We now have the May 2008 data from the Bank of Spain, and as we will see, in each case they continue to slow. But first, why do I say "the most important charts". Well simply because they sum up the core of what the problem is in a very simply nutshell. The Spanish banks are struggling to find liquidity, and as a result they are unable to maintain the pace of lending expansion to individuals and to households that they previously could. This is what is provoking the severity of the problem, and in comparison with this everything else is a mere detail (although of course some of the details will soon be becoming big problems in and of themselves). Basically, as we know, more houses are still being built this year than ever. So construction at this point hasn't slowed that much. The thing is though the builders are accumulating unsold homes (which will soon be passed on to the banks as the builders go bust one by one), since individuals don't have acces to sufficient mortgage finance to buy them.
Thus the rate of new lending to households has been dropping steadily:
And then we see that corporate Spain is having the same problem, which is why so many people are busy out there trying to sell subsidiaries, and such like, since they are having problems borrowing sufficient money, and of course sales and profits are now steadily going down.
Now if we look at the next chart, you will see that Spanish companies and households are much more indebted than their average eurozone neighbours, and companies especially - at around 120% of GDP.
Now you might say, well isn't it a good thing that all this is slowing, since so much lending and debt was hardly healthy? And I would have to agree with you. But nothing is so simple, since after so many years of debt indulgence the economy is badly structurally distorted, and relative prices are way out of line with most competitors, so as domestic consumption drops exports can't take over and down the whole edifice comes.
Those of you who can speak Spanish can probably read Italian too, and I just found this comment from one of the readers of this blog on an Italian financial forum:
"L'euro ha ucciso (finanziariamente parlando) la Spagna: una moneta troppo forte, ed un tasso di interesse troppo basso, hanno distorto il mercato del credito, provocato una colossale bolla immobiