU Treaty held that national bailouts of member states were illegal, until in fact one was urgently needed. [<a href="http://www.elclauer.cat/canvi_idioma/en.html">Keys on the independence of Catalonia</a>].<br />
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-67377480458750921732013-09-10T09:18:00.002+02:002013-09-10T09:18:34.803+02:00Doing Nothing Is Not An Option!<b>The recent IMF proposals to help stimulate growth and job creation in Spain at least deserve serious consideration.</b><br />
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In <a href="http://blogs.ec.europa.eu/rehn/spanish-sketches-a-d-2013-can-spain-achieve-what-ireland-and-latvia-did/" target="_blank">a blog post</a> which sought to defend the recent IMF proposal to for a social compact involving a 10% reduction in Spanish wages and salaries, the EU Economy and Finance Commissioner Olli Rehn cited a line from Bob Dylan - "Something is happening here, but you don't know what it is".<br />
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He was talking about the evident uncertainty surrounding the kind of economic recovery Spain might be having. But the line could equally be applied to the across-the-board response of Spanish society to those very Fund proposals he was defending. From employers to unions to government and opposition <a href="http://www.noticiasdenavarra.com/2013/08/08/economia/rechazo-unanime-a-la-bajada-salarial-propuesta-por-el-fmi-y-rehn" target="_blank">the country has spoken with one voice</a>, “something is going on here and we don’t want to know what it is”.<br />
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I say “don’t want to” since most of the comments appearing in the Spanish press have had little to do with the arguments that are being advanced or even with trying to understand them. Some journalists simply <a href="http://www.cadenaser.com/economia/articulo/sindicatos-empresarios-rechazan-propuesta-fmi-bruselas-bajar-salarios/csrcsrpor/20130807csrcsreco_3/Tes" target="_blank">focused their attention on the salaries received by the Fund’s own economists</a> (which recently went up). <br />
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Others argue, citing the example of the Brazilian representative who refused to sign-off on the latest payment to Greece, that<a href="http://www.abc.es/economia/20130811/abci-deficit-democratico-201308091716.html" target="_blank"> the institution is not democratic</a>, since the emerging countries are not adequately represented. Little does it matter that what these countries are in fact complaining about is too much European influence on Fund policy and too much simplistic optimism. The prize for irrelevance though must surely go <a href="http://www.larazon.es/detalle_normal_economia/noticias/3264372/alemania-se-subira-el-sueldo-un-20-mas-que-es#.Ui4IBManolQ" target="_blank">to the La Razon writer</a> who thought it worth dedicating a whole article to the fact that German wages have risen 20% more than Spanish ones during the crisis. <br />
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What this latter point has to do with anything I’m not sure, but all these arguments do share one feature, they fail to take notice of the fact that Spain is in deep crisis. They ignore the fact that unemployment, and especially youth unemployment, is unacceptably high, that the country’s future is leaving by the day on planes, boats and trains, that the economic growth outlook is pathetically weak, and that, en fin, something most definitely needs to be done.<br />
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As Spain IMF Mission Head James Daniel puts it, “we see a recovery, but only a weak one”.<br />
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What the IMF are saying is that if you leave the situation as it is then growth will not be sufficient to make any significant change in the unemployment rate. Thus they estimate that on the basis of present policies the rate will still be 25% in 2018.<br />
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In addition they draw attention to the way the impact of the crisis has been so unfairly distributed, with those aged under 30, who surely have little responsibility for what actually happened, being asked to carry the biggest part of the burden. Given this, is it really so surprising that many of them are now leaving to seek a brighter future elsewhere? Still being unemployed in 2025 is hardly an enticing prospect!<br />
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Much has been done to protect those members of our society who, like me, are over 60, but we need to remember that it isn’t the increase in life expectancy that represents a threat to future pensions, the real threat is not having enough young people left around to pay them!<br />
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To avoid this catastrophe, as James Daniel says, “Growth needs to be stronger and needs to become more job rich”. This, he argues, is something that requires action in many areas, among which he includes “increasing wage flexibility so that growth produces more jobs” and creates “a more even playing field between those with permanent jobs and those with temporary jobs”. Does any of this ring any bells?<br />
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By chance this week I spoke with a journalist from Estonia, a country whose recent progress many in Spain would like to identify with. What he explained to me was that in his country the highest average wages go to those in the 30 to 35 age group, while in Spain the top paid workers are aged between 50 and 59. This situation doesn't make any economic sense whatever and something is seriously wrong here if we want a country which is open to initiative, creativity, entrepreneurship and imagination.<br />
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The Fund’s proposal is effectively for a new set of “Pactos de la Moncloa”, a series of agreements between all parties and social agents arrived at during the transition from dictatorship to democracy in the 1970s, to agree not only wage reductions, but for employers at the same time to make employment commitments while measures are also agreed which could bring down prices.<br />
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This is the so called “internal devaluation” that macroeconomists like Paul Krugman, Dani Rodrik and myself have been advocating for some 6 years now. It isn’t a perfect plan, having the Euro doesn’t make things easy, but it is a damn sight better than doing nothing and watching and waiting while things get worse. Certainly it is a proposal worth studying and discussing and not simply dismissing out of hand.<br />
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The above is an adapted version of an article that originally appeared in the Catalan newspaper<a href="http://www.ara.cat/" target="_blank"> Ara</a>.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-25349533903944333362013-09-09T11:30:00.002+02:002013-09-09T12:06:24.057+02:00The Recession May Be Ending But The Crisis ContinuesWhat follows is an interview I did over the summer with the Madrid based publication <a href="http://www.thelocal.es/">The Local</a>.
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<b>Let's start with the basics: what are Spain's current economic problems?</b><br />
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Spain's economic problems are a knock-on effect of the end of Spain's property boom. The collapse of the property market led to a drop in incomes, depressed demand for goods and — slightly — lower wages.<br />
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At the same time, apart from property prices haven't come down.<br />
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In addition over one adult in four isn't working.<br />
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So consumption is steadily falling.<br />
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On top of that we have a debt overhang — which means it is difficult for Spain to borrow. Larger companies are struggling to get credit so they are delaying payments to smaller suppliers, which means smaller companies are finding it harder to get money. It's a vicious cycle.<br />
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We are also seeing imbalances within Europe with the Germans doing 'well' and young Spaniards leaving the country to work elsewhere.<br />
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<b>And how has the Popular Party (PP) government led by Prime Minister Mariano Rajoy tackled these problems?</b><br />
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One of the main objectives has been to avoid a financial rescue from the European Union. This was important for a number of reasons.<br />
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National pride was definitely one factor. Also, it is unlikely any Spanish government could have survived a bailout. Then there is the fact that Europe would have had a greater say in how the Spanish economy operated if a bailout had taken place. The EU would have been telling Spain which taxes to raise or lower, for example, or how to go about pension reform.<br />
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<b>How do you rate the government's attempts to cut spending?</b><br />
<br />
At the end of the day, this government is made up of 'middle of the road politicians' and they are basically economically liberal. Which means they would like to see less government. So if the deficit hasn't come down very far it hasn't been for want of trying.<br />
<br />
I would probably have to say their least recognized achievement has been their attempt to reform the public administration. This hasn't been easy for the PP as some of the areas where the party has a lot of support are also places where there is not a lot of industry, and where government is a big employer. This being said Spain still had the biggest deficit in the EU last year (government spending exceeded tax revenue by 10.6 percent).<br />
<br />
In addition, reform of the financial sector still has a long way to go as well because while there is increased liquidity in the system, more recapitalization is constantly required as the high unemployment and low demand for products means more bad loans are created with each passing day.<br />
<br />
<b>Recently, Spain's Economy Minister Luis de Guindos asserted the recession may be over. He didn't mention the crisis though. </b><br />
<br />
That's an important distinction. Luis de Guindos is an intelligent man and recognizes that while the crisis is ongoing, recessions are a normal part of the business cycle. Spain's second recession since the crisis began could well be over.<br />
<br />
And yes, we could well see two, or three, or even four quarters of weak economic growth but this is just part of the cycle. Indeed, our double-dip recession could eventually turn into a triple-dip one. This is because none of the underlying problems have been adequately addressed.<br />
<br />
We were told house prices would bottom out with the creation of a bad bank, but they are still falling. There is probably some way to go still, maybe two or three more years of falling prices. The organization charged with handling failed banks' property assets, the "bad bank" Sareb, isn't operating very well either. Sales are very low and the costs for potential buyers from Sareb is too expensive as the organization doesn't have depositors and has to make deals with other banks to give mortgages which end up making interest costs too expensive to make the purchase attractive.<br />
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<br />
And even while some of the old imbalances are adjusting new ones are being created since young people are now leaving Spain to work elsewhere in ever greater numbers. We don't know exactly how many are leaving because Spain's electoral roll doesn't keep accurate track of where native Spaniards are living and working. What we do know is that last year Spain's population fell for the first time in modern history, and that it will continue to fall as far ahead as the eye can see. A turning point of some kind has been passed.<br />
<br />
<b>What do you make of the spate of claims the crisis is over?</b><br />
<br />
I believe these predictions play to two audiences. The first issue is a confidence issue. Politicians would like to give the impression to the Spanish people that the crisis is ending to encourage them to spend.<br />
<br />
At the same time, Prime Minister Rajoy is fighting for his political survival. One of the likely consequences of the current lack of government credibility, in my opinion, is that Spain could - in time – become effectively ungovernable in a way which has become common in other southern European countries. Fresh elections are unlikely in the short run, but when they do come there is unlikely to be a clear majority party, the outcome is likely to be fragmented, and indeed the Catalans want a vote on whether to leave.<br />
<br />
The (opposition socialist) PSOE party continues to have a huge credibility problem following the fiasco of the Zapatero government. They are currently polling at very low levels (21.6 percent according to a July poll run by Metroscopia).<br />
<br />
It's also very hard to imagine a political party in Spain making an alliance with Catalonia's ruling CiU party given there is an independence referendum in the pipeline.<br />
<br />
<b>So what does the term crisis actually mean after five years?</b><br />
<br />
My feeling is that it's totally unrealistic to expect a 'return to the old reality'. We are now in a change of paradigm process.<br />
<br />
We all need to change our expectations and find ways to live with the new situation, since whether we like it or not we will have to. There is no quick fix - these have all been tried and failed - and Spain is now condemned to going through a painful long-term shift. The country will have to deal with its legacy debt.
<br />
<br />
Personally, I think the International Monetary Fund could have played a more important role. It could have acted as a kind of referee between Spain and the European Central Bank (ECB) and the EU, coaxing the country into adopting more fundamental changes. It could have pushed for the "front loading" of the deep reforms the country needs (especially the much needed internal devaluation) coaxing the country into making changes at a time when the population was still receptive. But unfortunately even though the Fund is now trying to recover lost ground, most of the principal social actors turn a deaf ear. No one wants to hear more about harsh sacrifices, they only want "sweet words" about a looming recovery and regeneration.<br />
<br />
In addition I believe the IMF is now increasingly trying to distance instance from Europe because it has become tired of playing the part of public relations officer for what are effectively EU-lead programmes. It is clear from the Greek case - and the recent IMF "mea culpa" - that this way of doing things doesn't work. Further, non-European members of the Fund like Brazil, China and India are now increasingly pressuring the organisation to stop molly coddling Europe's leaders. Look, for example, at how little money is being offered to Egypt and how much has been spent on Greece.<br /><br />But what this means is that the organisation is now unlikely to play the role it once could have.<br />
<br />
<b>To what extent is Spain responsible for its crisis, and to to what degree are international circumstances to blame?</b><br />
<br />
When the Euro was rolled out, the single currency idea clearly wasn't thought through well enough. The EU leaders didn't envisage the problems that have arisen.<br />
<br />
Another part of the problem lies in an idea that existed in Europe before the crisis — this was the idea that all countries all had equal levels of risk. And this clearly wasn't true. So to some extent the EU itself needs to assume responsibility.<br />
<br />
But on the Spanish side, it's obvious the political parties were up to their necks in fomenting the boom by letting regional savings banks keep lending money, and by allowing builders to keep building.<br />
<br />
During the building boom, many Spaniards also became property speculators in their own right, buying more houses than they really needed. As the saying goes, "When the music plays you have to dance".
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-7254565701139450352013-04-28T21:22:00.001+02:002013-04-28T21:22:15.168+02:00Beyond Their Ken?<strong>Spain's economic problems now form part of such a complex web of cause and effect, action and reaction, that it is getting increasingly difficult for laymen, journalists and politicians alike to get to the core of what is actually happening</strong>.<br />
<br />
<blockquote class="tr_bq">
“<em>To a herd of rams, the ram the herdsman drives each evening into a special enclosure to feed and that becomes twice as fat as the others must seem to be a genius. And it must appear an astonishing conjunction of genius with a whole series of extraordinary chances that this ram, who instead of getting into the general fold every evening goes into a special enclosure where there are oats- that this very ram, swelling with fat, is killed for meat</em>”. – Tolstoy, ‘War and Peace’.</blockquote>
<br />
After so many false dawns, the recent announcement by Spain’s Prime Minister Mariano Rajoy that <a href="http://www.eitb.com/en/news/business/detail/1302684/spain-economy-2014--rajoy-says-spain-will-return-growth-2014/" target="_blank">the government was revising down its 2013 economic forecast</a> hardly caused a blink among a citizenry that is now completely inured to deception and ready to believe the worst about the intentions of any politician willing to come forward with either good or bad news. The long announced recovery has once more been delayed, and will now be noted not in the last three months of this year, but during the first six of 2014. Naturally, a public which is now totally accustomed to such postponements will not be surprised if this one is far from being the last.<br />
<br />
In fact, the latest institution to throw a bucket of cold water over the Spanish government’s rose-tinted promises is the IMF. In their latest five-year forecast for Spain they paint a pretty bleak picture of low growth and high unemployment lasting at least all through what is left of the present decade. <a href="http://www.eitb.com/en/news/business/detail/1316030/spain-economy--rajoy-brushes-dismal-economic-predictions-imf/" target="_blank">Mariano Rajoy has already jumped into the fray</a> to take issue with their outlook for 2013, but it is their longer-term forecast which is most interesting and preoccupying. Growth between 2015 and 2018 is now only expected to average around 1.5 percent annually. This would seem to be what the IMF now consider longer-term trend growth to be for Spain, and the most notable thing about the number is that it represents a significant downward revision from their earlier optimism. Even this comparatively low number may still be overly optimistic and may yet come down again – I personally expect NO noticeable recovery as cumulative negative developments more or less cancel out positive ones – but it is certainly much more realistic than anything we have seen from the Fund before. There is no question here of any “V” shaped bounce. That is just a fiction of Finance Minister Cristóbal Montoro’s imagination.
<br />
<br />
Naturally, the other side of the coin on this is the consequence for unemployment. With growth so low there will be little in the way of job creation (watch out, pension system sustainability) and unemployment will linger over 20 percent for many years to come – indeed the IMF have 2018 unemployment at 22.9 percent, meaning they don’t expect it to fall below 20 percent come 2020.<br />
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<br />
And there’s another highly interesting detail from the IMF Spain forecast. Even to get that rather low level growth of 1.5 percent a year, the Fund pencil in Spain’s running a fiscal deficit of 5 percent a year all the way through to 2018, with the natural consequence that the debt-to-GDP ratio is expected to reach 110 percent by that point, and that isn’t making allowance for any further bank recapitalisation that will be needed. As I have been arguing since 2008 now, Spain’s sovereign debt simply is not on a sustainable path, and what 1.5-percent growth supported by a 5-percent fiscal deficit means is that there is no structurally adjusted growth going on in the economy at all. As a country you are getting more into debt than any increase in output you generate with the borrowing.<br />
<br />
<strong>A well-oiled crisis</strong><br />
<br />
<a href="http://iberosphere.com/2013/01/spain-economy-contraction/7836" target="_blank">As I have argued</a> in an earlier post, it may well be that the Spanish contraction machine is now so well-greased that it simply continues winding the economy down and down in such a way that things may never recover, in the classic sense of that term. The only argument which stands in the way of reaching this conclusion is the near religious belief now so often heard in policy circles that, well, “economies always recover, don’t they?”
<br />
<br />
As it happens, they don’t, as a quick look at what happened in Argentina in the 20th century would confirm. But Argentina is arguably an isolated case, and the current economic malaise (I hesitate to use the word “crisis” due to the duration of what is so evidently an ongoing process) seems to be far more general.
What people seem to find hard is asking themselves one simple question, “but what if this time really is different?” Which is strange, since reasons for thinking that things may well not return to what was previously considered “normal” are not in short supply.<br />
<br />
Populations in developed economies are all now ageing rapidly, generating a phenomenon never before seen in the entire history of known human societies – systematically falling numbers of under-15s coupled with an ever growing population in the over-80s group. The sheer novelty of this phenomenon, coupled with the manifest feeling of unsustainability it generates about our current welfare arrangements should at least give policy makers food for thought, yet evidence that it actually is doing so is in very short supply. Plough on regardless seems to be the watchword.<br />
<br />
The current round of cuts to health and education spending are described as “painful but necessary” in order to facilitate a return to growth which will make further adjustments in the future unnecessary. Unfortunately nothing could be farther from the truth. The credit ratings agency Standard & Poor’s, which has been one of the global leaders in highlighting the likely impact of “first world” demographic changes, <a href="http://www.standardandpoors.com/about-sp/articles/en/us/?articleType=HTML&assetID=1245349076851" target="_blank">argues in its latest report on the subject</a> that despite some recent progress, without ongoing and continuous changes in provision entitlement, deficits and debt in developed economies will spiral out of control as the century advances. <br />
<br />
I think everyone who stops and thinks for five minutes about the situation will recognize the obviousness of this point, yet scarcely a single politician is willing to come out from behind the curtain and explain to voters the longer-term implications of having shrinking and ageing workforces at the same time as the size of retirement age populations explodes.<br />
<br />
<strong>Ignoring the obvious</strong><br />
<br />
By the middle of this century, and without policy changes, average deficits for developed countries will rise to 15.1 percent of GDP as the interest cost of the increasing debt burden exacerbates the budgetary impact of demographic spending. Median general government NET (not gross) debt (as a percentage of GDP) is expected to increase to 71 percent by the mid-2020s (from around 40 percent today) – and would then accelerate to 216 percent of GDP by 2050. Government spending would rise to about 57 percent of GDP in 2050, from some 49 percent today.<br />
<br />
Naturally, these numbers are just very rough and ready estimates, and such levels are unlikely to be reached since markets will surely not fund them, and policy changes will happen. The problem is that many policy makers are still stuck in denial about the need to make them, and where they are willing to do so it is largely linen washing conducted in private and not in the public space provided by election manifestos. Spain’s leaders, for example, continue to insist that no major changes in either pension contributions or entitlement are in the offing even though the need for one or the other is evident, as the structural deficit in the system continues to grow.<br />
<br />
Worse, the more frequently they say in public that there is nothing to worry about and all is well, the lower their credibility falls, since few people continue to believe them. At the same time they insist and insist that the current level of health provision will be maintained no matter what, when obviously this is something the country simply cannot afford to do.<br />
<br />
But more than the simple impact on government spending possibilities, it is the impact of these demographic changes on growth which seems to be the least widely appreciated part of the story. This is not an oversight of which Standard and Poor’s is guilty. According to the agency: <br />
<blockquote class="tr_bq">
<em>For several sovereigns in the Eurozone (European Economic and Monetary Union), the financial strains caused by shifting demographics are being compounded by the current economic and financial troubles, which are both strangling growth and increasing the need for social safety net spending.
This environment can result in tighter financing conditions amid private-sector deleveraging, plus cuts in public investment leading to a reduction in total investment and consequently the stock of capital. At the same time, the decline in investment activity will likely hurt total factor productivity (a measure of an economy’s technological innovation). Adding to these adverse trends, low employment and net emigration from several sovereigns implies a smaller contribution of labor to future economic growth, a continuing threat if unemployment becomes structurally high.</em></blockquote>
As can be seen, Standard and Poor’s mention a number of other factors which contribute to what they call the current “strangling” of economic growth in countries like Spain (tighter financial conditions, private sector deleveraging, cutbacks in public sector infrastructure spending, net emigration).<br />
<br />
They could also have cited the mere existence of the euro. It is evident that participation in the common currency has had the perfectly foreseeable effect on Spain of making it simple to get into trouble and a lot harder to get out of it. Borrowing was cheap and easy of access during the boom years, now lending to Spain’s banks has all but dried up, and what there is available remains burdensomely expensive.<br />
<br />
Divergences in interest rates paid by businesses on bank loans across the Eurozone have recently reached record highs, despite ECB attempts to achieve the opposite result. While the spread between yields on Spanish 10-year bonds and their German equivalent has narrowed significantly the Goldman Sachs interest rate divergence indicator – a measure of cross-border variations in rates charged by Eurozone banks on a selection of business loans – has once more risen and <a href="http://www.ft.com/intl/cms/s/0/cbf94b90-993b-11e2-8dc6-00144feabdc0.html#axzz2Qc2Oars3" target="_blank">reached 3.7 percentage points in January</a>. This means that companies in southern Europe continue to pay significantly higher interest rates than their northern rivals, leading to the conclusion that while ECB measures may well have been effective in avoiding short term Eurozone break-up, they have still failed to address the problem posed by such inhibitive credit conditions along the southern periphery.
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<br />
<strong>The lessons learned from inaction</strong><br />
<br />
So not only does Spain have uncompetitive productivity levels, and a damaged brand image, it also has a high cost of new capital making investment in the country’s economy both unattractive and prohibitively expensive. With unemployment at over 26 percent, non-performing bank loans remain on their upward path, meaning that more companies are facing potential insolvency. The <a href="http://www.hispanicbusiness.com/2013/4/15/pescanova_spanish_fishing_colossus_files_for.htm" target="_blank">recent bankruptcy of food multi-national Pescanova</a> has<a href="http://www.expansion.com/2013/04/14/empresas/banca/1365936948.html" target="_blank"> renewed rumours in financial circles</a> that the Bank of Spain is preparing another round of provisioning increases – this time for loans to large corporates and small and medium companies – is an indication of how severely the crisis is now hitting the entire business sector. The Spanish problem is now no longer simply one of a construction collapse, since the ensuing impact on overall economic activity has now spread right across the board. A stitch in time saves nine, as the saying goes, but in the Spanish case there was no stitch (since according to policymakers there was no deep-seated issue to address) and the garment simply unravelled. Lesson – it is a lot easier to make things worse by inaction than it is to make them better using the same approach.<br />
<br />
But backtracking a bit, the euro makes correcting Spain’s present situation difficult due to the absence of a national central bank able to conduct a full range of monetary policy operations, a limited access to fiscal policy and the fact the country has no currency of its own to devalue. But that does not mean, <a href="http://www.ft.com/intl/cms/s/0/1e4547c8-9554-11e2-a4fa-00144feabdc0.html#axzz2Qc2Oars3" target="_blank">as Wolfgang Munchau recently suggested</a>, that it is becoming more and more rational to think about euro exit as the cost-of-leaving threshold gets lower and lower. Countries may well one day leave the euro, but if they do it will be because the cost of trying to hold it together has driven them all but mad, not because they have made some back-of-the-envelope calculation showing that the benefits outweigh the costs. Leaving the euro would be a huge leap into the unknown, leaving one side of the calculation sheet simply beyond our ken. As I argued <a href="http://business.blogs.cnn.com/2011/09/22/dr-strangelove-and-the-euro-doomsday-machine/" target="_blank">in a post for the CNN blog</a>, the currency bares an uncanny resemblance to Dr Strangelove’s doomsday machine, designed so that one day it would almost inevitably blow up the global financial system, but constructed so that any attempt to dismantle it would also produce the same outcome.<br />
<br />
Yet, despite the risks, as <a href="http://www.ft.com/intl/cms/s/0/f01f5c66-a5b7-11e2-9b77-00144feabdc0.html" target="_blank">Gideon Rachman puts it in the Financial Times</a>, in today’s Spain people are slowly but surely losing their faith in both national and EU institutions, and are slowly being driven towards ever more radical “solutions” which far from being rational bear a pretty strong resemblance to the exact opposite: <em></em><br />
<em><blockquote>
The “European dream” that Spaniards embraced promised a middle-class lifestyle for most people. But with little prospect of secure jobs for the young and a threat to the future of the welfare state, the fear now is that the Spain of the future will look more like Argentina than Germany. An Argentine future would involve the constant fear of financial crises – and a widening gap between the social classes, as many continue to enjoy a first-world lifestyle, while a growing underclass becomes detached from prosperity. Above all, Argentine public life is characterised by deep cynicism about national institutions and leaders.</blockquote>
</em>Leaving the euro would be an incredibly costly decision for Spain, and becoming yet another Argentina would surely be no panacea, but that doesn’’t mean it won’t happen.<br />
<br />
<strong>Following in the Footsteps of Japan?</strong><br />
<br />
Meanwhile Mariano Rajoy struggles on. Since it is quite obvious that the current policy mix isn’t working, and with one eye on the growing number of “platforms” out there desperately seeking his scalp (those affected by the mortgage crisis, those affected by the preference share haircut) he is desperately thrashing around for a fig leaf policy to stop the nightmare. Last week he found one – in Japan. “I think in Europe we must all ask ourselves whether the ECB should have the same powers as other central banks around the world,” <a href="http://www.ft.com/intl/cms/s/0/61306ff4-a06c-11e2-88b6-00144feabdc0.html#axzz2PwrQY1Sb" target="_blank">he told a press conference</a>. In particular he seemed to be thinking about what he described as the “very important” shift in monetary stance that had just been undertaken by the Bank of Japan. Now here is not the place to go into the background to the Japan crisis (see <a href="http://fistfulofeuros.net/afoe/japans-looming-singularity/" target="_blank">my arguments here if you are really interested</a>), but one thing I am sure about is that neither Rajoy nor his main policy advisers have any real idea about what lies behind Japan’s long lingering deflation problem. What he does know is that Japan is able to run a 10-percent fiscal deficit and a 235-percent government debt-to-GDP level with what Nobel economist <a href="http://krugman.blogs.nytimes.com/2013/02/05/the-japan-story/" target="_blank">Paul Krugman calls</a> “no evident ill-effects”. Sounds good to Rajoy. Will it work in the long run? “No idea”, could be his response. In the long run, as is well known, we are all dead, and “anyway I won’t be in the Moncloa” might easily be his reply.<br />
<br />
In fact, <a href="http://www.valuewalk.com/2013/04/george-soros-japanese-policy-dangerous-yen-could-collapse/" target="_blank">as billionaire investor George Soros recently warned</a>, systematically debasing a currency (ie not just conducting a one-off devaluation) is an extraordinarily dangerous move. The Bank of Japan has, <a href="http://krugman.blogs.nytimes.com/2013/04/11/monetary-policy-in-a-liquidity-trap/" target="_blank">in Krugman’s words</a>, committed itself “to credibly promise to be irresponsible”. What this “irresponsibility” means is devaluing the currency sufficiently every year to generate sufficient price rises to comply with the central bank’s recently announced 2 percent annual inflation target. This is one promise it will be hard for the bank to keep since Japan’s deflation is being caused not by a poor adjustment in the economic system by structural demand deficiencies produced by the country’s ageing and shrinking population.<br />
<br />
The best case scenario would be that the country’s policy makers realize in time that the experiment won’t work, and come to recognize that they have to learn to live with deflation – in which case the only big headache they will have will be what to do with all that debt (you know, the debt that many thought presented no evident problem). Far worse would be success, since if the Bank of Japan succeed in changing expectations (not in the why, but in the how) and lead people to believe that the currency will be debased every year ad infinitum (even assuming the rest of the G20 could ever agree to this), just to guarantee that 2-percent inflation, then they may well end up forgetting their supposedly innate “home bias” and start converting as many yen as they can get their hands on into dollars or some other convenient monetary unit, in the process creating a run on the currency which will make what happened in Argentina look like child’s play.<br />
<br />
Such details are doubtless lost on Mr Rajoy and his advisers, which is just my point. The current crisis – which is arguably no longer a crisis but rather a way of life – has all now gotten so complex that the issues involved are almost certainly, and in principle, “beyond their ken.” Spain’s economy will continue to march boldly forward towards what now seems almost guaranteed to be long term decline, while from within the captain’s tower, far from an acceptance that what is happening really is happening, we will continue to hear yet one more crazy and implausible story after another telling us “if only this”, or “if only that” even as representatives of the <a href="http://afectadosporlahipoteca.com/" target="_blank">Plataforma de afectados por las hipotecas</a> (or equivalents) start to assemble outside the local version of the winter palace looking for their hides.<br />
<br />
<b>Postscript</b><br />
<br />
I have recently established <a href="http://www.facebook.com/PopulationLossOnTheEuropeanPeriphery">a dedicated Facebook page</a> to campaign for the EU to take the issue of the Euro Area accelerating population imbalances more seriously, in particular by insisting member states measure movements of their own national populations more adequately and also by having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometimes great things from little seeds to grow.<br />
<br />
This is a revised version of an article which originally appeared <a href="http://iberosphere.com/" target="_blank">on the Iberosphere website</a>.
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-83347822284421563432013-03-25T15:53:00.001+01:002013-03-26T09:50:00.785+01:00Does Emigration Put Spain’s Health and Pensions System At Risk?According to <a href="http://www.economist.com/blogs/buttonwood/2013/03/european-migration" target="_blank">the Economist’s Buttonwood</a>, “desperate times require desperate measures”. I am sure this is right, times in Spain are certainly getting desperate and many of the measures being implemented in Brussels, far from representing radical and innovative solutions look much more like continually closing the barn door after the horse has bolted.<br />
<br />
The issue Buttonwood draws our attention to in the blog post which accompanies this statement is that of migration trends within the Euro Area and the impact these have on trend GDP growth and structural budget deficits in the various member countries. This is an important issue indeed, since such movements seem to be an unforeseen and largely unmeasured by-product of the current monetary and fiscal policy mix being pursued by the EU and the ECB, yet the consequences they have shape the long term future of the whole Eurozone, and with it the sustainability or otherwise of the component states.<br />
<br />
As I said <a href="http://iberosphere.com/2013/01/spain-economy-contraction/7836" target="_blank">in my last Spain post</a><br />
<blockquote class="tr_bq">
<i>One of the less commented features of Spain’s boom during the early years of this century is the way the arrival of economic migrants fuelled a significant part of GDP growth. The country’s population grew by more than six million (from 40 to 46 million) in the first eight years of the century, raising employment levels in both the formal and the informal economies. Migrants are still arriving, but the balance has now turned negative. According to data from the National Statistics Office, as of last June the net outflow was 20,000 a month and accelerating. That is to say a quarter of a million a year, or a million every four years. And the final numbers will almost certainly be much larger.</i><br />
<i><br /></i>
<i>So a country which already doesn’t have enough people working to pay for its pension system now faces having less and less as time goes by, while the number of pensioners looking to claim will only grow and grow. In part that is the end result of sitting back and watching a 1.3-child-per-woman fertility rate for over 30 years. But to this grave underlying problem is now being added a new and potentially more deadly one. Those leaving are not only migrants who came earlier. Increasingly, young, educated, Spanish people are upping and leaving, and unlike in earlier periods many who go now will never return. Not only is there a massive human capital loss involved here, trend GDP growth is evidently being reduced as the workforce steadily shrinks, while all those unsellable surplus-to-requirement houses become even less sellable.
</i></blockquote>
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The motivation for the Buttonwood post was a research report published at the end of last week by the European Financial Economist at Jefferies International, Marchel Alexandrovich. Ostensibly his concern is about optimal currency area theory as applied to the Eurozone, but underlying this concern is a further one: that Mario Draghi and his governing council at the ECB may not be living up to their promise. That is to say they may not be doing enough to hold the Euro together. The Outright Market Transactions (OMT) policy was intended to try to remove break-up risk in the capital markets. Despite the fact that the programme has not been made operational, it has worked reasonably well in that capital flight has been brought to a halt and even reversed, the bank deposit base in most countries on the periphery is now rising, and the break-up risk component in national bond spreads has been virtually removed.<br />
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But as often happens in economic matters, solutions to one problem may inadvertently lead to the creation of another. Avoiding radical debt restructuring on the periphery, and going for a "slowly slowly" correction doesn’t necessarily mean that all other things remain equal. Take the labour market, for example (I have already touched on this whole topic<a href="http://www.economonitor.com/edwardhugh/2013/02/24/the-shortgage-of-bulgarians-inside-bulgaria/" target="_blank"> in my recent post on Bulgaria</a>). As Alexandrovich points out one of the pre-conditions for the existence of an optimal currency area is the existence of cross frontier labour mobility, and the workings of the Eurozone have often been criticized on precisely these grounds. Buttonwood puts it like this:<br />
<blockquote class="tr_bq">
<i>“A SINGLE market works best when its workers are mobile; Americans have shifted to the south and west over the years, for example, as jobs in the rust belt have disappeared. Europeans have the right to work anywhere in the EU and have been doing so for decades; a British series about Geordie builders in Germany (Auf Wiedersehen, Pet) appeared all the way back in 1983. But language barriers mean it is more difficult in practice for Europeans to move than for their American counterparts”.
</i></blockquote>
But now, suddenly, in the wake of the current crisis things are changing. While “the political process to evolve the euro area toward an optimal currency area is slow,” says Alexandrovich, “the migration data suggest that there are rapid changes made in terms of the labour mobility dimension”.<br />
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The question is, is this good news? Obviously in one sense it is, if this is needed to make the Euro work it has to happen. But there is a downside, one which Alexandrovich points to: changes in the political process are lagging well behind developments in other areas, and especially in the migration one. It has been clear since the Euro debt crisis that a common treasury was a necessity for the good functioning of the currency union, yet progress in this direction has been painfully slow, and full of bitter recrimination. The migration problem might be just about to bring this simmering issue right to a head.<br />
<br />
As Alexandrovich points out, migration trends have recently reversed in some key Euro states. While Spain had rapidly growing population due to large scale immigration during the first decade of the century, migration into Germany was falling steadily, and at one point even went negative. Now all that has changed, people, on aggregate, are moving into Germany and moving out of Spain.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkVPHuKaJ_7QgyXsoNTMkj3bsSQ86p7ufALVjUI1hJ7alOjHeV4KiovdVYfEDgxRFfCvhE0zPaAU-s1_EQu009Yse2peVMJvioB_c01E_tH05iSQ7-PcVeEd7MjMzA-8m1Yz8V/s1600/2013-03-06_083303.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="174" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkVPHuKaJ_7QgyXsoNTMkj3bsSQ86p7ufALVjUI1hJ7alOjHeV4KiovdVYfEDgxRFfCvhE0zPaAU-s1_EQu009Yse2peVMJvioB_c01E_tH05iSQ7-PcVeEd7MjMzA-8m1Yz8V/s320/2013-03-06_083303.png" width="320" /></a></div>
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In fact a similar situation exists in Portugal, Ireland and Greece (see <a href="http://www.economonitor.com/edwardhugh/2013/03/09/the-great-portuguese-hollowing-out/" target="_blank">my last piece on Portugal</a>), while the UK, for example, has steadily been receiving economic migrants.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZe5yXRYSsN_bvDsCCowYxrfP_XMaeBjp2GAJFkGsv2esHMMsCwQKYxj_aKJVer1S-qXOy3hhPfG9BHItpDAdEzZo7Fea5mLoXGbxo7rEsPqD3xuHxsORWl310PcopFN8FVcnp/s1600/2013-03-06_083406.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="219" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZe5yXRYSsN_bvDsCCowYxrfP_XMaeBjp2GAJFkGsv2esHMMsCwQKYxj_aKJVer1S-qXOy3hhPfG9BHItpDAdEzZo7Fea5mLoXGbxo7rEsPqD3xuHxsORWl310PcopFN8FVcnp/s320/2013-03-06_083406.png" width="320" /></a></div>
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These migration patterns affect working age population growth, and with this the rate of underlying potential GDP growth, the number of people paying taxes and social security contributions, the rate of new family formation and demand for new housing, etc etc. As Alexandrovich notes, movements in population momentum are an important economic indicator, and the degree of uncertainty about what individual national population dynamics are is rising.
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<br />
One of the interesting details within the latest European Commission Winter economic forecasts for instance is the downward revision to Spanish population estimates, with the country’s population now expected to shrink in size by 0.2% in both 2013 and 2014 – the previous forecast from only a few months previously was a 0.1% annual fall (see table below). This may not seem particularly significant, but these are obviously just first estimates and as the economy goes through another tough year this years outcome could be much worse than expected with the drop potentially extending for years into the future.
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPDVTr8zjEijW5czXl7gIVh83ptxuMSJCVBqIh4qyxUHUvqsdj7ISMQsNINA79S6O4Ms8JIcZ5wL4-pQfE5R4Nbqc5ukAZPya_VcVtfVvmYxvc_F3Kf-bihqrgU2TFOjyMA7zE/s1600/2013-03-06_083438.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="132" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPDVTr8zjEijW5czXl7gIVh83ptxuMSJCVBqIh4qyxUHUvqsdj7ISMQsNINA79S6O4Ms8JIcZ5wL4-pQfE5R4Nbqc5ukAZPya_VcVtfVvmYxvc_F3Kf-bihqrgU2TFOjyMA7zE/s320/2013-03-06_083438.png" width="320" /></a></div>
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In fact the negative movement in Spain’s population is accelerating and no one really knows how far this acceleration will go, or how long it will continue. What we do know is that the likelihood of Spain’s unemployment rate falling below 20% by 2020 is small (it is currently over 26%), and with such high unemployment the pressure to move will continue to be strong.
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzFgKk-O_MQXWRTa4ytY-VKK929TFxB0rqnT8Jx13wlRqBq6YYOKzXZe2VIDmDCCQ-Y_IJMTxkN0GdIKFo-AzzdduQfQ4cKsQrMphzGN2Ny6m2d8LXQQDXtlf5QqjbQcE3b901/s1600/Spain+Net+Migration.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="193" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgzFgKk-O_MQXWRTa4ytY-VKK929TFxB0rqnT8Jx13wlRqBq6YYOKzXZe2VIDmDCCQ-Y_IJMTxkN0GdIKFo-AzzdduQfQ4cKsQrMphzGN2Ny6m2d8LXQQDXtlf5QqjbQcE3b901/s320/Spain+Net+Migration.png" width="320" /></a></div>
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Now, if we look back over Spain’s “good” economic years, it is clear that even though growth between 1999 and 2006 was normally in the 3% to 4% range, most of this growth came from population increase, which was extraordinarily rapid, while productivity growth was miniscule, and even in the best of cases less than 1%.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8YQmoo4PtYzFAWDhXH61Bw92KRah9IWFdIgvKGvkJttzNmoiQ6Dj2R_6t02eZSxIhCkLhS3Yl_Kx69pbWBU6SQ0CCskBzWRzZLF0En2BoEgK6juRZeQyD_GiANEnfgBM3aIgC/s1600/Spain+Population+Growth+and+Productivity.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="180" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8YQmoo4PtYzFAWDhXH61Bw92KRah9IWFdIgvKGvkJttzNmoiQ6Dj2R_6t02eZSxIhCkLhS3Yl_Kx69pbWBU6SQ0CCskBzWRzZLF0En2BoEgK6juRZeQyD_GiANEnfgBM3aIgC/s320/Spain+Population+Growth+and+Productivity.png" width="320" /></a></div>
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Spain’s population had been virtually stationary in the second half of the 1990s, and the subsequent rise was almost entirely due to immigration, the overwhelming majority of which was of working age population, as can be seen in the chart below from the Spanish national statistics office.
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwzYHIL9V7TCmAVGwRj-RRd0EXlb5MMIuyDDYHOmk3PBwUzQk85MIN3wBP4WiyT9mgBpRvuLDPuLXOEPmGMHnWHwkNbUHP8roE5f4TKFfHPBOukt3EzNTbnHD-yslr_GCoeDdq/s1600/Spain+population+pyramid+INE.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="235" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwzYHIL9V7TCmAVGwRj-RRd0EXlb5MMIuyDDYHOmk3PBwUzQk85MIN3wBP4WiyT9mgBpRvuLDPuLXOEPmGMHnWHwkNbUHP8roE5f4TKFfHPBOukt3EzNTbnHD-yslr_GCoeDdq/s320/Spain+population+pyramid+INE.png" width="320" /></a></div>
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Now why, if this was the case you might ask, did Spaniards feel so much better off during these years, since GDP growth per capita, and especially per working age person was not exactly stellar. Well, the next chart tells us why.
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_8jF14Tsg40HEkp-KjgG7721cg-ubGf6AaLgy5o_pBIgZ4ZM4KspwnY2n47C3ljHQ05EUKhBPBzkbdYs0KlBj6lP9fWnHofCSbOkvHAxQJG8o2XiVBwh2nkXSpnfcvTGtp6f4/s1600/Spain+Current+Account+1999+to+2006.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="176" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_8jF14Tsg40HEkp-KjgG7721cg-ubGf6AaLgy5o_pBIgZ4ZM4KspwnY2n47C3ljHQ05EUKhBPBzkbdYs0KlBj6lP9fWnHofCSbOkvHAxQJG8o2XiVBwh2nkXSpnfcvTGtp6f4/s320/Spain+Current+Account+1999+to+2006.png" width="320" /></a></div>
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Basically Spain as a country was getting into debt, by borrowing abroad through the European interbank market, and consuming a lot of products which were produced elsewhere. Naturally, with house prices going up each year, homeowners felt increasingly well off. Now, of course, house prices are going down each year, and exports are being increased to help pay down all the accumulated debt. So we getting the “continually feeling worse” effect. <br />
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Not unsurprisingly, IMF growth forecasts for Spain are being steadily revised downwards to reflect the new reality. And naturally if the current working age population dynamics continue they will be revised down further and further. This is what makes listening to that continuing string of speeches from Spanish politicians just so tiresome. They continually talk about recovery being just around the corner, but in reality they have no idea what recovery will mean in Spain, or even of what they are talking about.
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_Zr4RLnqp3luvmwreSGnTjPflqyUYZoHGbFzfzzFZJLXbcXDHd6F9oUGBWo-xpqn7EroTvB5KjRgKFhyphenhyphenhJhOcyhkAAbhw0aT0G7ERqStSMnvOMTWPyfBRMR3kHOrWl750Put0/s1600/2013-03-06_083505.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="151" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_Zr4RLnqp3luvmwreSGnTjPflqyUYZoHGbFzfzzFZJLXbcXDHd6F9oUGBWo-xpqn7EroTvB5KjRgKFhyphenhyphenhJhOcyhkAAbhw0aT0G7ERqStSMnvOMTWPyfBRMR3kHOrWl750Put0/s320/2013-03-06_083505.png" width="320" /></a></div>
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And there’s yet another nasty twist here. Spain’s employment legislation effectively protects older workers at the expense of younger ones. That is why while the overall unemployment rate is 26% the rate for 15 to 24 year olds is 55%. This “older worker bias” also has implications for productivity, as a recent report by Deutsche Bank’s Gilles Moec indicates:
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<br />
<blockquote class="tr_bq">
<i>"The dualism of the labour market in many European countries means that, on average, workers under the age of 25, since the beginning of the crisis, have contributed 4 times as much to the contraction in employment as their actual share in total employment (see Focus Europe 9 November 2012). Young workers often are the vehicle of innovation in companies and any labour market adjustment which is skewed towards young workers will ultimately reduce aggregate productivity. </i><br />
<i><br /></i>
<i>Using data collected at the firm level in Belgium (which in our view is a good proxy for the Euro area in general), Lallemand and Rycx estimated the impact of a change in the age structure of staff on productivity, by adding to a canonical model of productivity based on firms’ characteristics (such as sectoral specialization and educational attainment of workforce) the share of three age groups (below 30, 30 to 49, above 50) in firms’ workforce, as explanatory variables. To provide an illustrative order of magnitude of the negative impact of the recent change in the age structure of companies on aggregate labour productivity in the peripherals, we applied the coefficients estimated by Lallemand and Rycx on the actual changes observed in Spain and Italy between 2007 and 2012 (see Figure 1). This effect is actually quite sizeable, with an adverse shock on the level of aggregate productivity of around 2% in both countries". </i></blockquote>
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So really the whole current situation is most lamentable, since Spain’s ongoing loss of young talent means that the country may well be losing growth potential just as fast as the implementation of structural reforms is recovering it.<br />
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But, to go back to the start, and Buttonwood’s point that “desperate times require desperate measures,” these are just what Marchel Alexandrovich at Jefferies is calling for, serious and substantial political measures to shore up the Euro fiscal system, to enable people to move without making the instability in health and pensions systems, and the difficulty of carrying through national level fiscal adjustments, even worse. Spain’s pension system shortfall added at least 1% to the 2012 deficit, and the situation is only deteriorating as fewer people contribute to the social security system with each passing month while ever more people retire and claim benefits. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDY1xEsQDtZ8B6YD4MshIoF0FReXAZ_F9Jt58DTHfrG154UaUH4UkWF1lbrY2sANxNkxwEjfYJc38K_y86CTuztOL1vQeUWut_Y7vhBvynFfeU3VkI7uj-1sqoUiShmUFZlhoe/s1600/Spain+Afiliados+-+English.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="199" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDY1xEsQDtZ8B6YD4MshIoF0FReXAZ_F9Jt58DTHfrG154UaUH4UkWF1lbrY2sANxNkxwEjfYJc38K_y86CTuztOL1vQeUWut_Y7vhBvynFfeU3VkI7uj-1sqoUiShmUFZlhoe/s320/Spain+Afiliados+-+English.png" width="320" /></a></div>
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Alexandrovich is not, however, as Buttonwood appears to suggest, advocating “a fiscal union where tax revenues is distributed to the smaller countries to allow people to stay put”. This is what happened to the Spanish system of inter-regional solidarity following the 1970s transition and has now become part of the problem in Spain’s labour market. No, he is arguing for automatic health and pension fund stabilisers to be put in place, so that workers can move freely around without worrying about the implications for their parents or grandparents back home. Otherwise we really will have winners and losers coming out of this crisis, with some countries shoring themselves up, while others are (unknowingly) melting themselves down. <br />
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But first, we need to take more determined steps to really measure what is happening. At the moment our knowledge about these flows and their implications is woefully limited. As the European President of the Migration Policy Institute Demetrios Papademetriou put it recently: “The current knowledge base on the economic and social impacts of free movement is slim — in part because its evolving, flexible nature is difficult to capture in official data sources — but it must be improved, to afford a greater understanding of the effects on communities, local workers, and the public purse.”<br />
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In conclusion, I leave the last word to Mr Alexandrovich:<br />
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"And so we have gone full circle back to the idea of an optimal currency area. The way that a banking union tries to mitigate the effects of a potential bank run, similarly one could help mitigate the effect of Spanish or Greek workers going to work in Germany by having a union where tax revenues get redistributed between the various countries. Otherwise, debt needs to be serviced by fewer taxpayers which then need to be squeezed even harder to keep the whole thing ticking over. So on various levels arguably the euro project remains incomplete and migration data simply help shine a light on some of its further shortcomings, where some countries get isolated and left even further behind".<br />
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<b>Postscript</b><br />
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I have established <a href="http://www.facebook.com/PopulationLossOnTheEuropeanPeriphery">a dedicated Facebook page</a> to campaign for the EU to take this issue more seriously, in particular by insisting member states measure the problem more adequately and having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometime great things from little seeds to grow.<br />
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This is a revised version of an article which originally appeared <a href="http://iberosphere.com/" target="_blank">on the Iberosphere website</a>.
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-14176166254785417852013-02-17T21:19:00.001+01:002013-02-18T19:03:42.643+01:00Has Spain’s Economic Contraction Now Become Self Perpetuating?Spain’s political leaders are in cheerful, almost jubilant, mood at the moment. Economy minister Luis de Guindos, speaking in Davos, declared the tide had turned, and forecast that the Spanish economy would return to growth in the second half of 2013.<br />
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“The perception of the Spanish economy has improved and will continue to do so over the coming weeks and months,” <a href="http://www.bloomberg.com/news/2013-01-25/spain-doesn-t-need-bailout-or-budget-cuts-guindos-says.html" target="_blank">he told his audience at the World Economic Forum</a>. In similar vein,<a href="http://www.elmundo.es/elmundo/2013/02/16/economia/1361028185.html" target="_blank"> he told Spanish journalists in Moscow last weekend</a> that Spain's economy no longer being a key theme at G20 meetings was another welcoming sign of the times.<br />
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As ever, Spain's economy sage is hedging his bets - earth shattering the growth will not be, but grow the economy will, this is his mantra. Put another way, the bottom in Spain's economic collapse has now been passed. From here on in the road may be winding, but it will be up. Perhaps, he suggested, the economy will be stationary in the third quarter, and then we will see growth, albeit ever so slight, in the fourth one. And quite possibly he is right. The core of the issue is not whether the country could see one, or even two, quarters of positive performance, but whether any faltering recovery will be sustained out into the future, through 2014 and beyond. It is here that all the old doubts really emerge.<br />
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The brunt of the argument which says the country is now about to see a resurgence rests on the idea that Spain’s government have now enacted sufficient reforms to enable the economy to return to a strong growth path. Optimists claim they will, which the skeptics like myself are not convinced at all.<br />
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Certainly Mr de Guindos can point to occasions where he has carried the argument. Back in October last year, when he told an audience at the London School of Economics that Spain didn’t need a bailout <a href="http://www.cnbc.com/id/49298217/Spain_Finance_Ministerrsquos_lsquoNo_Bailoutrsquo_Remark_Sparks_Laughter" target="_blank">they simply laughed</a>. Four months later it is looking increasingly unlikely that the country will seek additional EU aid in the short term. “<a href="http://www.bloomberg.com/news/2013-01-25/spain-doesn-t-need-bailout-or-budget-cuts-guindos-says.html" target="_blank">Spain doesn’t need any sort of bailou</a>t,” he told Bloomberg TV recently, and this time no one laughed.<br />
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Perhaps the key point here hangs on your interpretation of the word “need”. If paying around 5% on your 10 year bonds is considered to be an acceptable cost for financing your country’s debt – Germany, for example is paying around 1.7% - then there is no need to apply to the EU and trigger ECB bond buying via the Outright Monetary Transactions program. If, on the other hand, you think the country could well benefit from lower funding costs, and the kind of pressure for reform which would be exerted from the outside though a Memorandum of Understanding, then clearly a bailout is needed.<br />
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Personally I take the latter view, since personally I think the country still has a long way to go in terms of reforms and since it is clear that introducing more measures that bite would be massively unpopular (and especially in the context of all the recent corruption scandals), the shelter provided by a troika driven program would make implementing them a lot easier.<br />
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Pension reform is a case in point. With the country’s elderly dependency ratio rising rapidly, and the number of people paying contributions into the pension fund going down by the month, the whole system is badly out of balance and urgently needs some deep structural reform. According to estimates provided by EU economics commissioner Olli Rehn at the last Euro Group finance ministers meeting, <a href="http://www.bloomberg.com/news/2013-02-11/spanish-deficit-haunts-rajoy-defying-junk-status.html" target="_blank">shortfalls in the pension system added more than 1% to the fiscal deficit in 2012</a>. And without major changes in the system this problem will only get worse. Yet Spain’s political leaders are apparently incapable of addressing this problem in public.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFRJxyGbZskt4eJDj0xjfwFsZC1T8xVTY4biowQoMWtYQqv8MhOUBlcUAMY098O8F5fO6KYTpqbBS1qWA5mVh1NStTkJIENHpcSBaIWmtARRmx9Ubs4VafElqUf8m16v448D48/s1600/Spain+population+pyramid+INE.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="235" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFRJxyGbZskt4eJDj0xjfwFsZC1T8xVTY4biowQoMWtYQqv8MhOUBlcUAMY098O8F5fO6KYTpqbBS1qWA5mVh1NStTkJIENHpcSBaIWmtARRmx9Ubs4VafElqUf8m16v448D48/s320/Spain+population+pyramid+INE.png" width="320" /></a></div>
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Another example is the urgent need to restore additional export competitiveness to the economy. Despite all the claims that the recent labor market reforms need time to work it is already evident that what has been done is far too little far too late. Exports have improved considerably, and the current account balance is moving into surplus. Yet despite this sterling performance the economy still contracted by 0.7% in the last three months of last year, and this during a period when the government was running at least a 7% annual fiscal deficit.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKexOmhyoapQebq_TDW3eL9muGDa1UJYM7tjMKSTWPQS_u_Gg799e-sYyYxUgu8zSj3G4HSt9dHNW0PiZoXEy2-FroZRBcsXggxDTjMN1bOJPghzvyqBcOJMHGX5hT30bbV6kf/s1600/Spain+Constant+Price+Exports.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="201" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKexOmhyoapQebq_TDW3eL9muGDa1UJYM7tjMKSTWPQS_u_Gg799e-sYyYxUgu8zSj3G4HSt9dHNW0PiZoXEy2-FroZRBcsXggxDTjMN1bOJPghzvyqBcOJMHGX5hT30bbV6kf/s320/Spain+Constant+Price+Exports.png" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidO-pgM60W-sqg7qwWkBroglDj4RT1f5TmZYZ4w5qgn_-ez9O2tqyuDSLjcEco5JSSlkdg0fwRzoHeXG6B09lV5XKztahkGtw0UqW7AdkH7fFgVeGJ07jbUnZlDk3bUO_NkPkL/s1600/current+account+balance.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="173" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidO-pgM60W-sqg7qwWkBroglDj4RT1f5TmZYZ4w5qgn_-ez9O2tqyuDSLjcEco5JSSlkdg0fwRzoHeXG6B09lV5XKztahkGtw0UqW7AdkH7fFgVeGJ07jbUnZlDk3bUO_NkPkL/s320/current+account+balance.png" width="320" /></a></div>
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Private domestic demand is weak, and weakening. Retail sales, for example, are on a continuing downward course. As salaries fall while prices continue to rise it would be wishful thinking to imagine this dynamic is going to change, especially as consumption patterns are altered by the population ageing process.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVm3b7a6zGQmCrGoHE4iRgOCgCWZ2_dV6Yt890ZC5JmL2yYh28lIo8urZipv6w7C0dh_Y7JS3fH-fAYTw_NQdK6sH9Oj1lPEDY8maBMcXEeFaNCzhbweRe8-X2dGzxqZwJMAB_/s1600/retail+sales.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="185" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVm3b7a6zGQmCrGoHE4iRgOCgCWZ2_dV6Yt890ZC5JmL2yYh28lIo8urZipv6w7C0dh_Y7JS3fH-fAYTw_NQdK6sH9Oj1lPEDY8maBMcXEeFaNCzhbweRe8-X2dGzxqZwJMAB_/s320/retail+sales.png" width="320" /></a></div>
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High unemployment (currently just over 26% of the workforce is unemployed) and heavy household indebtedness only add to domestic weaknesses, and it is clear that this will continue to be the case for years to come. No one seriously imagines an unemployment rate under 20% come 2020, and household and corporate deleveraging still have a long way to go.<br />
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On the other hand whatever deficit target relaxation the EU Commission gives Spain in 2013, fiscal accounts do eventually have to be brought into balance, so we can expect government spending to remain on a downward trend. The conclusion we are forced to draw is that all we have left are exports, if we want to see Mr. de Guindos’s hopes fulfilled and the economy return to sustainable growth that is. <br />
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So to cut through the jargon, and the war of statistics and counter statistics, I want to propose a definition – a country suffering from deteriorating demographics (rapid population ageing) and a private debt overhang is sufficiently internationally competitive when its exports grow quickly enough to fuel headline GDP growth sufficient to generate new employment on a sustainable basis.<br />
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This is patently not Spain’s case, and it won’t be in the coming years, so more needs to be done. Much more.
The employment generating caveat is important, since it is only by starting to generate new employment again that the Spanish economy could enter a positive dynamic, bringing to an end the surge in non-performing loans in the banking system, initiating a recovery in the housing market, and giving some sort of stability to consumer demand.<br />
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Thus, despite the fact that the country's current account balance is steadily moving into the black, this doesn't necessarily mean that growth is just around the corner. <a href="http://hungaryeconomywatch.blogspot.com.es/2013/02/hungarys-matolsky-joins-japans-abe-in.html" target="_blank">I recently carried out a study</a> of another economy in the process of adjustment, the Hungarian one, where the current account is now regularly positive, but the economy continually falls back into recession. As I point out in that study:<br />
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<blockquote class="tr_bq">
Surely there are lessons from the Hungarian case for the future outlook on the southern periphery of the Euro Area. Improving goods trade balances are steadily pushing current account balances in countries like Portugal, Spain and Greece back into the black. But far from being like Japan and having a large stock of external net savings these countries are more like Hungary with a large negative net external investment position (again hovering near 100% of GDP in all cases) and consequently a large external debt. What this means is that they are totally unprepared to receive the full impact of the kind of population ageing we have seen in Japan, an impact which is surely now under a decade away.<br />
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The Hungarian lesson is that exports can do well, very well, and the current account can correct, but the economy can still languish permanently on the verge of recession unable to generate sufficient growth to break out into a sustainable growth dynamic.
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Spain, like Hungary, has a very high negative net external investment position - around 90% of GDP - which means the country is extremely ill-prepared for the full impact of an elderly population.<br />
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<span style="font-size: large;"><b>Financial Economy - Real Economy Split</b></span><br />
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What is beyond doubt is that conditions in the financial economy have improved greatly. The government has opened a market for its debt, the banks have a solid capital base for 2013 and are able to access European wholesale funding markets – even if this is still at a considerable price in terms of interest paid. This is why Mr. de Guindos thinks the need for a bailout is receding.
But of course conditions in the real economy continue to deteriorate. Most estimates for 2013 are for a larger contraction than that estimated by the government (something which has become habitual), and many observers continue to expect the negative growth trend to continue in 2014. Unemployment was already over 26% as 2012 drew to a close, which makes 27.5% next December a virtual certainty and a number over 28% entering 2014 horrifyingly possible.<br />
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So despite all the positive “talking up” that Spain’s economy is receiving from well-wishers at the international level, the disconnect between the financial economy and the real one has now become markedly pronounced, and the clearest evidence for this is that what are now, at least for the time being, well capitalized banks are still unable to provide systematic credit to the deteriorating private sector.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRDO74DGv_6pTwMI0E8cyD-V_CmS9f60hSNLtmsj_LUqNlB4Z5veqTM56LxgT2lI4oIVlsyrGsi18YIMjUrj-wIeghf60CXDieNOcIh-jNG-g2onvg0XW6BwU9w8HheM6b7Jk0/s1600/Spain+Bank+Lending+(Total)+Y-o-Y.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="207" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgRDO74DGv_6pTwMI0E8cyD-V_CmS9f60hSNLtmsj_LUqNlB4Z5veqTM56LxgT2lI4oIVlsyrGsi18YIMjUrj-wIeghf60CXDieNOcIh-jNG-g2onvg0XW6BwU9w8HheM6b7Jk0/s320/Spain+Bank+Lending+(Total)+Y-o-Y.png" width="320" /></a></div>
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And if the private sector doesn’t improve, then the banking system will surely need more capital further along down the line. Even the relaxation of deficit targets comes at a price – next year (2014) government debt will almost certainly slip through that psychological 100% of GDP level, and still be heading upwards. Meaning that at some point a sovereign debt restructuring in Spain certainly can’t be ruled out.<br />
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Perhaps the worst of all assumptions that policymakers seem to be making is the one that “economies always recover”, an assumption which seems to be based on some sort of quasi-religious version of the “hidden hand” theory. Indeed, all that is necessary to makes this a less than universal generalization is one counter example, and unfortunately the real world is populated by several of them. Argentina in the 20th century would be one, the country started out among the richest globally, and look how it ended the century. Twentieth century Japan would be another, and once you start to look you can surely find more (try Ukraine, or Hungary). So recovery isn’t automatic, and something has to happen for recovery to occur. That something isn’t present in Spain at the moment, and indeed the danger is that as conditions deteriorate the contraction becomes self-perpetuating. <br />
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One of the less well commented features of Spain’s boom during the early years of this century is the way the arrival of economic migrants fueled a significant part of GDP growth. The country’s population grew by more than 6 million (from 40 to 46 million) in the first eight years of the century, raising employment levels in both the formal and the informal economies.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWIHr7kE78eJSEhoOlYPFK-iy8JSBSE0gZh2Kc_dosTSbmTR-OlMS0DQNNRrS_ybChmMAB0S6zmORT3dMXi7cBNsPIsRarM37P4-T5tSWe-xAOLaIMLdwRaAbuSxkaMY9uTQm4/s1600/spain+immigrants.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="174" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWIHr7kE78eJSEhoOlYPFK-iy8JSBSE0gZh2Kc_dosTSbmTR-OlMS0DQNNRrS_ybChmMAB0S6zmORT3dMXi7cBNsPIsRarM37P4-T5tSWe-xAOLaIMLdwRaAbuSxkaMY9uTQm4/s320/spain+immigrants.png" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGSOS8GTVCjMKkH5QjsANINgYRm_Xo6r7kkU-oJYdbcDewn5gZVFE34p9Rg3VfxwOn6v49ksf1InWh0UBi2_pgL2sV68r1e2OvH9ZZwwxPmxBcBK8uVc0RauGIYXUHWgTQO79X/s1600/Spain+Population.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="174" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGSOS8GTVCjMKkH5QjsANINgYRm_Xo6r7kkU-oJYdbcDewn5gZVFE34p9Rg3VfxwOn6v49ksf1InWh0UBi2_pgL2sV68r1e2OvH9ZZwwxPmxBcBK8uVc0RauGIYXUHWgTQO79X/s320/Spain+Population.png" width="320" /></a></div>
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Migrants are still arriving, but the balance has now turned negative. According to data from the National Statistics Office, as of last September the net outflow was around 20,000 a month and accelerating. That is to say a quarter of a million a year, or a million every four years. And the final numbers will almost certainly be much larger.<br />
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So a country which already doesn’t have enough people working to pay for its pension system, now faces having less and less as time goes by, while the number of pensioners looking to claim will only grow and grow. In part that is the end result of sitting back and watching a 1.3 child per woman fertility rate for over 30 years.<br />
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But to this grave underlying problem is now being added a new and potentially more deadly one. Those leaving are not only migrants who came earlier. Increasingly young educated Spanish people are upping and leaving, and unlike in earlier periods many who go now will never return. Not only is there a massive human capital loss involved here, trend GDP growth is evidently being reduced as the workforce steadily shrinks, while all those unsellable surplus-to-requirement houses become even less sellable. And so we may go on in what has all the hallmarks of a non too virtuous circle. So next time Luis de Guindos proudly proclaims that economic conditions are improving, he might care to consider stopping for a moment to reflect on the possibility, nay the almost certain reality, that Spain’s economic contraction now feeds on itself.<br />
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The country is no longer waiting, <a href="http://www.nytimes.com/2012/10/16/business/global/spain-may-pay-price-for-delaying-aid-request.html?pagewanted=all&_r=0" target="_blank">as the New York Times' Landon Thomas so aptly put it</a>, for Mr Rajoy. Indeed, Mr Rajoy himself has now turned his famous indecision into a virtue. "Sometimes the best decision is not to take any decision, and that itself is a decision,"<a href="http://www.lavanguardia.com/politica/20130213/54366686343/rajoy-rescate-decision.html" target="_blank"> he told enthusiastic supporters in his Partido Popular parliamentary group last week</a>. Or as one PP supporter put it to me last week, it now looks like Mariano Rajoy took a very intelligent decision last autumn, saying he would ask for a bond buying programme if the country needed it and doing nothing. Only time will tell if this was such a good decision as it seems. In the meantime far from waiting for Mr Rajoy, many young Spaniards are now only waiting to see who will be the last to leave so they can ask them to turn the lights out.<br />
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This is a revised version of an article which originally appeared <a href="http://iberosphere.com/" target="_blank">on the Iberosphere website</a>. Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-78357868622042742642012-11-19T10:52:00.001+01:002012-11-19T10:58:27.934+01:00El Rosario De La AuroraThe exact origins of the expression are unknown. They are lost back then, somewhere in the mists of time. But the meaning of the phrase is perfectly intelligible. In Spanish "to end up like the Rosario De L'Aurora" (acabar como el rosario de la aurora), means to end up badly. Very badly. The <a href="http://www.rosariodelaaurora.com/rosarioritual.htm" target="_blank">Rosario</a> in question is a procession (of the kind to be seen <a href="http://www.youtube.com/watch?v=0XV0KT8N5WA&feature=related" target="_blank">in this YouTube video</a>) and aurora here is not a woman's name, but the Spanish word for dawn. <a href="http://blogs.20minutos.es/yaestaellistoquetodolosabe/acabar-como-el-rosario-de-la-aurora/" target="_blank">According to legend</a>, the procession which gave birth to the phrase was characterised by a dispute which developed into an outright brawl during which all those precious sacred artifacts being carried by the devout got unceremoniously destroyed. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOP7WH9JOhhYMHMLDGRPDSQXonmVVUnaQ01CO2O9O8MsBr6K9EzcF46MQlZ8ZikCxkIeI6kWdlL1h3UAT2_3BOlMqAbcgjedSL9TEl8zC63AdY0kdMY8aqNkyiYHHsTOnuJ60U/s1600/2012-10-30_104727.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOP7WH9JOhhYMHMLDGRPDSQXonmVVUnaQ01CO2O9O8MsBr6K9EzcF46MQlZ8ZikCxkIeI6kWdlL1h3UAT2_3BOlMqAbcgjedSL9TEl8zC63AdY0kdMY8aqNkyiYHHsTOnuJ60U/s320/2012-10-30_104727.png" width="212" /></a></div>
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One popular theory has it that two rival processions tried to advance in opposite directions down an extremely narrow street, with neither being prepared to give way. Similarities with what is currently happening here in the Euro Area is, of course, entirely coincidental. What with the quantity of alcohol that people wandering the streets in the early hours during fiesta time would likely have consumed, and the fierce rivalry between the two "<a href="http://www.google.com/url?sa=t&rct=j&q=comparsas&source=web&cd=1&cad=rja&ved=0CC8QFjAA&url=http%3A%2F%2Fen.wikipedia.org%2Fwiki%2FComparsa&ei=_eSpUJrBG4jChAf6vYG4DA&usg=AFQjCNG1_SkEcUC9tWAI3uGDZnJ6IovvoA" target="_blank">comparsas</a>", the outcome is surely not that hard to foresee, or that worthwhile explaining. We can leave such details to the imagination of the reader.<br />
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But moving forward in time, and while again the versions of the story may differ, there seems to be little doubt that Spain's economy is in bad shape. Very bad shape. Such bad shape in fact that, <a href="http://www.ft.com/intl/cms/s/0/47bfc3f4-236b-11e2-a46b-00144feabdc0.html?ftcamp=published_links%2Frss%2Fworld%2Ffeed%2F%2Fproduct#axzz2BF62qvNh" target="_blank">according to Tobias Buck in a recent article in the Financial Times</a>, it has left most of the countries population "bewildered". Bewildered, and increasingly desperate and despairing, or as <a href="http://www.matthewbennett.es/14343/you-know-modern-spain-is-in-danger/" target="_blank">blogger Matthew Bennett puts it</a> dogged by the feeling that the modern Spain they know and love "is in danger". Indeed if we aren't all careful, the country could end up in a worse state than the one which befell that legendary rosario.<br />
<blockquote class="tr_bq">
You know the Modern Spain you love is in danger. </blockquote>
<blockquote class="tr_bq">
Thankfully, you can still eat abundant amounts of tasty Spanish ham whilst drinking a decent Rioja, and the Spanish national football team is still beating all-comers at international level—a truly world class achievement—but in your heart of hearts, you know a cataclysmic future outcome is a plausible option for a Spanish society that is struggling to adapt to a new world economically, politically and constitutionally.
</blockquote>
<blockquote class="tr_bq">
What happens to a society when tens or hundreds of thousands of its own citizens abandon the country to go and live and work abroad, with the approval of parents, government ministers and even the king? When record numbers of citizens—25%, nearly 6 million Spaniards—are unemployed, with no economic recovery or new jobs visible anywhere on the horizon? When the 12th largest economy in the world is ranked 136 for ease of starting a new business, behind Burundi, Afghanistan or Yemen?
</blockquote>
<blockquote class="tr_bq">
What happens when Spain’s existing national institutions aren’t capable of offering all of its citizens and residents a prosperous existence, or when political leaders steadfastly refuse to listen to their voters’ repeated cries for change and prefer instead to repeatedly lie to the nation, ignoring their own electoral programmes?<br />
</blockquote>
<strong>Put The Telescope To Your Blind Eye And You Will Surely See Recovery Ahoy!</strong><br />
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For <a href="http://online.wsj.com/article/SB10001424052970204349404578100312051762302.html?mod=googlenews_wsj" target="_blank">all the nay-saying</a> to which those who watch the country passing thorough its agony are now subjected on an almost daily basis, there can be no denying one point - better days Spain has surely seen. Despite the constant and repeated assertions that <a href="http://www.reuters.com/article/2012/10/26/us-imf-spain-idUSBRE89P0R520121026" target="_blank">great progress has been made with the reform programme</a>, or that <a href="http://www.thedailybeast.com/newsweek/2012/06/17/spain-is-more-competitive-than-you-think.html" target="_blank">exports are doing just fine</a> it's hard to see evidence for this in the <a href="http://www.nytimes.com/2012/10/27/business/global/jobs-data-underscore-rajoys-woes.html?_r=0" target="_blank">ever longer lines of unemployed</a>, or the <a href="http://www.foxnews.com/world/2012/11/15/spain-passes-decree-to-curb-evictions-most-needy-after-mounting-protests/" target="_blank">now daily diet of home evictions</a> to be seen in neighbourhood after neighbourhood. The number of reported green shoot sightings to which we have been subjected must now surely exceed the long term total accumulated for that other legendary beast, the Loch Ness monster. Yet this most terrestrial and long awaited of all resurrections has still not taken place. <br />
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But while the self-deluded continually claim to be envisioning signs of recovery, the data tell us another story. Almost every indicator we have points to deterioration, and the forward looking ones we have suggest there is worse to come.<br />
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The latest in the long line of examples I could cite comes to us in the shape of <a href="http://www.ine.es/en/prensa/cntr0312a_en.pdf" target="_blank">the third quarter GDP results,</a> announced last week by the national statistics office. Between July and September the economy shrank by 0.3% quarter-on-quarter, or by 1.6% when compared with a year earlier, making for the fifth consecutive period of negative economic growth. This put the Spanish economy back at a level approximately 4.25% below the highpoint achieved in the first three months of 2008, just before it entered the great recession.<br />
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But, of course, all of this isn't over yet. At the start of last week the Spanish <a href="http://www.reuters.com/article/2012/11/06/spain-economy-idUSL5E8M61HS20121106" target="_blank">newspaper El Pais published details</a> of leaked EU Commission forecasts for the country, showing that GDP is expected to decline by 1.5% in 2013, scarcely better than a 1.6 percent drop this year. Growth of 0.5% is then expected in 2014, and even if this result is eventually confirmed, what about 2015? Who is to say we won't be back to minus 0.5% again, or worse? Spain's economy won't be surging back to life again, the accumulated debt problems and continuing competitiveness issues virtually guarantee that, and only those who clutch hold of some kind of "but economies always recover, don't they" quasi religious type of fig leaf can summon the energy to convince themselves otherwise. The data and the analysis almost all point in another direction.<br />
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Yet, just like those historical reports that lie behind the rosario legend, this latest piece of economic data does inevitably allow for a plurality of alternative readings, and you can just glimpse a glass half full if what you really want to do is convince yourself that what is so obviously happening to the country actually isn't . Some will make a great deal of play of the fact that the rate of inter-quarterly contraction slowed when compared with the April through June period. Even the EU forecast can be used to this avail, since the annual rate of decline would seem to fall by one tenth of a percentage point next year. So thing are getting better!<br />
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Others will rejoin by pointing to the slew of other economic data which points to continuing deterioration, while yet others will argue that the fact the contraction wasn't deeper suggests the possibility that the austerity programme hasn't been all it is being made out to be, with the consequence that the deficit correction process is surely once more well off course. Indeed the EU and the IMF seem to now openly recognise this. Plus ça change!<br />
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At the end of the day, however, all of these interpretations miss what is surely the main point - Spain is and will continue to be stuck in depression, and not simply passing through a garden variety recession. Growth may be minus 0.3% one quarter and plus 0.3% the next. Frankly that doesn't change anything. Or at least not anything important. Without a more substantial set of growth restoring adjustments the economy will simply hover between growth and contraction for the rest of this decade, always assuming some major life-threatening event doesn't intervene first. The economy is broken, and there is no hidden hand at work on which to base expectations for an automatic fix. Recovery simply won't happen all by itself. That is to say, if someone somewhere doesn't do something to stop what looks set to happen happening, Spain and its economy can end up a lot worse off than even that famous rosario.<br />
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Let's look at some examples of what now seems to be more like a horror than an adventure story.<br />
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<b>Credit, Houses and Jobs</b><br />
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The economic crisis afflicting Spain and its economy has many aspects, dimensions and layers, but through the fog three interconnected elements stand out clearly - the availability of credit, the stock and price of houses, and the levels of employment and unemployment. Whatever starting point you chose, the final outcome always turns out to be the same. <br />
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The country seems to be trapped in some sort of modern adaptation of the traditional children's game "ring a ring o'roses". There is a shortage of credit in Spain because the economy is losing jobs, causing the demand for and prices of homes to fall, leading banks to accumulate unwanted assets and clock-up a growing number of bad loans which in turn makes them reluctant to advance new credit due to the fear of have to assume even more losses. But we could equally say that the economy isn't creating jobs precisely because of this shortage of credit, and that the rising unemployment is affecting the housing market. Or, if we are still not satisfied we could put it like this: the fall in house prices is reducing demand for houses, and weakening household consumption (via the wealth effect - 75% of all household saving in Spain is held in the form of property). This drop in consumption is causing the economy to contract, with the result that it is constantly shedding jobs leading the banks to incur even more losses.<br />
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Whichever way you look at it these three interconnected components lie at the heart of the Spanish malaise. There will be no resolution of the Spanish "problem" without a turnaround in all these areas, and at one and the same time. Kick-starting the Spanish economy means inducing an expansion in the number of those employed, a freeing up in the credit gridlock and establishing a bottom in the downward march in house prices. At the present time none of these objectives are anywhere in sight. Unemployment is rising, and will continue to rise in 2013. People are leaving the country, credit is falling, and house prices have just had one of their biggest interannual drops since the crisis began. This dynamic produces a vicious circularity which puts the country at risk of enduring the same fate as all those generations of children who have participated in the aforementioned ritual, namely that the climax is reached when everyone cries <a href="http://en.wikipedia.org/wiki/Ring_a_Ring_o'_Roses" target="_blank">A-tishoo! A-tishoo!</a> and then lies down.<br />
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<strong><span style="font-size: large;">Water Water Everywhere, But Not A Drop To Drink</span></strong><br />
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The question of credit flow is an especially complex one, since it is both cause and effect of the depression. Linear thinking will always have trouble with this kind of phenomenon. The banking system cannot freely supply credit since such a significant part of its balance sheet is "encumbered" with existing loans, some of which are already none performing. But there are many more which are in danger of becoming "troubled" if the crisis continues through the years ahead. Yet it is this very encumberment which virtually guarantees the crisis will continue. The loans in question are not only those made to property developers (many of these have in fact already been drastically written down). They are also syndicated loans to large companies, loans to small and medium enterprises, and loans to individuals for residential mortgages. As it is none of these portfolios are exactly going well, but the quality of the loans within them will continuously deteriorate for as long as the listless drift continues.<br />
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In addition, we need to remember that during the "good" years Spains banking system became considerably "overleveraged" - that is it gave an excessive number of loans in relation to the system's deposit base - in much the same way the Irish one did. So as well as working off distressed loans, the Spanish financial sector needs to reduce its leveraging which means (without a substantial increase in the volume of deposits) it has to cut back on lending. Naturally the kind of deposit flight Spain's banks saw in the first half of this year doesn't help matters.<br />
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So while the creation of the bad bank and the recapitalisation of the entire system will help clear some of the worst rubbish off the balance sheets, this doesn't necessarily mean that the clean up will lead to a flow of new credit, and indeed what has happened in Ireland (see chart below) tends to confirm this view. Irish banks handed over a large part of their distressed property assets to the bad bank NAMA, yet the interannual loan numbers continue to be in negative territory, just like the Spanish ones are.<br />
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To top it all, despite the fact that the country's banks had a net 378 billion Euros outstanding with the ECB in September credit is still not cheap. <br />
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Wholesale funding (where available) still comes at a hefty surcharge, and building the deposit base doesn't come cheap in a country where prices are rising at the rate of 3.5% a year. Typical fixed-term deposits now pay around 4%. Hence, according to the most recent ECB data (August) for lending rates to small and medium enterprises, German companies seeking a loan of €1million over a term of between one and five years typically pay something in the region of 3.8% – a record low for the Euro era – while their Spanish equivalent is paying 6.6%, the highest level since late 2008 when central banks cut rates after Lehman Brothers collapsed. So it isn't only wage costs that need to be reduced in Spain, capital costs need to come down to. This is naturally one of <a href="http://www.economonitor.com/edwardhugh/2012/10/22/taking-a-man-at-his-word/">the objectives of Mario Draghi's OMT programme</a>, but Mariano doesn't want to play ball, a strategy which may seem politically convenient but which comes at a high price for Spanish companies and those forming part of Spain's growing jobless mountain.<br />
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The second major issue facing Spain is how to stop the fall in property prices. Residential housing has seen falls now for almost 5 years, and prices are down around 30% according to real estate valuers TINSA, dropping by an annual 12.5% in October. Put another way, prices have fallen from something over 2000 euros a square metre, to around 1500. Spain's banks hold roughly 600 billion in home mortgages, and back of the envelope calculations suggest that once prices hit the 1,000 euros a square metre level the whole system (on aggregate) will be in negative equity - that is that homeowners will be standing on values in their property portfolio below the outstanding quantity owed in mortgage loans. At that point a critical moment will be reached, with the danger of implosion being much greater than "non negligible".<br />
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Spanish property prices have been being supported by a combination of three factors. <br />
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1) banks holding repossessed assets on their balance sheets<br />
2) the illiquidity of the market, with very few transactions in new property taking place<br />
3) a completely unfair distribution of risk between property developers (who can simply give back the keys) and those who bought the properties they built at the ludicrous prices they charged (who can't).<br />
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The nationalised banks are now set to move their "troubled assets" off balance sheet and into the newly created bad bank, Sareb. Although many questions still remain about the way Sareb will operate, its creation is unlikely to produce a turning point in the housing market, discounts may still not be sufficient to attract buyers in large numbers, and it is not clear how the mortgages those buyers who do appear will be financed.<br />
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Mortgages are not freely available in Spain, the volume of credit extended for house purchases is falling steadily year by year (see chart above) and attractively priced mortgages are normally only available to those buying properties on the balance sheet of the issuing bank. Those who seek mortgage finance for other property normally have to pay a hefty surcharge. Since Sareb will not be a bank, it will not have "own funds" with which to grant mortgages.<br />
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In the meantime Spain's unemployment continues to rise, hitting a record 25.8% in September. It is hard to say where this will peak, but the level looks certain to hit 27% in 2013. More importantly, simply getting the level back down to 20% again looks set to be a mammoth task, and one which is unlikely to be achieved this side of 2020. So many more years of pain certainly await the country.<br />
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One of the reasons the unemployment rate should peak reasonably soon is that people are now leaving the country in growing numbers. With 52.9% of the under 25 population who would like to work now unemployed a lot of young people <a href="http://www.huffingtonpost.com/2012/10/30/spain-crisis-emigration_n_2043951.html" target="_blank">are simply giving up and voting with their feet</a>. According to data from the national statistics office, in June this year a net 20,000 people left the country. That may not sound like much, but it is a rate of one quarter of a million a year, or a million every four years. More worryingly the rate of outflow is on an accelerating trend (see chart below). <br />
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Natrually this wouldn't matter so much if the Euro Area was one single federal state, since health and pension costs would be shared across the region, so it wouldn't matter whether people were paying taxes or social security contributions in one place or in another. Indeed such movement would be a rather positive sign of the existence of a single labour market, and labour force flexibility. But the Euro Area isn't a single state, and contributions and costs aren't shared. So some countries risk becoming unsustainable.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwSxBxs-TYS5fxWdiiKdmTwLJRN32EFVaBOGfHWF6um0Pe5Jcqua7pA2Gtj3kYSq45T47KLoyikB9GGWBIrjdr7x5d21Ya2Qv7-AoTmVKUc_1bDtVOD-Wp5HtZ5kVLGzRRaOwo/s1600/Spain+population+pyramids.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="224" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwSxBxs-TYS5fxWdiiKdmTwLJRN32EFVaBOGfHWF6um0Pe5Jcqua7pA2Gtj3kYSq45T47KLoyikB9GGWBIrjdr7x5d21Ya2Qv7-AoTmVKUc_1bDtVOD-Wp5HtZ5kVLGzRRaOwo/s320/Spain+population+pyramids.png" width="320" /></a></div>
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Several years ago, and according to UN estimates Spain looked destined to become one of the oldest countries on the planet come the 2020s. That picture changed dramatically during the first decade of this century as some six million migrants came to live in Spain and the population shot up from 40 to 46 million in just a few years.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhoZMIUJ8gnknN7IU_aVfJA0tMTG5HbAaQy4G61l5ucK7IjpP8-BcaYtteNbBuaBHykrMnNRxAKw_g2f3jwEPJfZrCK2rc_hZ0CyeUSDGEteuOuA-Du97OuvP_e_zWdUv9-NUwe/s1600/spain+immigrants.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="174" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhoZMIUJ8gnknN7IU_aVfJA0tMTG5HbAaQy4G61l5ucK7IjpP8-BcaYtteNbBuaBHykrMnNRxAKw_g2f3jwEPJfZrCK2rc_hZ0CyeUSDGEteuOuA-Du97OuvP_e_zWdUv9-NUwe/s320/spain+immigrants.png" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNtxaMiFSIcjE40O6fydUFDbz9ldh6PutxRsWaKhJYR-J3FnpzCou58UyUlNshNBeoB35JdNmK1WCnBoRSqxl1uRayHVnGdIBNgMlxtF5GLz2FSqCRadOTLzDoJd6XEpseAK0A/s1600/Spain+Population.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="174" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNtxaMiFSIcjE40O6fydUFDbz9ldh6PutxRsWaKhJYR-J3FnpzCou58UyUlNshNBeoB35JdNmK1WCnBoRSqxl1uRayHVnGdIBNgMlxtF5GLz2FSqCRadOTLzDoJd6XEpseAK0A/s320/Spain+Population.png" width="320" /></a></div>
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Before the arrival of the migrants Spain's population was virtually stationary. Really it is impossible to give any sort of precise forecast at this point of the Spanish population in 2020, or the rate of ageing, since the size of the population is so obviously path dependent on the evolution of the economy. It shot up as the economy was booming, and now it is falling back again as the country languishes in depression. It is almost a certainty that the population will continue to fall (births are also down) but how far and how fast depends very much on what happens in the job market.<br />
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This population exit has two important consequences. In the first place it reduces the future demand for housing, thus making it even more difficult to stabilise the market. And in the second place it means the pension's system, which is already becoming a significant drag on the fiscal deficit will continue to weigh ever more heavily on public finances, and will surely lead to ever more urgent and drastic modifications to the parameters in the country's pension system at some point in the future.<br />
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<strong>Exports Looking Good</strong>
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<br />
Well, that is all obviously extraordinarily bad news. But Luis de Guindos (the country's economy minister) <a href="http://online.wsj.com/article/SB10001424052970204349404578100312051762302.html?mod=googlenews_wsj" target="_blank">would retort</a>, that some things are going well. Exports, for example, have put in a strong showing in 2012.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEBv8PGD8Z83kRfb9DPjftYfpbsLmi3rM3Ze3yPqhiyVW_RzvuoUSXqccQ6qCfZv0JDsmJzQ_ok6U3Gtcx-3iYoZ_mvcMOvSchsoSLRZ9UhdRn5v9y9qOiGAJwk0JfOat-GKgR/s1600/Spain+Constant+Price+Exports.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="193" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEBv8PGD8Z83kRfb9DPjftYfpbsLmi3rM3Ze3yPqhiyVW_RzvuoUSXqccQ6qCfZv0JDsmJzQ_ok6U3Gtcx-3iYoZ_mvcMOvSchsoSLRZ9UhdRn5v9y9qOiGAJwk0JfOat-GKgR/s320/Spain+Constant+Price+Exports.png" width="320" /></a></div>
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Not only that the goods trade deficit is reducing:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgKtr3YAWLFkT-aeXuNTOJ_Qkql-qIKYDJde5SPL55HGofBBoR8oITtD4U707tUpYa9cXmrXUwu5QgEz6z0dyYu5uuzpZqSDEoE9ju8KPM3tPcni7eU4QceOYmIZDEBHGkcd3P/s1600/WTO+Trade+Deficit.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="195" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgKtr3YAWLFkT-aeXuNTOJ_Qkql-qIKYDJde5SPL55HGofBBoR8oITtD4U707tUpYa9cXmrXUwu5QgEz6z0dyYu5uuzpZqSDEoE9ju8KPM3tPcni7eU4QceOYmIZDEBHGkcd3P/s320/WTO+Trade+Deficit.png" width="320" /></a></div>
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The current account has also improved substantially, and in fact went positive in July and August for the first time in many years.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjyF75kiWYbDyVTx5yNwbiqxMsZ_80Br4sb5Se3zA-pnxvC8VcsQSw0AyhO77QhVLtqp-Uh-Xnz-BlknP8cMKGZ642QobBWf07yRL56s-6IXAUj0S5ClVRzoWpfM7Ziixqltar/s1600/current+account+balance.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="172" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjyF75kiWYbDyVTx5yNwbiqxMsZ_80Br4sb5Se3zA-pnxvC8VcsQSw0AyhO77QhVLtqp-Uh-Xnz-BlknP8cMKGZ642QobBWf07yRL56s-6IXAUj0S5ClVRzoWpfM7Ziixqltar/s320/current+account+balance.png" width="320" /></a></div>
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The improvement in the current account is evidently good news, and it is even better news that it is accompanied by a rise in exports, and not just a fall in imports as consumption declines. But the disappointing reality here is that even despite these improvements Spain's economy is still contracting, contracting <strong>and running an 8% fiscal deficit</strong>. The reason for this is that Spain's export sector is still <strong>way too small</strong> for the work it has to do. I have been over these arguments time and time again, so I don't propose to go into them here and now. You can find the issue thoroughly <a href="http://spaineconomy.blogspot.com.es/2011/06/nine-reasons-why-spains-economy-is-more.html" target="_blank">discussed here</a> (from June 2011), <a href="http://spaineconomy.blogspot.com.es/2010/08/on-shoulders-of-giants-how-spain-is.html" target="_blank">and here</a> (from August 2010), and all I can say is that the arguments I use are just as valid today as they were then. I'm not sure how many others can say the same.<br />
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With the private sector deleveraging, and the government trying to reduce spending the only thing which can really grow to the economy is the export sector, but until that is bigger the impetus given to the economy won't be sufficient to offset the drag from the other two sectors, and the economy will hover around the zero growth mark. One sign that things were really getting better would be a surge in investment, which would be reflected in demand for capital goods, but as can be seen in the chart below this demand just isn't there.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLv6RsHUgP0KV3b55J6hghnGx7qK8ZNMfCDIEaSMWIzxjC0pIcjzAN-Pg35bA8nDfseuB1iH20oZTUrFEAoGyuuYenKRhOowzm4DcJqyiptC84U2YiQZucpvxBXBnBKC7DRICR/s1600/Spain+Machinery+and+Equipment+Investment.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="189" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLv6RsHUgP0KV3b55J6hghnGx7qK8ZNMfCDIEaSMWIzxjC0pIcjzAN-Pg35bA8nDfseuB1iH20oZTUrFEAoGyuuYenKRhOowzm4DcJqyiptC84U2YiQZucpvxBXBnBKC7DRICR/s320/Spain+Machinery+and+Equipment+Investment.png" width="320" /></a></div>
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<strong>Where Is The End Game?</strong><br />
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The future of Spain is now very hard to see (so "que sera, sera"), and with it rests the future of the Euro. Interest rates on Spanish debt may well come down eventually if Mario Draghi starts the OMT bond buying programme, but <a href="http://www.economonitor.com/edwardhugh/2012/10/22/taking-a-man-at-his-word/" target="_blank">as I argued in this post</a>, intervention from the ECB alone isn't going to solve the Euro Area's underlying problems, only closer political union will be able to begin to address these, and <a href="http://www.ft.com/intl/cms/s/0/b3782bc8-2a8b-11e2-a137-00144feabdc0.html#axzz2BuhLLqe2" target="_blank">that seems farther away than ever</a> (or <a href="http://www.reuters.com/article/2012/11/09/germany-france-economy-idUSL5E8M97T220121109" target="_blank">here</a> and <a href="http://www.businessweek.com/news/2012-11-18/frankfurt-split-shows-euro-tension-over-banking-union" target="_blank">here</a>). At the present time everything seems to be on hold, with Mariano Rajoy on the one hand reluctant to formally ask for a bailout, while Angela Merkel on the other is in no rush to do anything till after the German elections are over. Meanwhile those without work, and those about to be evicted from their homes just have to wait and see. <br />
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Even the deficit seems to no longer be a priority. <a href="http://www.ft.com/intl/cms/s/0/3172d012-2e80-11e2-9b98-00144feabdc0.html#axzz2CGw3PgSc" target="_blank">Olli Rehn announced last week</a> that Spain will not be asked to apply any additional austerity measures until at least the end of next year, despite the fact that everyone acknowledges the country will substantially miss its deficit targets both this year and next. The most recent EU Commission forecasts see an 8 per cent deficit this year and 6 per cent in 2013, but even these may be to generous now that the straps are off.<br />
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Obviously this loosening in the policy stance could be seen as positive, if you thought that measures taken over the next two or three years would return the country to sustainable growth, but the sad reality is that the vast majority of the structural reforms being enacted are only likely to have marginal effects on the countries overall economic performance, and the one that could, the labour market reform, was described by the ECB <a href="http://www.ecb.int/pub/pdf/mobu/mb201208en.pdf" target="_blank">in its August bulletin</a> as being too little coming too late. As the bank puts it, "the authorities finally approved in February 2012 a far-reaching and comprehensive labour market reform that could have proved very beneficial in avoiding labour shedding if it had been passed some years ago." As it is, the bank continues, "given the low level of competition, further significant reductions in unit labour costs and excess profit margins are particularly urgent....To achieve this, first, flexibility in the wage determination process has to be strengthened, for example, where relevant, by relaxing employment protection legislation, abolishing wage indexation schemes, lowering minimum wages and permitting wage bargaining at the firm level".<br />
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In other words, the country needs to initiate some sort of internal devaluation process to restore competitiveness, something I have and others been arguing for over several years now. But looking at the political landscape inside Spain after five years of unending crisis, this policy is extremely unlikely to be implemented as the political will just isn't there. The recent attempt by the Portuguese government to try something similar <a href="http://www.bbc.co.uk/news/business-19684712" target="_blank">was over in a week</a> on the back of strike and protests. Too much time has been lost, and too much weariness has set in. So the rot stays stuck in the wood, and one way or another we are on collision course.<br />
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But the biggest catch in the deficit loosening agenda is the impact this will have on Spain's debt trajectory. As <a href="http://spaineconomy.blogspot.com.es/2012/03/homeric-similes-and-spanish-debt.html" target="_blank">I argued in this post</a>, putting the submerged part of Spanish government debt on the table was always going to be a risky move, since the debt level could rise dangerously near the critical 100% of GDP mark, above which no one in this crisis has yet risen and come back to tell the tale.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHs3WkNvqYm4IGTvaj7UsaZ5OmuMZmoL8PkOBIUZ-wL35vXNRm9gTMzjpwQSNATXAPUC10nfv1aAbI4pKFo1yAw5YXQt2EnPUO9MKVYk8nlXYcM3LRffxtN4GeBeTGPvP9ZBqU/s1600/Spain+Gross+Govt+Debt+To+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="174" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHs3WkNvqYm4IGTvaj7UsaZ5OmuMZmoL8PkOBIUZ-wL35vXNRm9gTMzjpwQSNATXAPUC10nfv1aAbI4pKFo1yAw5YXQt2EnPUO9MKVYk8nlXYcM3LRffxtN4GeBeTGPvP9ZBqU/s320/Spain+Gross+Govt+Debt+To+GDP.png" width="320" /></a></div>
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Well next year it looks very probable we will now cross that particular threshold, and what's more Spain's deficit will continue adding to the level for several more years to come. In addition there are still unquantified risks in the financial sector. Despite all the lauding of Mario Draghi's OMT programme, it could well turn out that Germany backing off from the June agreement on mutualising the bank recapitalisation costs could in fact mark the critical turning point in the debt crisis. One of two groups of people are going to be bitterly disappointed after the coming German elections - German voters who are being promised they will not have to bear part of the costs of recapitalising the Euro Area's troubled economies, or investment funds who are being constantly reassured in the background that once the elections are over this is exactly what is going to happen.<br />
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So this year Spain's banks are going to be adequately capitalised, but what about in 2014, or 2015, or later if the crisis drags on and on? The new banking union may well be in place, but if the principal of not mutualising legacy debt problems is maintained, then it is hard to see how the losses on debt obligations which are currently being rolled over - like the large number of residential mortgage resets which are being used to avoid eviction - are going to be funded once the finally have to be recognised. <br />
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This week the tragedy of Spain's <a href="http://www.bloomberg.com/news/2012-11-15/spain-suicides-spark-law-risking-bank-losses-mortgages.html" target="_blank">ongoing evictions drama has been in the news</a>, (and<a href="http://www.ft.com/intl/cms/s/0/30b64ae0-300c-11e2-a040-00144feabdc0.html?ftcamp=published_links%2Frss%2Fworld_europe%2Ffeed%2F%2Fproduct#axzz2CQ5pn5hp" target="_blank"> here</a>), and a new code of practice for evictions has been put in place by the government. But this is only scratching the surface. If, as seems probable, house prices continue to wend their way down then there really will be no way round the passing of some sort of new personal insolvency law to enable people to write down part of their mortgage, as we have seen in Ireland. The days of full recovery in Spain are numbered, since the social clamour, <a href="http://dealbook.nytimes.com/2012/10/08/ireland-mortgage-bill-aims-to-aid-owners-and-jump-start-economy/" target="_blank">as in Ireland</a>, will just become too great. Interestingly, ratings agency Moody's pointed out that in Ireland negative equity rather than unemployment was now becoming <a href="http://businessetc.thejournal.ie/mortgage-defaults-rising-ireland-602021-Sep2012/" target="_blank">the main driver of mortgage default</a> (and <a href="http://www.irishtimes.com/newspaper/finance/2012/0920/1224324198946.html" target="_blank">here</a>) - and indeed they predicted that one in five Irish mortgages would be in default by 2013. This is interesting because the models used by Oliver Wyman and Roland Berger to stress test the Spanish banking system do not use negative equity as a parameter, relying mainly on unemployment levels and GDP movements for their default estimates. Spain's entire mortgage system is likely to fall into negative equity on aggregate within 2 or 3 years, meaning the capital requirements could then well be very different from the ones we are seeing now.<br />
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Then there are the regions. On the worst case scenario Spain could see a 20% drop in GDP as Catalonia exits stage left (elections are being held on the 28th - I have <a href="http://iberosphere.com/2012/11/spain-news-catalonia-independent-state7226/7226" target="_blank">written extensively about this here</a>, and <a href="http://www.collectiuemma.cat/article/1440/what-the-elections-in-catalonia-are-really-about" target="_blank">the separatist case is put here</a>), and if the Spanish government insists on <a href="http://www.lavozdegalicia.es/noticia/espana/2012/10/31/gobierno-aplaude-rechazo-ue-ingreso-cataluna/0003_201210G31P19991.htm" target="_blank">carrying out its threat to veto continuing EU membership</a> for any new state which might be created, the reality is that the rump country's debt level will surge to 125% of their remaining GDP, even assuming there aren't worse dislocation problems for the economy. Naturally one would assume that the Spanish government would negotiate rather than shoot themselves straight in the foot (typical prisoner's dilemma type stuff this), but you can't be sure, and maybe you should take them at their word. It doesn't matter it seems if the whole Euro project falls apart, if the Catalans vote to be independent they will not be permitted to remain in the EU.<br />
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Naturally, intransigence is seldom a good policy, and investors who want to take an interest in the issue might ask Spain government representatives who are locked in to their "total veto" and blocking strategy how, if they ever had to implement it, they intend to get their exports out to Europe. The lines in blue in the chart below show the national rail network, and those who know some geography will quickly see that there are only two connections with France, one through Catalonia and the other through the Basque country. I have no idea whether Catalonia will be in or out of Spain 5 years from now, but what I am pretty sure of is that if the Catalans left the Basques wouldn't be far behind. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhHQuCkIcNgKADWThdLWb6rebFATHDuDIvvI4PHsuG7GhE06hYT8-wQoKg2VCUUllYjf6fxQ8zgHXn6oSfI5YVHgnFWNdOllpLjZZQGMC9mkeO8runbDXUkK0P2YuEazeV4ce0A/s1600/spain+rail+network.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="270" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhHQuCkIcNgKADWThdLWb6rebFATHDuDIvvI4PHsuG7GhE06hYT8-wQoKg2VCUUllYjf6fxQ8zgHXn6oSfI5YVHgnFWNdOllpLjZZQGMC9mkeO8runbDXUkK0P2YuEazeV4ce0A/s320/spain+rail+network.png" width="320" /></a></div>
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So there we have it. What we have is a country where not only are people of working age leaving in growing numbers, whole regions may want to go. A country where deficit numbers have been flouted time and again while bank interventions have been consistently implemented using the principle of always try to do too little too late. The country suffers from what the ECB calls deep competitiveness problems, yet there is not a single proposal on the table at present which would do anything substantial to correct this. <br />
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The pension system is spiraling quickly into a substantial structural imbalance, yet the government will hear nothing of any deep long-lasting pension reform. I could go on and on. I would like to be optimistic, but five years of watching this train crash in slow motion have left me with the feeling that this one now has no solution. The country's political leaders just aren't up to the levels of complexity involved (see this excellent summary of some of the "matters arising" in this regard from <a href="http://elpais.com/elpais/2012/09/12/inenglish/1347449744_053124.html" target="_blank">César Molinas here</a>, and Europe's leader not only drag their feet, they stick their heads in the sand at the same time. The exact details of how and when escape me, but this situation now has all the hallmarks of ending up in the same way as that legendary Rosario whose untimely demise gave the title to this post.
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This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-56949384993278070632012-10-22T17:47:00.000+02:002012-10-22T17:51:18.982+02:00Taking A Man At His WordLegendary hedge fund supremo<a href="http://www.bloomberg.com/news/2012-02-28/dalio-earned-clients-13-8-billion-to-lead-hedge-funds-as-paulson-slumped.html" target="_blank"> Ray Dalio</a> is in ebullient mood. Following a series of moves by Mario Draghi to underpin European government financing <a href="http://www.bloomberg.com/news/2012-09-21/bridgewater-s-dalio-says-euro-will-survive-region-s-debt-crisis.html" target="_blank">Dalio told Bloomberg</a>
that, in his opinion, the euro will now “likely” stay together because existing growth constraining austerity measures will henceforth be balanced by money printing over at the European Central Bank. His statement was, of course, a response to ECB President Draghi's save the Euro pledge.
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This story starts back in July, when Mario Draghi <a href="http://www.france24.com/en/20120726-european-central-bank-mario-draghi-pledges-save-euro-spain-italy-borrowing" target="_blank">calmly informed a London investors conference that</a>, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” Since that time, of course, this gamechanging statement has been qualified and clarified, and re-qualified and re-clarified innumerable times, but still the essence remains unchanged. The ECB President wasn't talking, remember, about any specific programme of bond purchases or exceptional liquidity measures, he was talking about doing "whatever it takes", and Ray Dalio for one is taking him at his word.<br />
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What Bridgewater's founder was getting at when he made this assessment is that there is now no meaningful limit being placed on what the ECB might eventually do. Naturally there is the mandate to work around, but the mandate can always be changed if Europe's political leaders see fit, and who at this point in the crisis still doubts that if needs must they will see fit.<br />
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Indeed in many ways it is easier to envision a change in the EU Treaty to tweak the EU mandate than it is to envision one to establish, for example, a full fiscal union. Especially now the ECB has become the in-tray into which all the politically unpalatable and thus unresolvable issues ultimately get dumped. The most recent example of this is the suggestion that <a href="http://www.ft.com/intl/cms/s/0/2e32670e-17ac-11e2-9530-00144feabdc0.html?ftcamp=published_links%2Frss%2Fworld%2Ffeed%2F%2Fproduct#axzz29YvohQsU" target="_blank">Spain applying for a precautionary credit line would be the ideal solution to the country's current dilemma</a> since no money would actually need to change hands, making the move easier to sell to the German parliament.<br />
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No money would need to change hands because Mr Draghi and his governing council would be stepping up to the plate alone. This outcome looks and feels rather different to the "burden sharing" approach outlined by Mario Draghi during the August ECB press conference.It looks and feels different because it essentially is different, even if the two possible modalities of ESM action were laid out from the start. What wasn't envisioned was that NO ESM money would be used to buy bonds. That the ECB would be acting alone.<br />
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Of course any talk at this point about the forthcoming Spanish bailout means navigating in an ocean of uncertainty, but as far as we can see at the moment the end result of all the negotiations, crying wolf and procrastinating seems to be that the ESM <strong>won't</strong> be buying bonds in the primary market.<br />
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Instead some of the Euro Areas financial institutions (acting as brokers for the ECB) will do so and then re-sell them on to the central bank. This differs in substance from what some have referred to as ECB LTRO-style "<a href="http://www.bloomberg.com/video/80235010-niall-ferguson-on-ecb-quantitative-easing.html" target="_blank">QE by stealth</a>" in that the central bank would be owner of the bonds, and not simply holding them as collateral. While adding considerably to central bank risk this procedure is seen as being politically more palatable in the north, and limits the sovereign bond/bank capital "death spiral" many worry about in the south, since it avoids the need for periphery banks themselves to hold more bonds on their balance sheet.<br />
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But whichever way you look at it we will still see significant bond purchases, thus maintaining a kind of <strong>strange fiction</strong> that Spain still remains "in the markets". Obviously, without ECB support in the form of LTROs and the OMT the country would be absolutely incapable of financing itself. So perhaps a better way of putting it is that "the ECB is in the markets" and hence Spain is able to finance itself.<br />
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We will leave aside at this point the rather byzantine issue of whether or not these purchases will constitute "money printing", since with the large quantities of money core European banks have sitting on deposit at the central bank the question of whether or not the purchases are sterilised seems to be a totally academic one.
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<strong>Waiting For The Bailout That Never Comes</strong><br />
<br />
As London Thomas <a href="http://www.nytimes.com/2012/10/16/business/global/spain-may-pay-price-for-delaying-aid-request.html?ref=landonjrthomas" target="_blank">suggested in the New York Times recently</a>, the classic work of theatre that is currently being performed on the Spanish stage does not come from the portfolio of <a href="http://en.wikipedia.org/wiki/Pedro_Calder%C3%B3n_de_la_Barca" target="_blank">Calderon de la Barca</a>, but rather from an Irishman, <a href="http://en.wikipedia.org/wiki/Waiting_for_Godot" target="_blank">Samuel Becket</a>. It is entitled "Waiting For Rajoy". However, unlike the original this modern adaptation is unscripted, and resembles more a <a href="http://en.wikipedia.org/wiki/John_Cassavetes" target="_blank">Cassavetes</a> film where the actors constantly improvise. Naturally the markets are unsure how to trade the situation, but with the passage of the days, weeks and even months I am sure they are steadily learning and adapting.<br />
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In recent weeks an almost enless supply of ink has been spilt in the press about the kinds of conditionality which might be applied in the event of a bailout. Naturally there are questions oustanding which the Troika would like to address with Spain - the seriously needed pension system reform, for example, or the across the board wage reduction solicited by the ECB in its August bulletin - but this doesn't seem to be the priority at the moment. The number one objective appears to be getting a firm grip on a country which has proved more slippery than a conger eel when it comes to holding it down to firm commitments.<br />
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But, even if we are not party to the intimate conversations which take place on a daily basis between Mariano Rajoy and his chief economic adviser <a href="http://www.elcorreo.com/vizcaya/v/20120923/economia/descubriendo-nadal-20120923.html" target="_blank">Alvaro Nadal</a> (seen together in the photo below) it does look very much like Spain has been trying to play hard ball with Berlin. In the short term this strategy was used to some effect in Los Cabos (given the surprise element involved) and then subsequently at the June EU summit. However it now seems that this particular window was firmly closed by Angela Merkel at last weeks meeting. Over the weekend it must have been back to the drawing board time at the Moncloa, and the whole world is now waiting to see what the new approach will be.
Prior to this I can almost imagine the tenor of the conversations which have been taking place. "Look Angela, cariño, you must have read your Margaret Thatcher. I don't actually pay these blasted interest costs out of my own pocket, you understand. They are supportable, at least for the time being. We are in no rush." Nervousness can only have been growing at the other end. The nearer we get to the German elections before the bailout comes, and the more deteriorated the Spanish economy at that point, the worse the headache for the CDU.
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Arguably Mario Draghi's verbal intervention in the Bond markets has been almost <strong>too</strong> succesful. He has brought down interest rates without actually doing anything. Probably this is one of the most successful interventions of its kind in recent history.<br />
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But the result is that Spain is in no hurry to receive yet another Memorandum of Understanding, not to mention Italy where there is absolutely no interest at all. So we all finally got a free lunch, didn't we?<br />
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Well no, not exactly. The ECB is now committing the worst of all sins (according to the version of biblical law to be found in the EU treaty) and helping monetise Spain debt. Even worse, it is doing so with only a virtual intervention. There is no conditionality, and no support measure to withdraw, so no possibility of using a threat to do so. Mario Draghi can hardly go to the next press conference and say, "since there are no takers, the OMT programme is now formally closed".<br />
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Meanwhile Spain can continue to go happily along ignoring its EU deficit commitments, since there is no programme, there are no conditions and no sanctions, and the Spanish government are fully aware of just how reluctant both the IMF and Germany are to publicly criticise the country. No one wants to inflict the kind of reputational damage that has been uselessly inflicted on Greece.<br />
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Investors, on the other hand, don't want to get "burned" by Mario Draghi - intervention is, after all, just a phone call from Rajoy away, so they do the intelligent thing and stand back on the sidelines. Waiting for Godot (sorry Mariano Rajoy) to decide.<br />
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Is this a good outcome? Only if you think Spain is headed to some nice place to be.<br />
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So, since the EU has already approved Spain's adjustment programme, looking at the balance of forces and balance of interests I now think it is unlikely very stringent additional measures will be required when finally the big day comes. But this isn't the point. There will be a Memorandum of Understanding, there will be supervision, and there will be reviews. This is what this tug-of-war is all about. This is why <a href="http://www.google.com/hostednews/afp/article/ALeqM5ixlpjLtltpWEuORXpei84wI22_Ag?docId=CNG.b7490d699f872ba1c830ddc9ac429b95.201" target="_blank">Angela Merkel went before the Bundestag</a> last week to explain that she would propose the EU seeking powers to intervene (regardless) in countries who habitually fail to comply. She didn't spell out S-P-A-I-N, but she didn't have to. When the next MoU is nicely in place failure to comply with the objectives which are laid down (highly likely) will then trigger more measures during the review process, as we have seen in Greece.
So there will be plenty of opportunity later. What the Troika representatives want at the moment is to get their claws on, and firmly locked into, their prey.<br />
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As I say, the bailout one will not be the first such MoU Spain's present leaders have signed, and with <a href="http://www.cincodias.com/articulo/mercados/pulso-linde-enviados-troika-retrasa-banco-malo/20121017cdscdsmer_6/" target="_blank">progress on determining bad bank asset handover prices</a> painfully slow, while progress on the "burden sharing" involved in the preference-shares-haircut is seemingly non existent, the men on the other side of the table will surely now be adopting a "once bitten twice shy" approach. Troika representatives are caught between the rock of having to talk up Spain and the hard place of coming to terms with the country's continuing non compliance and deteriorating reputation. I am sure Alvaro Nadal is well aware of this, <a href="http://www.bloomberg.com/news/2012-10-15/rajoy-delay-marks-bet-renewed-turmoil-makes-bailout-terms-easier.html" target="_blank">hence the hard ball</a>, and hence the leverage he is able to apply. Contagion, what contagion?<br />
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But moving away from Spain and returning to the opening theme: Ray Dalio's ebullience. The whole issue of the OMT is mere detail, but a tiny comma in the already voluminous history of the Euro Area crisis. What has market participants really whetting their lips is the idea Mario Draghi is willing to do anything, literally anything (within the mandate, but then, if things get desperate what exactly does that mean?) to save the Euro. And believe him, it WILL be enough. If you follow my line of argument, what was meant as a threat becomes a promise. Just imagine how male eyes light up when a woman says she is willing to do absolutely anything for him to save a relationship (or start one). (Incidentally this should not be read as displaying gender bias. No woman would still, in this day and age, believe any man who said the same, at least not unless she wanted to).<br />
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So investors have backed off on periphery spreads, and on the Euro. Gravy there will be. Enough to go round everyone. But leaving all that aside, what about Ray's stronger line of reasoning that the promise of all this market fun changes the outlook for the Euro in the longer term? Does it hold?<br />
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Or Mario's promise, is it valid? Does he really have it within his power to deliver? Many men promise before the altar that they will be faithful to their wives. Often they aren't. Later some of them learn you shouldn't make promises you can't keep. Can Mario keep his promise?<br />
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Let's see.<br />
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<strong>Deactivating the alarm system, not defusing the bomb.</strong><br />
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Perhaps the view of the Euro as some kind of unexploded bomb just waiting to go off isn't a new one, indeed in my <a href="http://business.blogs.cnn.com/2011/09/22/dr-strangelove-and-the-euro-doomsday-machine/" target="_blank">Dr Strangelove CNN blog post</a> I have already likened the currency union to the famous "Doomsday Machine", designed in a way which means it will eventually blow up, but also designed in such a way that any attempt to disarm it will produce a similar outcome. But tired as the metaphor may now be I still think that it is a valid and useful one since this is still exactly the situation we are all in.<br />
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One of the peculiar things about the Eurosystem is that, just like any garden variety virus that surreptitiously enters your computer hard disk, it has the power to systematically disable all the potential warning signals which could alert you to impending danger.<br />
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Perhaps the best example of this unsung virtue has been the way in which central bank FX reserves - a traditional indicator for up and coming balance of payments problems - were rendered all but irrelevant, even though there were in fact no joint and several agreements in existence to guarantee the external debt of any of the participating, but independent, sovereigns. We all now know what got to happen next - countries which had been sustaining unsustainable current account deficits suddenly found themselves with funding problems associated with massive balance of payments crises.<br />
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It was at this point that financial markets stepped in to replace an EU system of governance which had been shown to be incapable of either controlling or regulating dysfunctional behaviour on the part of the participating member state governments. At first these moves were welcomed, especially at the central bank, since they had the potential to force the reluctant back into line. But eventually matters got out of hand, and now those very market forces which were once seen as the cure have become part of the problem.<br />
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So what do we do? We disconnect the cables (via OMT) which served as the transmission mechanisms for the warning signals being sent by the markets, that's what we do. This naturally puts a break on one "self fulfilling" component of the financial crisis - the one which follows the reasoning chain whereby excessive interest rates on excessive debt can drive a country into insolvency, while fear about the possibility of such interest rates in and of itself drives up interest rates, sending the country over the cliff in any event. Clearly, given this analysis, what you need to do is disconnect the worry factor. Some mistakenly call this "restoring confidence".<br />
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So the central bank intervenes to buy government debt, and stop interest rates becoming excessive, then things are just fine, aren't they? But what about the excessive debt which caused the surge in interest rates in the first place? And what about the fact that it is not sustainable. And then there is the lack of economic growth which was producing the fiscal deficits in the first place. Are these problems fixed by the bond buying programme? Of course they aren't. That's why people talk about OMT buying time, and why I talk about deactivating the alarm system. The bomb has still to be defused. But where are the bomb squad? Oh yes, I forgot, they are called the "men in black", and a good job they have been doing of it in Greece.
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<strong>Printing Money Is Inflationary And Good For Growth?</strong><br />
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But let's leave all these secondary issues to one side, entertaining as they are, and go right back to Ray Dalio's best and strongest argument (since I'm sure he agrees with much of what I have just said). The heart of the issue is that Mario Draghi has vowed to do enough, and enough seems to have no limits. So what could the ECB do if we really put our imagination to work on the issue? Well like Ray argues, they could print money, lots of it, even to the point of doing it helicopter style. Those people who think the ECB is already printing money (which they aren't necessarily doing when they increase their balance sheet) ain't seen nothing yet. That's what the "it will be enough" promise means. None of this is in the mandate yet, naturally it isn't, but it could be, and it would be much easier to put more in the mandate than it would be to keep going to the German Parliament to ask for more money. So it could, and most probably will, happen.When you're crossing that rope bridge and it starts to creak and sway then you just have no alternative but to continue moving towards the other side. We have all seen far too many movies about what happens to the people who try to turn back.<br />
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As the US saw in Vietnam, the deeper you get in the harder it is to get out, since you plough-in ever more resources simply to go the course, and the losses you would have to accept to leave keep growing and growing, so you keep deciding to do whatever it takes.<br />
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So let's imagine this is what happens, and the ECB really goes to the imaginable limits and beyond.<br />
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Will it work? Will it be enough? Well this is where I think I find a flaw in Ray's argument, and it is a very common flaw to be found in the thinking of those educated in the US monetary tradition. Ray is assuming the ECB's eventual "money printing" will produce inflation, and that this inflation will help burn down the debt (often today this is termed "financial repression"). Whatever the pain this entails for bondholders, since in this case it is the central bank that is going to be the main bondholder (in our imaginary thought experiment) the outcome may not seem so objectionable from an investor perspective. After all, there are other assets they can get into.<br />
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Inflation, always and everywhere, so the argument goes, requires money printing to happen (whether via private or public debt), and in fact it seems to be the case of so far so good, it is almost self evident.<br />
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But is the argument symmetrical? That is, does it work the other way round?<br />
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Let's give an example. If I want to suffocate myself I need to deprive myself of air. If I don't deprive myself of air I won't suffocate. Fine. And if I deprive myself of air, does that mean I will suffocate? The answer is it depends, the absence of air is a necessary but not a sufficient condition. I need more conditions to be able answer adequately, even though I find it impossible to imagine myself suffocating without a lack of air.<br />
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Something similar happens with the inflation and money printing argument. It is unthinkable of having inflation unless someone somewhere is printing money, but does that mean that printing money always and everywhere leads to inflation. No it doesn't.<br />
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Worse, in one developed country after another across the globe a lot of money printing is going on, we just aren't seeing the inflation. Why could this be?<br />
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<strong>What's Going On In Japan?</strong><br />
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Well arguably we have a canary in the coal mine here, since Japan has been printing money for more time than I care to remember, and we still see no sign of inflation. Quite the contrary, the country is plagued by deflation, and by the permanent threat of relapsing into recession. So, in this case at least, printing money is not self evidently being inflationary, neither does it seem to be working wonders for growth.<br />
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Really Japan is quite a remarkable case, since neither fiscal nor monetary policy seems to be working to achieve the anticipated results. This year Japan will have a fiscal deficit of around 10% of GDP and gross government debt will hit 235% of GDP, yet the country is still struggling to find growth. Instead of reiterating old dogmas (whether they come from Keynes or from Hayek) more people should be asking themselves what is happening here. This is not a simple repetition of something which was first time tragedy and is now second time tragedy, it is something new, and could well be a harbinger for more that is to come, elsewhere. Oh, why oh why are economists not more curious?<br />
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At the start of this century, at the end of the internet boom, some economists were warning that other countries could end up like Japan. Ten years have now passed and they have. ZIRP was once an oriental curiousity, now it is the central banking norm, and there are few signs of early exit.<br />
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<strong>Will Europe Follow Japan?</strong><br />
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Basically I think it is only necessary to ask this question to have already found the answer. If Japan's demographics have got some important part to play in the drama which is unfolding there, then it is Europe which is most likely to follow, since the continent's demography is the closest to the Japanese one. Printing money would not be inflationary on the periphery, because there is little solvent demand for credit to generate it, domestic demand remains depressed and this situation isn't changing in the foreseeable future. And it won't be inflationary in Germany, because German domestic demand is just as exhausted as the Japanese variety is in terms of becoming a driver of the economy there. Indeed some peripheral economies have such rigid labour and product markets that headline inflation has stayed above that in Germany almost throughout the present crisis. Naturally, this is hardly good news.
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<strong>So Will The Euro Likely Stay Together?</strong><br />
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Which brings us to the crux of our problem, will money printing at the ECB (lot's of it, helicopters galore) save the Euro, or simply put back the "sell by" date? Really at this point in this blog post I don't want to reiterate the arguments I advanced <a href="http://www.scribd.com/doc/87576916/Wolfson-Essay-Revised" target="_blank">in my Wolfson Prize entry</a>, but I do consider they are more valid today than they were at the time I wrote it. The core of the issue is this. All participants ahve sunk costs from participation (whether hidden or self evident) which makes it very difficult for members states (at either end of the spectrum) to actively take the decision to leave.<br />
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On the other hand, few are convinced that the measures taken to date will actually resolve the underlying problems. They have simply stabilised the situation, and bought time. But time to do what? For the ECB to print money, if Ray Dalio is right. But as I am suggesting, the money printing will not resolve the issue, but will simply buy even more time.<br />
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However, when we come to consider how the story will end, many of the traditional versions of the future seem to have been disactivated. Countries will not leave in an orderly way, and markets will not be able to win the war with Mario Draghi. Ratings agencies remain a problem, but at this point they are unlikely to be decisive. But let's step back a bit. The Euro is a political project, and will sink or swim politically. Indeed, perhaps the most perceptive critic of the Euro experience in this sense has been Marty Feldstein, since he took the view from the outset that while the intentions of Europe's leaders was to use the common currency formula to bring the continent closer together politically, a more likely outcome would be that it drive the member countries apart.<br />
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This, indeed, seems to have been an insightful analysis, since even while Europe's leaders give the impression of unity, what is actually going on is <a href="http://www.ft.com/intl/cms/s/0/ad222a9a-19ff-11e2-a379-00144feabdc0.html#axzz2A27LWGuc" target="_blank">a constant process of, often bitter, haggling</a> (video link <a href="http://www.youtube.com/watch?v=O_ZQxaZtEzI" target="_blank">here</a>). Haggling in which moral hazard type threats play a not insignificant part.
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And the issue doesn't stop with the (often visible) disagreements between the various leaders, there is a growing distance between politicians and the voters they represent. The world's press are making great play today of this weekend's victory by Mariano Rajoy's Partido Popular in the Spanish region of Galicia, but perhaps the most significant point about these elections is that around half the voters didn't vote. Another example of a similar disconnect would be Wofgang Munchau's recent description of Bundesbank president Jens Wideman <a href="http://www.ft.com/intl/cms/s/0/9095a970-03dd-11e2-9322-00144feabdc0.html#axzz2A27LWGuc" target="_blank">as the unofficial leader of the German opposition</a>. So even if Europe's leaders give the appearance of moving closer together, it is quite apparent that the people they represent - whether in the core or on the periphery - are moving farther apart. The classical fault lines of European politics are disintegrating, and democracy is weakening not being strengthened.<br />
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<strong>To Vote Or Not To Vote In Catalonia?</strong><br />
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The most recent, and perhaps clearest, example of this process is to be found in the growing tensions between Catalonia and the Spanish central government. This situation has more general interest for the current evolution of the Euro Area than the simple desire of one of Spain's regions for independence. It has more significance, since the frustrations currently being felt in Catalonia stem from the situation of being one of Spain's richer regions and having to bear what is perceived as being more than a fair part of the cost of the failure to resolve the Euro crisis. Catalonia is a net contributor to the Spanish fiscal system, and wants to make, at least, a smaller net contribution. The situation has been brought to a head by the fact that the region's income-to-debt ratio has risen to the extent that government bonds are ranked at junk status by ratings agency Standard & Poor's. Shut as it is out of the markets Catalonia has been forced to ask for a financial rescue from the central government, a rescue most Catalan's consider to be ridiculous given they feel they are only asking for some of their own money back.<br />
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Catalonia's economy has collapsed along with that of the rest of Spain, but the debate becomes a particularly poignant one given the growing feeling of desperation in the face of the inability of Spanish governments of varying political complexions to take the steps necessary to move the country forward. This frustration is now coupled with the growing awareness that more and more austerity is not the formula needed to restore the region to economic growth. As former
Catalan President Jordi Pujol put it in <a href="http://www.ft.com/intl/cms/s/0/6ebd07ee-fa5f-11e1-b775-00144feabdc0.html#axzz2A27LWGuc" target="_blank">an interview with the FT's David Gardner</a>, “Europe without solidarity would not be possible, but at the same time an excess of solidarity would make Europe impossible.”<br />
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He was re-iterating here the view of German foreign minister Guido Weterwelle, to the effect that German pockets are not bottomless. What Mr Pujol was inferring is that Catalan ones aren't either. Naturally behind the Catalan independence drive there are also many identitarian issues, issues which are not easily soluble and which are making for a highly combustible environment inside Spain. But underlying the independence debate there lies a much deeper question. If Europe is moving towards a deeper banking, fiscal and political union, but moving far too slowly, why should an unfair share of the burden fall on the richer areas of the countries in the greatest difficulty? Why should more of the burden not be shared more equally and more quickly. This is not a uniquely Catalan problem, since similar issues are arising in Belgium (<a href="http://www.ft.com/intl/cms/s/0/db760980-12c4-11e2-aa9c-00144feabdc0.html#axzz2A27LWGuc" target="_blank">Flanders</a>) and Italy (<a href="http://www.theage.com.au/world/venice-takes-to-canals-for-independence-20121006-2765o.html" target="_blank">the Veneto</a> among others). Europe is a continent of nations, and the Euro crisis is opening up the fracture lines.<br />
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My feeling is that market participants are not taking all this too seriously, and that could prove to be a risky bet. The consensus view was recently expressed in a research report from UBS analyst Matteo Cominetta (summarised by CNBC correspondent Liza Jansen <a href="http://www.cnbc.com/id/49459644" target="_blank">here</a>). The title of the report - Can Catalonia leave? Hardly - is suggestive, and reflects what I perceive to be the present market consensus.<br />
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The ins and outs of the issue are complex. Who, for example, would end up with responsibility for Spain's massive debt burden in the event of separation? Probably Spain it seems, unless it were willing to recognise the new state. In the event of non recognition, what sort of bailout would Spain need, and would the EU be willing to provide it if Spain didn't want to recognise its new neighbour? Would an independent Catalonia be inside or outside the EU and the Euro? This is at present unclear, the legal issues are tricky, but I think it should be remembered here that the ECB's initial legal report on Euro exit concluded that a country leaving the common currency would need to exit the EU, and I think there is now a consensus that this wouldn't need to be like this.<br />
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Largest of all looms the question of whether the new country (were it to exist) would automatically belong to the Euro, and have access to Eurosystem liquidity. Common sense says it would, whatever the letter of the law, since the region has a financial sector in the region of 500 billion Euros (or 2.5 times Catalan GDP - ie significantly larger than Greece) and some, at least, of the institutions concerned could be considered systemic. So unless you want systemic institutions collapsing........<br />
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Perhaps Cominetta's clinching argument (for him) is that the Spanish government has the legal right to prevent a referendum, or veto any forthcoming law on popular consultations (of the kind which just took place in Island). In fact, to prevent an "irregular" consultation the Spanish government could go further. As Cominetta points out, according to article 155 of the Spanish Constitution, Spain's central government has the power to stop a vote from going ahead if “a regional government does not comply with constitutional law” or “acts against the general interest of Spain.” “The Spanish government could even suspend Catalonia’s regional government".<br />
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Well, that's fine. The ECB could also expel Greece from the Eurosystem, but will it? And is this the best way of going about things? Arguably suspending Catalan autonomy and introducing direct rule from Madrid would be the quickest way of convincing those who are still in doubt that they want to vote for independence. Naturally the has to be an easier way of handling this problem than simply uping the ante, and hoping the whole Euro Area doesn't fall of a cliff in the ensuing uncontrollable and unpredictable chain of events.<br />
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Matteo Cominetta concludes his report as follows:<br />
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"We think after the Catalan elections on November the 25th the word
“independence” will become suddenly rarer in Mas’ rhetoric".<br />
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In fact here he is already somewhat behind the curve. The word "independence" only appeared momentarily in President Mas's rhetoric, around the time of the September 11 demonstration. Since that time Mas has only spoken of Catalonia as"a nation which is now arriving at full maturity", a nation which to express that maturity will need what he terms the "instruments of a modern state."<br />
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Now the language he is using is very conscious language, and very precise. It should not be interpreted, as radical separatists in Catalonia are already doing, as some kind of backsliding. What lies behind his point, and it is a theme he stresses continually, is that the term "independence" is something of a historical anachronism in the context of the modern EU and Euro Area.<br />
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What Catalonia wants are the same instruments of state as all the other nations in the Euro Area have, nothing more and nothing less, but this doesn't necessarily mean "independence" as many have traditionally understood the term. It does mean, however, and for example, that as long as there are still national central banks to intermediate regional (by regions here I mean places like France and Germany) financial systems, then Catalonia as a nation which in coming to full maturity wants one too.<br />
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Naturally all this looks like a huge mess, and a growing one across the Euro Area. That is just the way it is going to be, but people should have thought about all the longer term ramifications before creating the Euro, since whichever way you look at it, the Euro and its problems form the backdrop to what is now happening in Catalonia. If full political union had been achieved first, this kind of thing would never have started happening. But it is happening, and the will of a people to express themselves in a vote won't be stopped by simply telling them they can't have one, a point which President Mas iterates and reiterates constantly.<br />
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So, the 65 trillion dollar question is, does President Mas have the majority of the Catalan people behind him when he advances along this road to acquire the institutions which go along with statehood? My opinion is overwhelmingly yes. About 75% of those expressing an opinion in the polls are saying they want a vote on self determination, even though Madrid is stressing that this vote would be made illegal.<br />
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How then does all this now start to pan out? Well first we will have elections next month. President Mas's party, CiU, will win, and the only issue is really whether they have an absolute majority or not. Between 60% and 70% of the deputies in the new parliament will be in favour of holding a vote, and of voting yes. And on the question of the vote the CiU programme is very clear, one way or another it will happen, and indeed they are holding these elections exclusively to get the mandate needed for that vote. So if they didn't have one the electoral process would have been meaningless.<br />
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But in one sense Cominetta is right. The coming confrontation isn't going to be about money, it is going to come be the right to have a vote. In my opinion the outcome of that vote when it is held is not really in doubt. However, instead of going off into the realm of conjecture, and speculation, and coming up with ever more grotesque scenarios, I think it is better to await developments, since they surely won't be that long in coming. The only sensible way forward I see here is for the EU, when it takes Spain in for a bailout, to act as intermediary, take the head of the table, and organise negotiations between the two sides. I think if they can't do that, then the Euro may well come under threat much sooner than anyone is contemplating.<br />
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So to answer the my own question set at the outset - "can Mario Draghi keep his pledge?" I would say, go ask the Catalans. There are some problems that simple money printing won't solve, and the quantity of these problems in the Euro Area is growing, almost by the day.<br />
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This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-37198187788421500542012-08-12T20:31:00.002+02:002012-08-12T20:50:13.960+02:00The Owl Of MinervaLast week was the fifth anniversary of the outbreak of the global financial crisis. Not uncoincidentally it was also the fifth anniversary of continually rising unemployment in Spain , since it was in early summer 2007 that seasonally adjusted Spanish unemployment embarked on its steady upward path. And after it started climbing, naturally it hasn't stopped since. Indeed we seem to have at least another year of growing unemployment before us, maybe more. <br />
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Anyway, as if to celebrate this uncanny anniversary the Spanish government has decided to take the bold step of officially requesting an EU loan to recapitalise the country’s banking system. In addition, part of the money will be used to set up some form of bad bank with the objective of cleaning up some of the toxic property and other assets off the bank balance sheets. Smart moves both of them. Pity the people responsible weren't prepared to accept the need to do this five years ago, when unemployment was only running at 8%, and when the economy and Spain's citizens were better placed to accept the kind of burdens that are now about to be imposed upon them.<br />
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Just to round the commemorations off, in <a href="http://www.ecb.int/pub/pdf/mobu/mb201208en.pdf" target="_blank">the August edition of their monthly bulletin</a> the ECB finally let out that dirty little secret than every insider in the know has already discounted. The Bank have finally accepted that the much heralded Spanish labour reform isn't going to work. At least not as planned. As <a href="http://www.ft.com/intl/cms/s/0/cc277fb2-e205-11e1-b3ff-00144feab49a.html#axzz23LAvDnEb" target="_blank">the Financial Times put it</a>, the Spanish labour market reform approved in February was “far-reaching and comprehensive” but came too late, the ECB implied, saying it “could have proved very beneficial” in avoiding job cuts if the measure had been passed some years ago. <br />
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Exactly. But once we recognise this point, isn’t that rather leaving the Spanish economy adrift in stormy seas without a rudder? Simply cutting the deficit back and cleaning up bank balance sheets won’t get the economy back to growth.<br />
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Indeed this habit of continually getting behind the curve, and trying vainly now that the economy is spiralling almost out of control to introduce measures which should have been brought in a decade ago extends well beyond the issue of labour reform. Take reducing the generosity of unemployment benefits. This is also something that should have been done years ago, since the two year allotment really did encourage people to refrain from actively seeking work in times of relatively full employment. But cutting benefits now, as the Rajoy government has just done, when unemployment stands at 25% and rising seems insensitive and even cruel. A government’s job is to introduce policies to create employment, not to cut benefits going to those who cannot find work in an environment where total employment is falling and has been doing so for five years. Quite frankly, if cuts have to be made, better to reduce pensions, but that is political dynamite, so it doesn't happen. <br />
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Again, reducing the fiscal advantages of home ownership made mountains of sense during the years of the property bubble, but it didn't happen. Now, with around two million housing units (between finished and uncompleted) needing to be found purchasers removing tax benefits on mortgages, increasing VAT rates on property transactions and raising the local property taxes - all of which make buying a homea lot less desirable - looks very much like trying to shoot yourself in the foot. There is a lot of merit behind the desire to stabilise Spain's public accounts, but shouldn't we also try to remember why the country has this crisis in the first place?<br />
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Anyway, having recognised that the labour reform comes to late to really change course decisively this deep into the crisis - something incidentally which we much maligned macroeconomists have been arguing all along - what does the ECB propose to supplement it? Well, according to the bulletin "countries with high unemployment also needed to abolish wage indexation, relax job protection and cut minimum wages." Indeed the bank went beyond its usual practice of avoiding country specific commentaries to issue a direct prescription, saying it expected a “strong decline” in wages in Greece and Spain, countries which have the highest levels of youth unemployment in the eurozone, with more than 40 per cent of under-25-year-olds in the labour force out of work.<br />
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This strong decline in wages does not, mark you, form part of the kind of "internal devaluation" some of us have been arguing in favour of for some years now, whereby a battery of measures are introduced to try and bring down <strong>both</strong> prices and wages at one and the same time. Not at all. July inflation in Spain was running at 2.2% compared to 1.7% in Germany. Prices in Spain are going up, largely due to all those tax increases laid down in the adjustment measures. Annual inflation will probably surge by around two percentage points in September as the new consumption tax rates fall into place. So it is only wages which are likely to be coming down, and this makes it all feel much more like 1930s type wage deflation than the sort of internal devaluation that has been being advocated (see my January 2009 piece "<a href="http://fistfulofeuros.net/afoe/the-long-and-difficult-road-to-wage-cuts-as-an-alternative-to-devaluation/" target="_blank">The Long And Difficult Road To Wage Cuts As An Alternative To Devaluation</a>" as a harbinger of all this). <br />
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Well, if you let things go to hell for the best part of five years, naturally the patient is in a poor state and in need of radical surgery. I won't say "I hope they know what they are doing," since <a href="http://www.cnbc.com/id/47262708/ECB_Behold_the_Wonders_You_Have_Wrought" target="_blank">I am pretty sure they don't</a>. Perhaps I would rather say I hope Mariano Rajoy knows what he is letting himself in for when he asks for help from the ECB.<br />
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Talking of which, and turning to another of the "troubled" countries, Italy, I see Finance Minister Vittorio Grilli <a href="http://www.chicagotribune.com/business/sns-rt-us-grilli-deficit-italybre87b08n-20120812,0,5439390.story" target="_blank">has come out today and confirmed</a> two issues I was conjecturing about in <a href="http://italyeconomicinfo.blogspot.com.es/2012/08/is-italian-elephant-about-to-break.html" target="_blank">my blog post only yesterday</a>. In the first place he admitted in an interview in the newspaper La Repubblica that it was unlikely the country would meet this years deficit target due to the depth of the recession, and in the second one he confirmed my fear that getting agreement to ask for EU help would be much more difficult than Mario Monti recognised during the press conference he held with Mariano Rajoy at Spain's Moncloa Palace. Italy plans to wait for the ECB to act, and see what the measures look like, despite the fact that Mario Draghi has made it quite clear he will only do so after a request for assistance goes to the EU. <br />
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So instead of preparing a “battery of measures” to go to the root of Italy’s problems it looks like we what we may well face is protracted debate about how to avoid making any kind of formal request. The <a href="http://edition.cnn.com/2012/08/07/business/italy-monti-bailout/index.html" target="_blank">latest idea to surface</a> is that of trying to get ECB agreement for the Cassa Depositi e Prestiti, a state-financing agency controlled by the Treasury and managing some €220bn in postal savings deposits, to be allowed to use its banking licence to secure loans from the central bank in order to explicitly buy government debt. As the saying goes, this one can run and run. <br />
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Which all brings me to the main point I have been thinking about all weekend, which is why it is that policymakers find it so incredibly hard to see situations coming, and to take corrective action before the train crash occurs?<br />
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"One more word about giving instruction as to what the world ought to be. Philosophy in any case always comes on the scene too late to give it... When philosophy paints its gloomy picture then a form of life has grown old. It cannot be rejuvenated by the gloomy picture, but only understood. Only when the dusk starts to fall does the owl of Minerva spread its wings and fly".
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G.W.F. Hegel, Preface to the Philosophy of Right<br />
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This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-62428104375135891962012-06-16T13:27:00.001+02:002012-06-22T16:24:15.037+02:00Rescue MeI guess we will never know whether or not Mariano Rajoy uttered the two magic words so effectively immortalized in song by Fontella Bass that Saturday afternoon in late May as he cruised down the Chicago River in what Spanish media called a <a href="http://www.moneycontrol.com/news/wire-news/chicago-%22love-boat%22-steered-spain-to-bailout_717682.html" target="_blank">"Love Boat" ride</a>, but one thing certainly is now clear, Angela Merkel has finally and definitively accepted Spain into the German embrace. Whether it will be a tender and loving one remains to be seen. <br />
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What is obviously true is that Spain is in trouble, and needs help. Five years after the Global Financial Crisis broke out unemployment is at 25% of the labour force (and rising), house prices continue to fall, non performing loans continue to rise in the banking sector, bank credit to the private sector is falling, and, as <a href="http://www.irishtimes.com/newspaper/breaking/2012/0605/breaking2.html" target="_blank">Finance Minister Cristobal Montoro said two weeks ago</a>, the sovereign is having increasing difficult financing itself. Hence the bank bailout. On top of which Spain's economy is once more in recession, a recession which will last at least to the middle of 2013, even on the most optimistic forecasts, and is in danger of falling into the dynamic which has so clearly gripped Greece, whereby one austerity measure is piled onto another in such a way that the economy falls onto an unstable downward path, as austerity feeds yet more austerity. Spains citizens are naturally nervous, anxious and increasingly afraid. Hardly a dynamic which is likely to generate the kind of confidence which is needed for recovery to take root. <br />
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The economy is steadily seizing up as the release of pressure (which was previously facilitated through the devaluation mechanism) which it badly needs cannot take place. All the dials move to red, but there is no safety valve available to drain off steam, so the danger of the boiler exploding through the giving way of one joint or another grows with each passing day. <br />
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<strong><span style="font-size: large;">No Mea Culpa From The ECB</span></strong> <br />
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Advocates of the proposed Euro Area debt redemption fund - which would pool all government debt over the 60% of GDP permitted under Maastricht - do so using the argument that we should treat the first ten years of the common currency's existence as a "<a href="http://www.smh.com.au/business/germany-thaws-on-debt-pooling-20120614-20d1y.html" target="_blank">learning experience</a>". Fine, but what exactly have we learnt? Surely almost everyone who has read at least one article on the Spanish crisis now knows that the issue in Spain is private not public debt. But just how did countries like Spain and Ireland accumulate all this debt? Well one thing should be clear by now, part of the responsibility for the situation lies with the ECB who applied (as they had to) a single size monetary policy even though this was clearly going to blow bubbles in the structurally higher inflation economies. And so it was, Spain had negative interest rates applied all through the critical years, and now we have the mess we have. <br />
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Back in 2006 inspectors at the Bank of Spain <a href="http://www.elmundo.es/elmundo/2011/02/21/economia/1298251668.html" target="_blank">sent a letter to Economy Minister Pedro Solbes</a> complaining of the relaxed attitude of the then governor, Jaime Caruana (the man who is now at the BIS, working on the Basle III rules) in the face of what they were absolutely convinced was a massive property bubble. Their warning was ignored. What could have been done, many say. Well, at least two very simple things could have been done, and well before things got out of hand - on the one hand apply much stricter loan to value and income documentation rules which offering a much higher proportion of fixed interest rate loans (quotas could have been applied), and on the other insist the Spanish government run a much higher level of fiscal surplus to drain demand from the overheating economy. Of course, the politicians were not interested in hearing about any of this, since as measures they would have been highly unpopular, but where were M Trichet and his colleagues? They were too busy presenting Euro Area aggregate data to be willing to warn about growing imbalances between the individual economies. Now of course, the imbalances are undeniable, and the ECB is having to implement an asymmetric set of collateral rules (among other things) to try to counteract their impact. <br />
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<strong><span style="font-size: large;">The Root Of Spain's Problem Was The Property Bubble, But The Key To The Solution Is Restoring Competitiveness</span></strong> <br />
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Internal demand in Spain is imploding. This is not surprising, with household debt just under 90% of GDP and private corporate around 120%, it is clear that both sectors badly need to deleverage. Classically the way to do this is by devaluing and boosting exports to sustain growth. But Spain is in the Euro, and has no money of its own to devalue. The common currency makes it very easy to generate distortions, and much harder to correct them. In that sense it is systemically biased towards negative outcomes, something the founders of monetary union didn't give enough thought to. The key institutional stabilisers - a common banking system, a common treasury, and a central bank capable of targeting interest rates on all the participating sovereigns - weren't in place from the start, and even now are considered controversial, so the constituent economies have a lopsided tendency to veer either one way or the other. <br />
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Spain's export companies have put in a heroic effort since the crisis began, and export levels have well surpassed their pre crisis peak. The problem is simply that, after years of neglect, the sector is now just too small to do the job which is being asked of it. Exports surge, even while the economy does not.</div>
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A very different state of affairs from that seen in Germany, where a revival in exports leads to strong growth. Advocates of the "competitiveness" of Spain's economy should ask themselves "why the difference?".</div>
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Another interesting comparison comes from a nice measure of capital goods investment - spending on machinery and equipment. In the German case such spending recovered sharply after the crisis, even if it has recently tailed off again as the global economy has steadily slowed. <br />
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In the Spanish case however, the recovery was muted, soon ground to a halt, and then tapered off again. That's what competitiveness means, ability to sell in sufficient quantities in global markets. Germany has it, Spain doesn't, and all the rest is simple pedantic casuistry. Or ask yourself, why is Germany bailing out Spain, and not vice-verse? Come on! <br />
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<strong><span style="font-size: large;">Half Finished Business </span></strong><br />
In fact, Spain has clearly carried out part of the needed correction. The current account deficit is less than half of what it was. <br />
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And the trade deficit has been reduced. <br />
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But all of this is relative. There is still a long way to go. If we look at industrial output, we will see that far from having revived it is way below the pre-crisis level, and is now falling back again.</div>
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And its the same picture wherever you look. Unemployment keeps rising.</div>
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And in recent months, as the country falls back in recession, it has been doing so at an accelerating rate. <br />
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House prices keep falling, and again <a href="http://www.thisismoney.co.uk/money/mortgageshome/article-2159303/Spanish-house-prices-drop-13-year.html" target="_blank">at an accelerating rate</a>. According to real estate valuers TINSA they have now fallen something like 30% from peak, and credit rating agency S&Ps <a href="http://articles.economictimes.indiatimes.com/2012-06-14/news/32235957_1_house-prices-home-prices-household-debt" target="_blank">estimate they have another 25% to fall</a>, although the truth of the matter is no one really knows, since stopping the housing slide involves fixing the economy, and fixing the economy involves stopping the housing slide. Such is the double bind which Spain economic policy finds itself in. And the problem posed by falling house prices is an important one since, as we will see, the whole effectiveness of the bank recapitalisation process involves putting a floor under house prices.<br />
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Meanwhile there is little sign of credit moving in the economy, and mortgage lending outstanding is dropping by something like 2% a year.</div>
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With the evident result that there is little sign of house sales improving, despite the fact that there is now a backlog of something like <a href="http://www.spanishpropertyinsight.com/buff/2012/04/29/2-million-homes-on-the-market-that-will-take-10-years-to-sell/" target="_blank">2 million unsold homes either finished or in the process of being built</a>. <br />
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Naturally in this environment it is not difficult to understand that people are having difficulty paying their bills. Bad debts held by Spanish banks <a href="http://online.wsj.com/article/SB10001424052702303360504577411541801631340.html" target="_blank">rose to yet another 17-year high in March</a>. According to data from the bank of Spain, 8.37% of the loans held by banks, or EUR147.97 billion, were more than three months overdue for repayment in March, up from 8.3% in February--the highest ratio since September 1994. The total number of non-performing loans is now almost 10 times higher than the level reported in 2007, when Spain's decade-high property boom peaked. And of course, this steady increase will continue for as long as the economy is not fixed. <br />
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And to cap it all, the uncertainty over the future of countries like Greece and Spain is now <a href="http://www.economonitor.com/edwardhugh/2012/06/03/global-manufacturing-growth-shudders-towards-a-halt/" target="_blank">bringing the whole global economy steadily to a halt</a>, and this is boomeranging back on Spain, since it hits exports directly. In fact, Spain's exports have been down on an annual basis since February.</div>
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<strong><span style="font-size: large;">What's In A Name?</span></strong> <br />
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Whatever name you give to the EU financial support for Spain, one thing is clear. Spain alone was unable to go to the financial markets and raise the 100 billion Euros or so it needs to meet the capital requirements of its banking system for 2012/2013. The country’s leaders wanted one of the European funds (the EFSF perhaps) to inject the money directly into the banking system, but Europe’s leaders said no, it would need to be the Spanish sovereign that borrowed (via its bank reorganization fund FROB), and responsibility for repayment would lie with the Spanish state. <br />
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So, five years after one of the largest property bubbles in history burst, with an economy which has fallen by around 5% from its pre crisis peak and is now expected to contract by around another 2% this year, while unemployment is hitting the 25% mark, Spain has finally had to accept that it cannot manage alone. <br />
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Whatever way you call the aid Spain is now receiving from Europe it is clear that this is the beginning and not the end of what is likely to be a long process, one which will now inexorably lead to either the creation of a United States of the Euro Area, or to failure and disintegration of the Euro. There will be no middle path, so the stakes are now very high for all involved. <br />
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Unfortunately Europe's leaders are still too busy thinking short term, and practicing one step at a time-ism. In a pattern that has now become so familiar since the crisis started back at the end of 2009 with the Greek deficit problems, they are so concerned about negotiating the details of how to handle the next stage that they tend to miss the bigger picture. Essentially there are three key players in the present situation - the EU in Brussels, the German government in Berlin, and the Spanish administration in Madrid. <br />
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All three have probably walked away feeling satisfied they have gotten something out of this latest deal. The EU leadership in Brussels have long wanted to draw Spain in. After months of issues about number quality relating to both public finance and the financial system, they will now feel they have a firmer grip on the situation. They will also be perfectly well aware that Spain's financing needs go well beyond the 100 billion euros which has been agreed to as the current ceiling. <br />
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At the time of writing it still isn't clear just how much of this will be injected initially. <a href="http://www.reuters.com/article/2012/06/14/spain-banks-audit-idUSL5E8HE6S020120614" target="_blank">Press leaks suggest</a> that the figure could be between 60 and 70 billion Euros, slightly more than the 40 billion euro number recently given by the IMF. This is more or less in line with a recent report from Standard and Poor's, which said they anticipated losses in the Spanish banking system before the end of 2013 of between 80 and 112 billion Euros. Naturally recognising these losses up front now will present Spain's banking system with a difficult challenge. As Standard and Poor's say: <br />
<blockquote class="tr_bq">
<em>"In the event that banks are required to recognize provisions for 2012 and 2013 already this year, the amount of capital support that the banks could require could be substantial. This is because banks would face greater difficulty to absorb the impact of required provisions in such a short period of time with anything other than excess capital over the regulatory minimum. In this scenario, and assuming no changes to minimum regulatory capital requirements of 8% or 10% of core capital plus the buffer established by the Royal Decree 2/2012, we would expect that only Banco Santander, Banco Bilbao Vizcaya Argentaria, and CaixaBank would have capital levels comfortably above the regulatory minimum. The remaining banks in the system would likely face significant challenges to remain compliant with the abovementioned minimum regulatory capital requirements, in our view "</em></blockquote>
Three points need to be made here. The first is that what we are talking about is provisioning against anticipated losses and writing down problematic assets over the two year 2012/13 period - if the economy doesn't recover and house prices continue to fall (both highly probable given the policy mix currently on the table) then further injections will be required over the 2014/15 period - although this is very academic, since the future of the Euro will more than likely have been decided one way or another by that point. <br />
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Secondly, there is the issue of how those banks who don't apply for government funds will do the necessary provisioning. Apart from operating profits, the only real measure on the table is what is colloquially know as a "bail in", whereby owners of hybrid instruments like preference shares and subordinated bonds are forcibly converted into equity. Now Spain is already reeling under the scandal of what many consider to have been regulatory negligence as the insolvent bank Bankia was allowed to go to Initial Public Offering on the Spanish stock exchange. As the Victor Mallet <a href="http://www.ft.com/intl/cms/s/0/772a64b6-b6d1-11e1-8c96-00144feabdc0.html#axzz1xVjDHNDv" target="_blank">writing in the Financial Times put it</a>: <br />
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<em>The Bankia saga has prompted thousands of angry savers to consult lawyers and pressure groups, and is expected to lead to a flood of lawsuits that will cause new headaches for the government, as well as for banks and regulators already struggling to deal with the eurozone’s sovereign debt crisis. This and other cases involving billions of euros worth of products sold by Spanish banks to their retail clients will complicate any effort by bank managements or European regulators to impose losses on shareholders and bondholders to reduce the bill paid by Spanish and other European taxpayers for bank bailouts. </em></blockquote>
<blockquote class="tr_bq">
<em>The debacle at Bankia, however, is merely the latest and most grievous blow inflicted by banks and cajas on Spaniards who were sold or mis-sold lossmaking financial products by their local branches. </em></blockquote>
<blockquote class="tr_bq">
<em>In March, a court in Alicante ruled that Santander should return money to a client who invested in its so-called valores bonds, of which it issued €7bn in 2007 to finance the purchase of its share of ABN Amro. The Santander bonds are typical of the controversial convertible products sold by many Spanish banks, except that they are due to convert into equity at a fixed price of over €13 per share in October – and because Santander shares are now worth just over a third of that, the 139,000 retail clients who bought them stand to lose most of their capital.</em></blockquote>
While details of the bank rescue package and its impact on bondholders have yet to be worked out, most analysts are busy speculating that subordinated debt holders will be forced to contribute to the recapitalisation effort. But as I say any such "bail in" would involve subordinated debt holders - and in particular holders of hybrid instruments like preference shares - taking losses. The hierarchy is just like that, you can't haircut seniors before you have hit "juniors". <br />
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These are the banks own customers, who were basically sold the instruments on the understanding that they were "just like deposits" and very low risk. Bank of Spain inspectors warned Minister Pedro Solbes in a letter in 2006 that these very instruments were being sold to finance high risk developer loans, but no action was taken. Far from making irresponsible investors pay this measure would penalise the very people who help keep Spain's banking system together, those small savers who forwent going for holidays on credit to Cancun,Thailand or Japan, and failed to increase their mortgages in order to buy lavish SUVs in an attempt to save for their retirement. These are the people who now face the prospect of losing their precious savings to cover the losses generated by those who did both of the above. <br />
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Hence the sort of bank "bail-in" EU regulators want, is politically impossible in Spain, especially after the Bankia scandal, and Mariano Rajoy knows this only too well. Only the Swedish path of direct nationalisation and subsequent resale is open to Spain. Unless, of course, your objective is to totally politically destabilise the country. As is evident, Spain's developers who offered no guarantee for their lending beyond the property are now handing back the keys and assets as fast as they can, while individual mortgage holders who guaranteed the mortgage with their lifetime salary struggle to pay down mortgages which are often now worth twice the market value of the property they are associated with. If this manifest injustice is also followed up with a wipe out of small savers while large institutional bondholders walk away scot free, well I think the next best thing to a populist revolution is what you are likely to see. <br />
<blockquote class="tr_bq">
<em>It is still unclear what conditions will be attached to the loans to cover capital needs which total around 60-70 billion euros, according to a source close to an audit of Spanish banks due to be completed on Monday. Forcing losses on junior bondholders is currently illegal in Spain, but legislation could be rushed through in an emergency situation, as it was in Ireland, lawyers and economists say. However unlike Ireland, where junior bondholders suffered losses of up to 90 percent at Allied Irish Banks and Bank of Ireland during state bail-out processes, a large part of Spanish banks' subordinated debt was sold to bank customers as savings products. Barclays estimates 62 percent of subordinated bank debt is held by retail investors in Spain, stripping out Santander and BBVA, compared to 34 percent in Ireland.</em> <a href="http://in.reuters.com/article/2012/06/15/spain-banks-bondholders-idINL5E8HE7JG20120615" target="_blank">Sonya Dowsett and Helene Durand writing for Reuters</a></blockquote>
Naturally, the details of the loan conditions are still being negotiated, and will be become clearer as time passes. At this point I would simply emphasise three things. Firstly the money the country has asked for is not a problem fixer. It is a stopgap to enable Spain's banks to maintain capital levels as losses are crystalised over the next two years. In this sense the money addresses one of the symptoms of the problem, but not the root of the problem itself. What we can now certainly say is that Spain's banks will be well capitalised through to the end of 2013. <br />
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But credit isn't flowing to the private sector in Spain, and these funds will do little to change that situation. So this is the second point I would make, to get credit moving again a necessary (but not sufficient) condition will be deleveraging the banks - which have a loan to deposit ratio of something over 175% at present - and achieving this deleveraging most certainly means taking some of the problematic property assets off the balance sheets, to be "ring fenced" and deposited in a Nama style bad bank, for example, following the line of the reports the Spanish economy Ministry were recently reported to be studying. Doing this will need finance even after these troubled assets have been written down - it is hard to put a number till we know the extent of the write down, but 200 billion Euros would be a conservative estimate, so furbishing that finance may well be the next stage in the bailout. <br />
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Then, thirdly, we have the sovereign funding issues. As is well known <a href="http://ftalphaville.ft.com/blog/2012/06/01/1026331/on-spains-banking-recap-and-capital-flight/" target="_blank">foreign investors have been exiting their Spanish debt holdings</a>, and there is no reason to imagine this posture will change. Spain's banks have been filling the gap by using LTRO liquidity to buy government debt, but there has to be a limit to this process, otherwise the banks will be as bust with the bonds as they are with the property. In fact Spain's bank dependency on the ECB is growing with every passing month, and <a href="http://www.bloomberg.com/news/2012-06-14/spanish-banks-net-ecb-loans-jump-to-record-288-billion-euros.html" target="_blank">hit 288 billion Euros in May</a>. <br />
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<blockquote class="tr_bq">
<em>But the inescapable error is in failing to inject the money directly into the banks as equity, routing the money instead through the Spanish government. By doing so, the European authorities are intensifying the “doom loop”, as one analyst puts it.</em><br />
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<em>That link was already redoubled when the European Central Bank’s December and February longer-term refinancing operation led to Spanish banks, far more than most, recycling the cash into sovereign bonds – buying €83bn since December. Spanish banks account for a more than a third of Spanish sovereign bond ownership, nearly double the tally five years ago.</em><br />
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<em>The increase has helped offset international investors’ dimming faith in Madrid – making Spain’s banks a valuable stabilising force in the country’s economy. Without them, Madrid would have little hope of financing itself. But it is a delicate and dangerous balancing act, for the banks and the country. And this bailout could be the tipping point. As well as cementing the government’s vulnerability to the banks as it transmits the bailout money to the weakest operators in the sector, there could be yet another layering of sovereign investment going the other way.</em><br />
Patrick Jenkins, <a href="http://www.ft.com/intl/cms/s/0/26b9135a-b3da-11e1-8fea-00144feabdc0.html#axzz1xVjDHNDv" target="_blank">writing in the Financial Times</a></blockquote>
So financing Spain's bond redemption needs between now and the end of 2015 – something like 200 billion Euros - plus the deficit (another 100 billion Euros, at least) will be the third bailout stage. Royal Bank of Scotland analysts headed by Alberto Gallo put the full ESM package size needed to get Spain through to the end of 2015 at between €370billion and 455billion. This seems a perfectly reasonable estimate to me. As I said, removing property related assets from the balance sheets is a necessary but not a sufficient condition for getting credit flowing. The other condition is having solvent demand, which means getting the economy moving again, and this means addressing the competitiveness issue. If the economy isn't turned round then property prices will continue to fall, and the banks will continue to have losses, which means at the start of 2014 we will need another round of capitalization just to cover for the losses to be anticipated in 2014/2015, and so on. <br />
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<strong><span style="font-size: large;">Approaching The Psychological 100% Debt To GDP Threshold</span></strong><br />
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As I have been saying, Spain's debt problem was primarily one of private debt. In 2007, when the crisis started, Spanish sovereign debt was a mere 36% of GDP. This year, once the 100 Billion Euro loan for the banking system has been accounted for it will probably be very near to 90%. At the very latest it will pass through the 100% level in 2014 (that is to say, assuming there are no more "unexpected losses" to be added in the meantime - for a full account of the background to all this, see my <a href="http://www.economonitor.com/edwardhugh/2012/03/06/homeric-similes-and-spanish-debt/" target="_blank">Homeric Similes and Spanish Debt</a> post). And it won't stop there. As long as the economy isn't fixed and returned to growth the level of public indebtedness will continue to grow, as private debt steadily gets written down and shuffled across to the public account. If the country moves to budget deficit zero, then if the competitiveness problem remains the economy will simply contract, and probably contract and deflate, which will mean the ratio will rise even without more deficits, as we are seeing right now in Italy.<br />
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But we are getting ahead of ourselves here since we still don't know how Spain and the Euro are going to get through to the end of 2012, let alone where we will be in 2014. Obviously accepting that Spain needs a full bailout is going to be hard for the German leadership, but the alternative of Spain Euro exit and default will probably prove even less appetising for them. After several years of neglect and refusing to face up to issues, talk is in the air of internal devaluation to address the loss of competitiveness Spain suffered during the boom, but so far nothing has been done. Maybe this is the next reform Brussels should be discussing with Madrid, the most recent IMF proposals certainly point in this direction . Beyond all the talking, if Europe's leaders really do want to save the Euro, and not have Spain go back to the Peseta to devalue, then one day or another this internal devaluation will have to happen or the Spanish economy will simply never recover. If it doesn’t recover then the issue will not be simply saving Spain but rather how to save the global economy when the Euro then finally falls apart. Time is now running out, as <a href="http://community.nasdaq.com/News/2012-06/lagarde-warns-just-three-months-left-to-save-the-euro-eu-braces-for-the-worst.aspx?storyid=147667" target="_blank">Christine Lagarde recently reminded us</a>. I think she and Soros are being a little unfair - they have till Christmas. <br />
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This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-20414902385624451242012-05-31T12:16:00.000+02:002012-06-16T19:17:21.163+02:00Grexit? Spexit? Let's Call the Whole Thing OffOne thing we've learned as the euro crisis has unfolded is that the enthusiasm of experts in London and New York for offering advice to the struggling countries on Europe's periphery is matched only by their passion for awkward neologisms. The world was just getting used to "Grexit" (Get it? A <b>Gr</b>eek <b>exit</b> from the euro!) when "Spexit" began to rear its ugly head in the financial press.<br />
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Naturally, the events of recent days have brought Spain back to the forefront of the debt crisis, generating insecurity about the reliability of the official fiscal deficit numbers, the validity of central bank statistics, and new numbers showing capital flight reaching <a href="http://ftalphaville.ft.com/blog/2012/06/01/1026331/on-spains-banking-recap-and-capital-flight/" target="_blank">alarming levels</a>. Only this week, Spain announced that the central bank governor, Miguel Angel Fernandez Ordoñez, <a href="http://www.reuters.com/article/2012/05/29/us-spain-centralbank-idUSBRE84S17O20120529" target="_blank">will be leaving early</a> as part of a government effort to restore its credibility. Some are now anticipating that Spain's exit from the eurozone will <a href="http://www.foreignpolicy.com/%22http://www.cnbc.com/id/4761">come before Greece's departure</a>.<br />
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I would hope that those clamoring for these countries to go their own way are at least better intentioned than they are informed, since normally they exhibit a singular lack of understanding about how political systems in southern and eastern Europe actually work.<br />
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It is now essentially <a href="http://www.foreignpolicy.com/%22http://www.ft.com/cms/s/0/4bdda8a0-9dad-11e1-">conventional wisdom</a> in the British and American press that Greece needs to return to the drachma. British journalists are even racing to <a href="http://www.independent.co.uk/news/business/news/no-word-yet-on-drachma-job-for-de-la-rue-7800972.html">hunt down</a> the London printing works that have supposedly been given the contract to print New Drachmas, the putative local replacement for the euro. The only snag is, according to all <a href="http://www.pewglobal.org/2012/05/29/chapter-2-views-of-european-unity/">opinion polls</a>, the Greeks themselves are not happy with the euro but have no interest in dropping it. (Perhaps the perfect Solomonic solution here would be to have the New Drachma introduced as a non-convertible currency for use only within Fleet Street bars and the boundaries of the City of London.)<br />
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The Greeks, naturally, are tired of austerity, and of a stupid EU/IMF bailout plan that has only served to totally collapse their economy, explode their debt, and destroy what semblance of external reputation Greek companies had. The Greeks are tired of austerity in the way many in the United States have tired of fiscal stimulus in the run-up to the next presidential election. But no one would suggest that this weariness is an indication that Americans want to drop the dollar.<br />
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As an economist, I have always argued that the common currency was a mistake. I am a "euro" skeptic, but not a "Euroskeptic," and I think it important that people outside Europe understand that this distinction exists. There is no doubt that the euro, <a href="http://business.blogs.cnn.com/2011/09/22/dr-strangelove-and-the-euro-doomsday-machine/">like Dr. Stangelove's doomsday machine</a>, is an infernal device destined to blow up one day, but also so designed that any attempt to dismantle it simply detonates the bomb. This is why, tired as they may be, those who live on Europe's southern fringe have little appetite for leaving or taking part in yet another experimental new currency order. Better put, they have little appetite for leaving in a disorderly fashion. And disorderly the leaving would have to be, since if core Europe has<a href="http://www.foreignpolicy.com/%22http://www.reuters.com/article/2012/05/24/us-ecb-greece-idUSBRE84G0DA201"> little appetite for assuming the cost</a> of keeping the eurozone together, it will surely have even less for paying the much larger bill associated with exit and default.<br />
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The media's increasing scrutiny of Spain is similarly misguided. Despite the many voices now recommending a "Spexit," few are really knowledgeable about daily life here in Spain, and even fewer are actually to be found inside the country. <br />
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The story of how Spain got to this point is well-known. There was a huge property bubble (could we say the mother of all of them?), a decade of above-EU-average inflation, a massive loss of competitiveness, a huge current account deficit, and an unprecedented stock of external debt. All of this now needs to be unwound, but here's the rub: It is very easy to structurally distort an economy within the framework of a currency union, but very difficult to correct the distortions once generated. This is why so many rightly say that in Spain it is all pain as far ahead as the eye can see. It is not that the Spanish people like this, but just that they don't see any clear and better alternative. And indeed, while only 37 percent of Spaniards believe having the euro is a good thing, <a href="http://www.pewglobal.org/2012/05/29/chapter-2-views-of-european-unity/" target="_blank">according to a recent Pew poll</a>, 60 percent favor keeping it.<br />
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The departure of Ordoñez, the central banker, may seem more dramatic from the outside than it does from within. Certainly Mafo, as he is called, bears a heavy responsibility for Spain's continual failure to get a grip on the rot in its financial system, and for the disastrous decision to allow the insolvent Bankia conglomerate to <a href="http://www.bloomberg.com/news/2012-05-16/bankia-ipo-leaves-shareholders-2-billion-poorer-after-bailout.html" target="_blank">go to IPO last year</a>, losing shareholders more than $2 billion and badly damaging the credibility of the country's banking sector. But his is only one name on what should be a very long list of putative villains, including members of the present government, the previous one, the EU Commission, the European Central Bank (ECB), and last but not least the IMF, where ex-Bank of Spain deputy director Jose Viñals has been busying himself for months <a href="http://blog-imfdirect.imf.org/bloggers/jose-vinals/" target="_blank">writing reports</a> suggesting the condition of Spain's banks was not all that bad.<br />
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The real question is what happens next. Spain, like the euro itself, is both too big to rescue and too big to fail. Spain's banks need capital from the government, but the government itself can't finance them. Foreign investors are leaving in droves, but no matter how many liquidity offers they get from the ECB, the country's banks simply can't buy all the debt. So the country needs European (read: German) money. The problem is that if this takes the form of an injection of bank equity, then Germany could end up all but owning Spain's banks, which would expose German taxpayers to considerable potential losses should the situation deteriorate further. At this point Berlin could firmly put its foot down, and we will have another impasse.<br />
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At the end of June, Europe will face what many consider to be a perfect storm: results of the Greek elections and details of the new, independent, Spanish bank valuations, which are sure to find that significantly more money will be needed for recapitalization. This will undoubtedly be a make-or-break moment in the ongoing debt crisis, and, if things were to spiral hopelessly out of control, a Spexit could become a real possibility. My advice to all those external well-wishers would be: Be careful what you ask for, since you might not like what you finally get. <br />
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This article <a href="http://www.foreignpolicy.com/articles/2012/05/31/grexit_spexit_let_s_call_the_whole_thing_off?page=0,0" target="_blank">originally appeared in the magazine Foreign Policy</a>.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-25064447.post-41132083511105950072012-05-13T15:01:00.000+02:002012-05-21T22:36:48.638+02:00It's Time to Stop Using Chewing Gum And Chicken Wire In Spain<br />
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"Every leg of the eurozone crisis has been marked by denial of the full scale of the problems. Whether Spain’s authorities have been deceitful or wilfully blind makes little difference at this point. The banks will need more capital; the government will need external help, with all the market uncertainty and strings attached that this implies. And the pain in Spain will only get worse".<br />
<a href="http://www.ft.com/intl/cms/s/0/5836e434-9b3e-11e1-b097-00144feabdc0.html#axzz1udllp400" target="_blank">The top Line, Financial Times</a></blockquote>
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According to reports now widely circulating the Spanish press (<a href="http://www.lavanguardia.com/economia/20120510/54291886887/bruselas-auditorias-independientes-bancos-espanoles.html" target="_blank">in Spanish only</a>), the EU is pushing Spain hard to accept EU aid on completion of an independent external evaluation of the problems in the banking sector that is to be conduced by Blackrock Solutions and Oliver Wyman. The evaluation has been imposed on Spain by both the ECB and the EU Commission following doubts about just how faithfully the numbers published by the central bank do reflect the likely losses to be sustained by the Spanish banking system. Following this weeks revelations <a href="http://www.reuters.com/article/2012/05/10/us-spain-banks-idUSBRE8481HJ20120510" target="_blank">about the extent of potential losses in Bankia</a> (product of the fusion of a number of savings banks, and one of the country's largest financial institutions by assets) it is not hard to understand why.<br />
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Not only has the issue placed in doubt the capacity of the country's political and financial leaders to handle a crisis of this magnitude, it has once more raised question marks and doubts about the adequacy of data presented in commercial bank annual accounts. What brought matters to ahead was the publication on Friday 4 May of Bankia's unaudited accounts for 2011 wherein the parent bank BFA still valued Bankia, in its individual accounts, at book value. In fact at the time Bankia was trading at around 0.3 of BV, while listed stakes in companies like Mapfre, NH Hotels, and Indra were by no means fully marked to market. The reason the accounts remained unaudited was that Deloitte, the bank’s auditor during the time of the stock market listing, <a href="http://www.ft.com/intl/cms/s/0/d49da954-99f9-11e1-accb-00144feabdc0.html#axzz1uAMc7wgZ" target="_blank">had refused to sign off on them</a>. <br />
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In fact, not only is the bank suffering from the falling value of its property assets, it is also feeling the squeeze of the sharp fall in stock prices, which affect the value of its commercial holdings. The country's IBEX 35 Index <a href="http://www.bloomberg.com/news/2012-05-09/spanish-stocks-plunge-to-eight-year-low-on-europe-crisis.html" target="_blank">hit its lowest level since October 2003</a> this week, and with holdings which some describe as the "<a href="http://www.larazon.es/noticia/3214-bfa-bankia-se-saneara-a-costa-de-las-joyas-de-la-corona-entre-sus-participadas" target="_blank">jewels in the bank's crown</a>" down sharply, bank capital has taken a hit. Bankia's holdings include a 5.4% stake in the troubled hydrelectric company Iberdrola, which is now only valued at 21 billion Euros, some 40% down from the 35 billion Euro valuation the company had only one year ago. A back of the envelope calculation suggests this drop alone has cost the bank 800 million euros, making it unlikely that a forced asset sale of all holdings would bring in anything like the 3 billion euros some are estimating. However hard Mr Goirigolzarri, the new CEO, struggles to put a brave face on things ("contra mal tiempo buena cara"), and no one doubts his good will, the battle in front of him is enormous. <a href="http://www.bloomberg.com/news/2012-05-12/spain-may-need-to-inject-6-4-billion-in-bankia-expansion-says.html" target="_blank">Estimates in Spain</a> suggest that in addition to the 4.5 billion Euros in Frob loans converted into equity, the bank may need a further 5 billion Euros in capital injection, just to cover the new provisioning requirements.<br />
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Concern about how the whole financial reform process was being handled by the Bank of Spain only grew with the acknowledgement by Bankia itself that it had renegotiated €9.9bn of assets in 2011 to avoid them from going bad. This is a practice which external observers had often suspected regulators at the Bank of Spain were permitting, but the latest revelations only confirm suspicions and raise worries that more of Spain's banks are understating their problematic loans, particularly along the sensitive line which divides "good" from "bad" developer loans. Indeed, many ask how five years into the crisis there can still be good developer loans in the system once guaranteees are adequately valued .<br />
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Naturally the whole BFA/Bankia edifice is the first good example I will point to of the use of chewing gum and chicken wire in Spain, since it is hard to imagine a more complicated way of doing something that is almost guaranteed not to work. Basically BFA, the parent bank, was created as a bad bank, where the toxic property assets (largely land) of the seven participating savings banks were to be warehoused, supported by a mixture of preference shares, subordinated debt and own resources in terms of company shares, equity etc, plus a 4.5 billion euro "hybrid capital" loan from the government restructuring fund (FROB), which was to be paid 8% a year. Naturally the value of the toxic assets was bound to drop as time past, and I suppose the hope must have been to tranfer earnings from new ("better" - not "good") bank Bankia to both offset losses and service the FROB loan. But things weren't to work out that way (as could have been anticipated), since Bankia itself was created with its own property exposure (especially in the form of developer loans, many of which were on the point of "souring") as there simply were not enough resources available to wharehouse everything. And when the new government introduced a law requiring more provisioning, well it was all over, bar the large injection of public money now needed to clean up the mess. Others were given the opportunity to kick the can a little further down the road by entering a merger, and thus offseting the write-downs against capital rather than having to charge them directly to profit and loss. But Bankia was already too big, and too about to fall over, to be able to find a "dancing partner". <br />
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Beyond the fact that what was created was a flawed structure from the start, especially given the lacklustre economic environment facing Spain over the coming years, and the ongoing downward adjustment in property values, the whole Bankia affair raises important issues. Just what did regulators at the Bank of Spain think they were doing when they gave approval not only to the bank's business plan, but to the stock market flotation? Didn't they realise there was a high probability of failure, and that hundreds of thousands of small savers - many of them clients of the bank itself, who were sold the idea of buying shares in their local bank on the basis of the promise that it was going to be a "great opportunity", especially when normal deposits were paying so little - would almost certainly lose a lot of their money. Weren't the Bank of Spain aware of just how vulnerable those "good" developer loans really were?<br />
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But the root of the problem here is not one irresponsible decision, it is a whole comedy of errors, going back to the early days of the financial crisis in 2007, and the constant declarations that due to their substantial provisioning programme, Spain's banks were among the most sound and solid on the globe. These provisions were indeed important, but their existence and the constant comparison with the property slump of 1992 to 1995 lead regulators at the central bank and policymakers in the Economy Ministry to have a false sense of security. They were simply determined to put that brave face on, keep trying to maintain confidence, and simply ride the thing out. How many times over these years have I heard bankers lament that one day all the property assets will offer a valuable legacy for their children if they can only find a way to get through the present storm intact. Unfortunately, looking at the youth unemployment numbers, many of their children will be long gone to work in another country by the time property prices start to recover, if - looking over at Japan - they ever do.<br />
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<strong><span style="font-size: large;">EU Rescue Needed</span></strong><br />
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In one sense Spain is too big to rescue, but in another it is also too big just to let it go to the dogs. In fact, when I say it is too big to rescue, I mean it is too big to rescue using the now classic model put into practice in Greece, Ireland and Portugal. Spain and Italy are simply too large (both in terms of GDP and in terms of population) to put under the tuteledge of the Troika in this way. The political risks of facing a runaway train are just too great. In addition taking Spain completely out of the sovereign bond market, in the way Greece, Ireland and Portugal have been, would be very expensive, and is probably not necessary.<br />
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On the other hand, if we think about it, Spain has already had a partial bailout, first via the ECB SMP (the Spain government bond purchases,which began last August), and then via the more recent support for the banking system offered by the two 3year ECB "liquidity" LTROs. According to data from the Bank of Spain, Spanish banks have borrowed something like 316 billion Euros in these offerings, of which (and as of March) some 89 billion Euros had been left with the ECB deposit facility.<br />
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Also, when we talk about rescues, it should also be borne in mind that the EU is progressively implementing a whole new set of governance procedures which will leave individual Euro Area countries with a lot less freedom to decide for themselves on key economic matters, as Mariano Rajoy discovered to his cost when he went to Brussels and asserted that his country, being sovereign, could decide its own deficit target. So rather than one dramatic intervention what I expect to see is the application of a steadily tightening set of pincers, and a growing number of controls over the freedom of action of both the Spanish government and the Bank of Spain.<br />
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In essence the liquidity measures implemented by the ECB via the LTROs have solved one problem - the difficulties the country's banks were having financing themselves, and helped with another by enabling the banks to buy more Spain government bonds, although if the objective here was to resolve Spain's financing issues they have been less successful, since 10 year bond yields are still constantly pushing against the 6% mark. <br />
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On the other hand the LTROs have done nothing to help with the other key issue, the lack of credit in the economy. Indeed by making it easier and more profitable for the banks to buy government debt they have arguably made it even more difficult for the private sector to obtain credit. In some ways what we are seeing is truly a form of "crowding out" of new investment projects by a combination of zombie property developers and the public sector. According to data from the bank of Spain, credit to the private sector fell for the 18th consecutive month in March - by an annual 1.7% to corporates, and by 2.7% to households.<br />
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So obviously something needs doing to resolve issues in the financial sector, since in the meanwhile unemployment only goes up - for the 60th consecutive month in March (on a seasonally adjusted calculation) - hitting just under 25%, or nearly one in four of the workforce.<br />
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While house prices, the key variable around which the Spanish economy hangs, go down and down. It is impossible to say at this point just how far they will fall, this in part depends on how many years Spain needs to get back to job creation, and how many young people leave in the meantime, but 2002 looks to be a critical level in terms of the likely impact on the mortgage book.<br />
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Part of the solution to the problem, but only part of it, lies in cleaning up the balance sheet of Spain's banks. This is the part that Mr de Guindos is currently trying to address. The other part is the absence of solvent demand for credit, even were the balance sheet to be less encumbered, given the high levels of unemployment and corporate bankruptcy, and the low levels of income security prevelent in the current depressionary environment.<br />
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The main point which stands out is that Spain's banks badly need to deleverage, in terms of reducing their loan to deposit ratio - a hard thing to do when all the insecurity which accompanies the crisis is leading the system as a whole to lose deposits. The loan to deposit ratio is still way to high in Spain, and the banks need to deleverage in some way or other to bring this down on aggregate - liquidating toxic property assets from their balance sheets to independent management companies would be one way to start. Simply reducing credit to the private sector wouldn't be.<br />
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There are currently about 2 trillion loans issued by the Spaining banking sector, and about 1.2 trillion deposits. That's about 165% leveraging. The ECB LTROs are to some extent masking this situation by allowing the banks to refinance. The only way forward is to raise savings and hence deposits, and write down loans. Otherwise, Spain's banks may have a huge balance sheet, but be able to give few loans because one way or another large parts of it a permanently encumbered. It may, or may not, be obvious to those responsible for taking decisions, but from a macroeconomic point of view the key to achieving this balance sheet restructuring passes through having a lot more export capacity, and a large goods trade surplus.<br />
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In Ireland loans to deposits had reached 180% before the bailout. Here's what the central bank intoduction to the BlackRock stress tests says:<br />
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<blockquote class="tr_bq">
"The Central Bank has agreed with the External Partners that a sustainable Loan to Deposit Ratio for the aggregate domestic banking system is 122.5%, meaning a surplus of some €70bn of loans. Deleveraging these loans will reduce dependence on wholesale funding and set the foundation for a sustainable banking sector. It will help to create smaller, cleaner banks that are capable of providing the new lending necessary to support economic activity in Ireland".</blockquote>
I thoroughly agree with these Bank Of Ireland objectives, and these very same ones ought to be the objectives in Spain too. Removing the 90 billion euros in acquired real estate assets and the 400 billion in developer and construction loans (see Barcap Table below) from the books would be one huge step in the right direction, the trouble is the quantities of money required to finance this would need to come from Europe. The idea that foreign investors would put money in, if the assets weren't priced below 30 cents on the Euro, is simply laughable.<br />
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The background to the latest episode in the crisis is that Spain urgently needs to find the finance to completely clean up its banking sector, and not come up with yet another 30 billion euro chewing gum and chicken wire provisioning job simply to avoid EU involvement. There is too much at stake for everyone now.<br />
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And if all of this wasn't enough, the most tacky piece of chewing gum is still to come, in the form of the idea of leveraging Spain's <a href="http://www.fgd.es/es/index.html" target="_blank">Fondo de Garantía de Depósitos de Entidades de Crédito</a> to finance an asset guarantee scheme for each of the banks that buys one of the more troubled ones which have been taken over by the FROB. The FdGdD was set up in 2011 to, guess what, guarantee deposits. I think it is worth citing the actual objectives of this organisation as set out in the Decreto Ley which set it up:<br />
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<blockquote class="tr_bq">
El Fondo tiene por objeto garantizar los depósitos en dinero y en valores u otros instrumentos financieros constituidos en las entidades de crédito, con el límite de 100.000 euros para los depósitos en dinero o, en el caso de depósitos nominados en otra divisa, su equivalente aplicando los tipos de cambio correspondientes, y de 100.000 euros para los inversores que hayan confiado a una entidad de crédito valores u otros instrumentos financieros.</blockquote>
Well, I won't translate all the jargon, but what the Spanish says is that the Fund's objective is to guarantee deposits up to 100,000 Euros. This is the protection most Spaniards think they have, and they do, but how much is there in the Fund to guarantee those deposits? Well, almost nothing, since the money has been spent on paying off the FROB participation in CAM and UNIM when they were sold to Bank Sabadell and BBVA respectively, for 1 Euro in each case. And why was the financing of the operation done in this peculiar way, using a Fund whose intention was to guarantee deposits in case of bank failure? The answer is obvious, it was done in this way due to the high priority given by Mr de Guindos and the government he represents to trying to maintain that no public money is being put into banks. The FdGdD is financed by a 0.2% levy on bank deposits, and it is the income stream from this levy over the next 8 years that "experts" in the Economy Ministry are now reportedly thinking of securitising in order to pay for the coming Asset Guarantee Schemes. The banks are going, Baron von Munchausen style, to pay for their own clean up. Clever isn't it? So now you see why the I said the chewing gum in this case was particularly tacky. Yet one more piggy bank has now been raided, and the only guarantee for deposits will be the Spanish government, which itself has trouble financing. You see why I say they need to get into an EU harbour, and quickly.<br />
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Indeed such are the lengths to which Mr de Guindos seems prepared to go to fool all of the people all of the time when it comes to whether or not public money is being spent that last Friday he even burst through what the FT's John Dizard calls the <a href="http://www.ft.com/intl/cms/s/0/7ca5ec32-9073-11e1-8adc-00144feab49a.html#axzz1udllp400" target="_blank">Harold Wilson standard for public doubletalk and evasion</a>. The British Prime Minister, it will be recalled, told the British public that even though the Pound Sterling was being devalued by 14%, the pound in their pocket would not be affected. Well Spain's Economy Minister has now gone one better. To <a href="http://economia.elpais.com/economia/2012/05/11/actualidad/1336762069_549716.html" target="_blank">an astonished group of journalists at last Friday's government press conference</a> he calmly explained how the new bank provisioning rules would not mean that any public money was being spent, since in the first place the estimated 15 billion Euros that FROB would inject into banks who couldn't manage from their own resources would be in the form of a loan at a penal rate of interest (and this is supposed to help them), while in the case of Bankia the existing FROB loan which was being converted into equity wouldn't be an injection of public money, since - drum roll - the money had already been leant to the bank. How you square these two statements, well, you'd better ask Mr de Guindos that.<br />
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<strong><span style="font-size: large;">How Big Is Big?</span></strong><br />
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So, if the extra 30 billion Euros in provisioning is but a drop in the ocean, how much do the banks really need? Well <a href="http://www.bloomberg.com/news/2012-05-09/spain-underplaying-bank-losses-faces-ireland-fate.html" target="_blank">the prestigious Brussels based think tank CEPS came up with a 250 billion Euro number during the week</a>, and since they are not only geographically but intellectually close to the Commission, it wouldn't be unreasonable to think this number isn't far from what EU policymakers have in mind. Certainly 200 - 250 billion euros seems to be in the right ballpark, especially when you take into account not only the problematic developer loans, but also the stock of properties on bank books, the need to help householders who will increasingly struggle to finance their mortgages and <a href="http://news.xinhuanet.com/english/business/2012-05/08/c_131575549.htm" target="_blank">the growing numbers of small and medium sized enterprises facing bankruptcy</a>.<br />
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Over 1.5 million housholds in Spain now have no one working, and have exhausted their unemployment benefit entitlement. They simply live from savings, family support and the 420 euros a month minimum payment. Clearly it is hard for such people to meet there repayment commitments, and their number is growing. Finance Minister Noonan deliberately over capitalised the Irish banks because he could see this problem coming - even though even in that case more may now be needed - and it would be a good idea for Spain to follow his lead. Spain's banks have more than a trillion euros in property-related assets, and simply deriding those who are pointing to the potential problem this constitutes <a href="http://www.businessweek.com/news/2012-04-26/santander-ceo-derides-surge-in-spain-defaults-mortgages" target="_blank">by suggesting doing this is stupid</a> because "mortgages get paid in good times and bad", as Santander CEO Alfredo Saenz did recently, seems to me to be just another case of the kind of Spanish bank denial the country now needs to put behind it.<br />
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<strong><span style="font-size: large;">Then There Is The Deficit Issue</span></strong><br />
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According to one popular current of opinion the Spanish economy is now rebalancing nicely, competitiveness is being steadily restored while exports are going well. The strange thing, if this is so, is how the economy continues to go so badly. Even though undoubted progress has been made with the trade and current account deficits, and exports have improved, there is obviously still a long hard road to travel. Indeed, in general terms the situation is worsening, and we face two years of recession at least, while 2011 saw very modest growth.<br />
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I don't suppose the continuing rise in unemployment and the ongoing fall in house prices have something to do with the way this bad outcome continues to go on and on.<br />
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On the "things are steadily improving" kind of view there is only thing, apparently, which is standing in the way of full blown recovery, and that is the lack of investor confidence. This, apart from limiting inward investment, is behind the rising cost of financing government debt (the huge quantities of money the commercial banks need from the ECB - 220 billion Euros in March -apparently isn't that much of an issue to worry to much about in this context). So Spain needs help from European partners to bring down borrowing costs on government debt, then all will be well, and "comeremos perdices" (we will all live happily ever after).<br />
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The question I ask myself is which world these people are living in. The biggest source of increase in government borrowing costs comes from the rapid growth in the size of the debt. So why is the debt growing so quickly? Aha, that must be a trick question, since normally the argument gets stuck precisely at this point. <br />
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The sad truth is that despite all the marvellous progress, the root of the problem still lies in the fact that Spain's economy still isn't sufficiently internationally competitive for the export sector to grow fast enough to pull GDP growth forward. Blaming the problems the periphery economies are having on a negative external environment is to miss the point, since the real issue here is why some countries are able to maintain some semblance of growth even in this context while others collapse into full blown recession. The only explanation can be that those who don't fall back at the first hurdle are better able to survive in the negative environment because they are more competitive. People can show me all the charts they want showing what magnificant progress has been made on unit labour costs, etc, etc, but the real Northern Blot test is this one: who is growing and who isn't?<br />
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So while earlier levels of government spending which are now unsustainable steadily retrench, and the private sector deleverages from all that accumulated debt, the economy struggles constantly for breath, with the result that attempts to reduce the deficit prove to be a source of eternal frustration as revenue constantly falls faster than expected.<br />
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In this context it is hard not to see <a href="http://ec.europa.eu/economy_finance/eu/forecasts/2012_spring/es_en.pdf" target="_blank">the latest EU forecast for Spain</a> as an attempt to pile on the pressure, and force the country into some sort of rescue, and indeed this is <a href="http://www.reuters.com/article/2012/05/11/eurozone-forecasts-idUSL5E8GB5CT20120511" target="_blank">how it is widely interpreted in many parts of the press</a>. The Commission said that without additional measures the country is set to have a budget deficit of 6.4 percent of GDP in 2012 and 6.3 percent in 2013, way above the agreed Stability Programme targets of 5.3 percent and 3 percent respectively. The 5.3 percent figure was itself an increase from earlier commitments, agreed with Spain's new government to give it some leeway. So it looks very much as if by drawing attention to the country's difficulties in the way Europe's leaders are trying to get the Spanish ones to see sense and come in and talk about things, and especially the needs of the financial system.<br />
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This looks doubly true when you take a hard look at the numbers for growth and gross debt, since the EU expect Spain to have a 1.8% GDP contraction this year followed by a 0.3% one next year. They also expect the recession to be at its worst in the second half of this year as the already-in-place austerity measures really start to bite, following the respite Spain leaders allowed themselves for the Andalusian elections in the first half.<br />
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Government gross debt, on the other hand, is expected to continue to rise, hitting 87% of GDP in 2013. This is getting near to the kind of numbers I was talking about <a href="http://spaineconomy.blogspot.com.es/2012/03/homeric-similes-and-spanish-debt.html" target="_blank">in my recent post on this topic</a>. Some of the unpaid bills have now been factored in, how many are left we will have to wait for future publications of the financial accounts to see. There is still of course the debt hanging about on the books of state owned companies like railway operator RENFE or airports controller AENA (maybe another 5% of GDP) to be consolidated, and resolution of this will become especially important if any of these are ever to be privatised, as the government has said is its intention. <br />
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But more importantly than this I would draw attention to two additional factors people need to think hard about, and these are the longer run impact of additional costs in the financial sector, and the consequences for Spanish debt if the country hits a bout of Japan style deflation at some point. Both these risks are hard to calculate, but they do exist nonetheless. The Commission forecast is based on a no policy change assumption, which means they have not projected any additional impact on the debt of financial system reform. There will undoubtedly be some, but how much is a hotly contested issue, with estimates ranging from 5% to 20%. Given that everything we have seen in Greece, Portugal and Ireland suggest numbers suddenly go out when national accounts are subjected to intense scrutiny I would veer towards the higher end, especially given the recent debt/deficit revelations together with the now known inadequacies of Bank of Spain public reports. <br />
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The second, the impact of low growth with deflation or strong disinflation with negative growth also seems to be a scenario which is not widely contemplated, but which has a probability well above zero. Indeed, in this year's projections for gross debt increase this factor is already at work, since nominal GDP will likely shrink (lowering the denominator in the calculation). If GDP falls by 1.9% and the GDP deflator only rises 0.9% then debt automatically rises around 0.9% as a percentage of GDP. What is hard to quantify is how important this factor might be between now and 2020. Certainly raising competitiveness implies disinflation/deflation while lack of competitiveness, debt and fiscal adjustment imply near zero average growth over a number of years, and, as we are seeing, more frequent than normal recessions.<br />
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Then there is <a href="http://spaineconomy.blogspot.com.es/2012/03/homeric-similes-and-spanish-debt.html" target="_blank">another item I touched on in my recent Spain debt report</a>, the impact of outstanding pension liabilities on deficit reduction efforts. In fact the Commission itself have explicitly singled this issue out in their forecast.<br />
<blockquote class="tr_bq">
"Whereas the (5.3 percent) target of the central government should be within reach, deviations are projected at this stage for regional governments," the Commission said. "Moreover, the social security system is projected to record a deficit again this year in line with a deteriorating labour market outlook."</blockquote>
I will come back to the regional governments issue in a minute, but let's think about the other item, the social security system. I went into all this in some depth in my debt post, but basically Spain has a problem that as the economy deteriorates, fewer and fewer people are paying into the pension fund, while more and more people are retiring. In addition, more people are becoming entitled to pensions than are dying, and those who retire tend to be entitled to a significantly higher pension than those who expire. Hence there is a growing annual deficit. The problem is structural, and not simply cyclical, given the ageing population phenomenon, but it is also doubly structural given the fact that any early recovery in employment is not to be anticipated. <br />
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Now normally, what would happen in these circumstances is that the social security system would dig into the reserve fund to cover the differences for a time. But, aha, this is just the issue, since the fund, which currently has a nominal 65 billion Euros in it, really has very little, since now something like 90% of the investment which has been made has been in Spain government bonds (see pie chart below), and due to the complicated accounting rules of Eurostat these bonds to not count towards EDP Spanish debt, unless, unless - wait for it, drum roll - they are sold externally, to a non government third party. In this latter case they raise liquidity to help pay pensions without impacting the deficit, but they do add to debt. So here comes another 5% debt to GDP at some point, not to mention the loss the fund may have to take in selling, and in the meantime (ie before a decision to bite the bullet is taken on this) the shortfall rows in the opposite direction to attempts to reduce the deficit.<br />
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Obviously this is another case of chewing gum and chicken wire accounting, and it puts me in mind of the little child who tries to save money in a variety of piggy banks, but each time he/she wants an icecream or a visit to the fairground she takes some of the money and leaves an IOU. Hemmingway reportedly said the bankruptcy creeps up on you slowly at first, and finally seizes you all of a sudden. I guess it is due to the operation of this kind of process, with widespread recourse to robbing Peter to pay Paul accounting.<br />
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<span style="font-size: large;"><strong>Spain's Regions</strong></span><br />
Spain's regions are widely held to be behind the "uncontrollable" deficit story. To some extent <a href="http://spaineconomy.blogspot.com.es/2012/01/rain-in-spain-falls-mainly-on.html" target="_blank">I have already gone over the topic in this post</a>, and <a href="http://www.aljazeera.com/programmes/insidestory/2012/03/2012331944431897.html" target="_blank">Raymond Zhong adds a local Catalan perspective here</a>, but still, lets have a quick run over some of the ground one more time. The story so far was offered by <a href="http://www.reuters.com/article/2012/05/11/eurozone-forecasts-idUSL5E8GB5CT20120511" target="_blank">EU Commissioner Olli Rehn at the economic forecast press briefing</a>:<br />
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<blockquote class="tr_bq">
"The Commission has full confidence in the determination of the Spanish government to meet the fiscal target in line with the pact. For Spain, the key to restoring confidence and growth is to tackle the immediate fiscal and financial challenges with full determination," Rehn told a news briefing."This calls for a very firm grip to curb the excessive spending of regional governments."</blockquote>
The real question, however, is whether this overspending stems from the decentralised structure in and of itself, or is largely a consequence of the kinds of areas which the regions are responsible for together with the extent to which the central government itself adequately provides finance for these.<br />
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Obviously everyone has their <a href="http://www.aerocas.com/" target="_blank">favourite unnecessary airport story</a>, and it is clear that during the boom years there was massive and irresponsible overspending. But it is important not to get carried away with all this. In a way I don't consider either the regions or the town halls to be the big culprits here. They are victims in the same way many ordinary Spaniards are. That is to say they are the victims of their own ability to borrow and spend during the good times without thinking about the future.<br />
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But they are not the big players in the Spanish story, and the issue in Spain is mainly in the private and not the public sector. Public debt is rising uncontrollably because the economy is bust, which is very different from, say, Greece, where the economy is bust because government debt is rising uncontrollably.<br />
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On the other hand I do think the way the Partido Popular are leveraging the regions' situation is interesting, along with the growing power-elbowing going on inside the PP itself. President of the Madrid Autonomous Community Esperanza Aguirre - a leading figure on the right of the PP, and a key actor in the background to the Caja Madrid/Bankia saga - has been out and about of late, campaigning for more centralisation. Now this - given her declared ideology - was not surprising, what was surprising was what she wanted to centralise - education, health and justice. What she didn't want to do was abolish 15 of the 17 regional parliaments, which is one of the things many observers consider could help. There is duplication of politicians all across Spain, and not all Spain's regions have a separate national identity like the Catalans and Basques do. Letting these latter two retain their poitical autonomy while centralising the rest of Spain would seem like national minority favouritism to the majority of Spaniards, so it is seen as politically undoable. But if a government had sufficient will it could happen. The UK has a decentralised health service without the need for so many parliaments, and it seems strange to me that someone wants to leave the parliaments and centralise health. Only Wales and Scotland have parliaments. Does anyone else smell a political agenda being advanced here?<br />
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The same thing goes for many of Finance Minister Montoro's proposals. Most of them are perfectly reasonable as techniques for getting spending in hand, but they end up leaving me with the feeling that he is just itching to get inside Andalusia (controlled by the opposition PSOE) and Catalonia (where the government is lead by the nationalist party CiU) and start laying the law down. Since some of the worst cases of extravagant overspending have been in regions contolled by the PP itself (like Valencia, which nearly had to go bankrupt around Xmas) it will be interesting to see just how impartial his actions are at the end of the day. <br />
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But the key point to "get" is that Spain's regions have a spending problem due to the competences they have - like heath, education and care of the elderly - which account for over 50% of their budgets (in Catalonia this year they amount to nearly 70% of the total). It isn't simply a question of them being spendthrift in these areas, but rather it is Spain's demography that is working against them. A growing elderly dependent population - ten years from now Spain could be the oldest country on the planet - means the health budget rises every year (possibly by 3%) just to offer the same level of care, while the recent influx of immigrants pushed up the birth rate and lead to more demand for education. This latter phenomenon, while being one of the keys to the solution in the long run, only adds to the country's problems in the short term since the dependent population is rising at both ends of the age scale. Now the crisis has once more reversed the birth trend, and new intake at the infant level fell last year for the first time in a decade, but it will still be another decade before the knock-on effect works its way through. Leads and lags in demography are much longer than in normal economics. <br />
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So the problem is not the regional structure, arguably this is a much better way to organise service provision, but entitlement, which is often decided at the national level, and which is often derived through rights guaranteed via the country's constitution. Central government passes laws, which underfunded regions then have to pay to implement. Take the new Care Law, which ratings agency S&P's warned in 2010 would lead to growing pressure on regional finances. This provides entitlement to assistance in the care of an elderly dependent relative or disabled person, it provides entitlement but it does not provide funding, which the regions have to find from their already overstrained budgets. And this is the main complaint you will hear from the regions, that they are systematically underfunded in a way which makes central government deficit figures look a lot better, and their's a lot worse. This is one of the key reasons that Catalonia is pushing for its own tax agency, so that it can raise the revenue itself - as the Basque region already do - and then forward to the central government what is agreed to each year.<br />
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So central government also needs to be more responsible. Spaniards have been lead to expect world class health care, and while this was possible during the boom years, it isn't now, given the economic slump and the growing demographic headwinds. But someone has to tell Spain's voters that their pensions, health support and aid for their elderly relative is going to be reduced, and since no one has the courage to come forward and do this we have the "regional overspending" issue on the table.<br />
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<strong><span style="font-size: large;">Austerity Weariness In Spain?</span></strong><br />
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I think austerity and why it is necessary is largely misunderstood in Spain. No one likes pain, and it is nice to think that there is a way out of all this that is relatively painless. The fact that the insistence on austerity comes from Germany adds to the problem, since it only serves to highlight a religious fault line that has long divided Europe.<br />
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Next Tuesday will be the first anniversary of the foundation of the 15 May movement (known colloquially as the "indignados"), and young (and not so young) people are demonstrating this weekend in cities all across Spain. There are no burning rubbish containers for the international press to photograph and the marches are largely pacific and earnest in their expectations. My feeling is that they are quite similar in composition to the supporters of the Greek Syriza movement, who did so well in the last elections in that country. And with the Bankia scandal ricocheting around Spanish public life, and the government unable to identify anyone especially responsible for the mess, anger and indignation is growing even among the PPs own supporters, many of whom were enticed into buying Bankia shares. <br />
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Part of the problem is that this situation has all become so complex that it is hard for people to understand. There is the Euro, the developed economy debt, the rise of emerging markets,China and, just to confuse things further, plummeting house prices. There is little in the way of employment opportunities, and young people are being forced to leave in growing numbers and look for work abroad. To cap it all, <a href="http://www.bloomberg.com/news/2012-05-10/lights-go-out-in-spain-as-cuts-plunge-highways-into-darkness.html" target="_blank">Spaniards are now having to drive along their motorways at night in the dark</a>. "Who turned the lights out" is the question they are increasingly asking.<br />
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Naturally arguments and countearguments abound - would, for example, Eurobonds hep? Some say they would, while other experts are totally opposed. The dividing line between political opinion and technical expertise has become totally blurred. The layman or woman has no way of making a decision over many of the issues presented. What we do know, however, is that popular sentiment will eventually tire of making sacrifices and seeing no progress. This is the key factor which makes me fear demagogic outcomes.<br />
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The situation in the United States is often contrasted with that in Europe, but it is far from clear that the US economy has actually recovered. This is an election year, and double digit deficits are still permitted, but what about next year? Somehow I doubt even the United States will be able to avoid its own share of austerity. <br />
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The recent general strike was understandable on the one hand, people are feeling frustrated, and sense that austerity alone won't work, but on the other the idea that the answer is more government spending also isn't too convincing. Japan has had expansionary fiscal policy for over a decade now. We have seen little in the way of sustainable economic recovery there, but we have seen a huge explosion in government debt. Is that an advisable path to go down? Is Japan stable in the longer run? There are too many questions lurking here to buy the simplistic solutions. Once you strip the anti-austerity arguments down, they are based on an idealisation of the US and Japanese experiences. <br />
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<strong><span style="font-size: large;">So Where Are The Long Run Solutions?</span></strong><br />
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Well, my opinions on the solutions front haven't changed much in recent weeks. The scenario <a href="http://www.scribd.com/doc/87576916/Wolfson-Essay-Revised" target="_blank">I outlined in my Wolfson prize submission</a> is still my baseline expectation. I think there are no perfect solutions, we are in the midst of a huge demographic transition which compounds the debt crisis due to its impact on population pyramids, on growth rates and on what is sustainable and stable in the longer run in terms of public spending. The Euro is not the root of the problem - which affects all developed market economies to a greater or lesser extent - but it is certainly an aggravational element. That is to say, the countries on Europe's periphery could be a lot more effective in confronting the problems they face if they weren't in the Euro, but they are, and we need to live in this world, not some imaginary one that would be a lot nicer. Leaving the Euro would be an option if it could be consensually agreed, with a sharing of the collective losses, but this isn't going to happen, since core Europe won't agree.<br />
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On the other hand, the austerity measures are dividing Europe down the middle, and the continents democratic foundations are being shaken. <a href="http://www.reuters.com/article/2012/05/12/hungary-protest-idUSL5E8GC24B20120512" target="_blank">Hungary is an even clearer example than Greece</a>. <a href="http://business.blogs.cnn.com/2011/09/22/dr-strangelove-and-the-euro-doomsday-machine/" target="_blank">The Euro is a kind of Doomsday Machine</a> which is neither stable in itself, nor can it be dismantled. As I have often said, whom the gods would destroy they first make mad. Funny how that is a phrase which has its origins in Greek literature.<br />
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Having said all of that, we here in Europe could be doing much better than we actually are. A common fiscal treasury and joint and several Eurobonds on their own won't entirely resolve the difficulties countries like Spain find themselves in - due to the existence of the competitiveness and growth problem - but both of these certainly would help. Another alternative would be a structural change in the Eurozone - <a href="http://www.economonitor.com/edwardhugh/2011/08/15/going-dutch-one-possible-solution-to-the-euro-debt-crisis/" target="_blank">dividing the Euro in two</a>, for example. But, anyway you look at it, losses need to be crystalised, and shared, and hard core Europe isn't ready or willing to talk about this. And so we head for disaster.<br />
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While the attitude to Eurobonds could change following elections in France and Germany this year and next, I am not optimistic that the changes will move fast enough and deep enough to bring that much needed relief. And meantime the "high noon" moment is fast approaching in Greece.<br />
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Democracy is coming under threat along the periphery as people become steadily more and more frustrated and search for alternative "unorthodox" policies that can offer a miracle cure. As <a href="http://www.nytimes.com/2012/04/16/opinion/krugman-europes-economic-suicide.html" target="_blank">Paul Krugman said in a New York Times Op-ed recently</a>, "The question then was whether this brave and effective action (the ECB LTROs) would be the start of a broader rethink, whether European leaders would use the breathing space the bank had created to reconsider the policies that brought matters to a head in the first place. But they didn’t. Instead, they doubled down on their failed policies and ideas. And it’s getting harder and harder to believe that anything will get them to change course". <br />
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<span style="font-size: large;"><strong>And Whither Spain?</strong></span><br />
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In the Spanish case doing a bank recapitalisation which wasn't just based on working back from the number the country could manage to fund unaided would help a lot. The bank balance sheets need freeing up so the commercial banks can go back to their more normal activities, and help that part of the company sector which is able to grow and create employment. A large sum of money needs to be injected, and this can only come from a common European effort. Having the Bank of Spain accept two external valuations of bank assets and likely losses under a variety of scenarios is a step in the right direction. Having European auditors installed inside both the Ministry of Finance and the Bank of Spain would be another, given the doubts which have been raised about how Spain packages sensitive data for public consumption. Europeans who put their money in need some sort of guarantee about the effectiveness of implementation.<br />
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On the political level, Mariano Rajoy's leadership is obviously wobbling. This was always coming, but I hadn't seen it happening so quickly. But then I hadn't forseen the mediocrity of the present Spanish administration, and <a href="http://www.economonitor.com/edwardhugh/2012/01/22/a-month-in-spain-that-didnt-shake-the-world/" target="_blank">the difficulty they would have speaking with one voice</a>. The latest performance surrounding the Bankia crisis, with Rodrigo Rato saying one thing (that he was forced to go) and Luis de Guindos saying another (that he wasn't) <a href="http://economia.elpais.com/economia/2012/05/11/actualidad/1336762069_549716.html" target="_blank">while the government have still not "detected any reprehensible behaviour" in the whole affair</a> simply serves to underline the country's lack of credible leadership - a factor which only makes Europe and the markets even more nervous. Manuel Arias Maldonado, politics professor at the University of Málaga summed the situation up in a quote in a Financial Times article recently, “<a href="http://www.ft.com/cms/s/0/21c83a62-857f-11e1-90cd-00144feab49a.html" target="_blank">There’s no single voice explaining clearly to the citizens what’s going on</a>,” he told Spain correspondent Victor Mallet, “I think Rajoy lacks the qualities needed for this job – to be self-possessed and clear, and to transmit the confidence that is needed now.”<br />
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Basically this administration has easily excelled the last one in its ability to contradict itself. Perhaps the best recent example was that of Jaime Garcia-Lehaz, Secretary of State at the Economy Ministry, calling for ECB intervention with bond purchases almost exactly the same time as <a href="http://www.ft.com/cms/s/0/21c83a62-857f-11e1-90cd-00144feab49a.html" target="_blank">Mariano Rajoy was in Poland arguing that Spain could manage on its own</a>. “Talking about a rescue makes no sense", he told his audience, "Spain is not going to be rescued, Spain can’t be rescued. There’s no intention, and no need and so Spain will not be rescued.”<br />
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The bickering between PP aparatchick and Finance Minister Cristobal Montoro and the far more independent Luis de Guindos has been constant, and the big fear investors have is that the Economy Minister is not able to carry through the sort of financial reform he must be able to see Spain needs due to his being overruled by the Finance Minister, who is much more sensitive to what accepting a bailout and injecting public money into the financial system would do for his party's electoral outlook. <br />
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Again <a href="http://www.economonitor.com/edwardhugh/2012/01/22/a-month-in-spain-that-didnt-shake-the-world/" target="_blank">arguing in public about the actual size of last years deficit didn't help</a>. But surely the turning point in the perception of this government came when Mariano Rajoy went to Brussels to give press conference asserting his country's sovereignty and his ability to decide his country's budget for himself. The irony, of course, was that he was in the EU capital to sign an agreement for greater cooperation between Euro Area member states, and he completely omitted to inform his peers of his intentions, thus highlighting the ineffectiveness of the measures being agreed to. The end result was to put in question both his abilities and judgement and the capacity of his country to fulfil its deficit targets. Since that day he has been fighting hard to recover lost ground.<br />
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Previously my hopes would have been on what people in Spain call a new version of the <a href="http://www.google.es/url?sa=t&rct=j&q=pactos+de+la+moncloa&source=web&cd=1&ved=0CHgQFjAA&url=http%3A%2F%2Fes.wikipedia.org%2Fwiki%2FPactos_de_la_Moncloa&ei=0YmvT_fNIIaw0QXohZyZCQ&usg=AFQjCNFeBkTmiyQ2WrV3XKv2s3JtJclTOw" target="_blank">Pactos de la Moncloa</a>, these were the agreements reached between all Spain's political parties and social partners in 1977 (with the King playing a decisive intermediating role) and laid the basis for the framework of the new Spain following the ending of the Franco dictatorship. I say previously because, apart from the apparent absence of anyone with the calibre and moral authority to lead the country in this difficult moment, <a href="http://www.dailymail.co.uk/news/article-2131587/Spanish-King-Juan-Carlos-apologizes-Botswana-elephant-hunting-safari.html" target="_blank">a recent unfortunate accident in Botswana</a> has effectively ruled out one of the key participants.It is hard not to get the feeling that Spain is "jinxed" right now, especially with <a href="http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/telecoms/9253321/Argentine-Spanish-trade-row-escalates-after-Telefonica-fined.html" target="_blank">Cristina Fernandez also deciding now is a good moment to start a vendetta with the country</a>.<br />
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<span style="font-size: large;"><strong>If at first you don't succeed................</strong></span><br />
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In the meantime, this is now the fourth attempt at financial reform since the crisis started, and it surely won't be the last. “All the previous efforts have been announced with a drumroll and a big clash of cymbals but they weren’t credible in the end,” Javier Diaz-Gimenez, an economics professor at the University of Navarra’s IESE business school in Madrid <a href="http://www.bloomberg.com/news/2012-05-10/spain-stakes-credibility-on-fourth-bank-cleanup-in-three-years.html" target="_blank">told Bloomberg news</a>.<br />
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Dare I say it, the current proposals run the risk of suffering the same fate as all the earlier ones. There is a difference though, previous reform efforts had been based on working backwards from the level of provisioning the banking system could provide without breaking it. This one is based on a reverse engineering calculation about how much provisioning the Spanish state can afford to support without going to Europe for help.<br />
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What is needed now, however, as Europe's leaders are demanding, is a full, frank and independent assessment of the true extent of the provisioning needed to withstand a realistic shock scenario - real estate prices hitting 2002 levels and staying there, unemployment over 20% till the end of the decade, Spain's population falling by 2 million young people as they leave due to lack of work, etc - and then go and get the EU to provide the funds needed - under conditionality of close and constant EU inspection of Spain government and Spanish bank numbers, this is the only way to now get credibility back, and this way Spain could really demonstrate it is making the progress it claims to be making.<br />
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As a friend of mine said to me yesterday, the goalposts are moving, and that is good, but they still have some way to move yet awhile. Simply allowing Spain's reform efforts to degenerate into a debate between PP and PSOE about who is more responsible for the Bankia mess - Mariano Rajoy and Esperanza Aguirre (PP leaders who put Rodrigo Rato at the front of Caja Madrid) or Bank of Spain governor Miguel Angel Fernandez Ordoñez (a card carrying PSOE member, and former aide to Pedro Solbes in the 1990s) is a childish and stupid waste of time. All of Spanish society is somehow implicated here, since almost everyone either actively or passively (by not allowing themselves to see what they should have seen) has participated in the charade. Blimey, only a couple of months ago the Spanish press were even leading their readers to believe that BBVA in buying Unim were grasping a good business opportunity. And almost everyone was trying to argue that Spain is not Ireland, let alone Greece. Time will tell, but the bank numbers now look more and more like Ireland, while the statistical issues increasingly resemble Greece, even if the difference between Spain and Greece is that Spain's bankers and politicians do know perfectly well what they numbers are, they simply don't want to admit them in public.<br />
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Going back to gum and chicken wire, I remember reading in the report on the Three Mile Island nuclear accident, that in the run-in to the problem maintenance had either been neglected or was completely ad hoc. The archetypal example for this was the discovery that a hole in a cooling pipe had been plugged using a basketball. There you go Mr de Guindos, that's the missing link in your chain of half-thought-out botched jobs, go find a basketball!<br />
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This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0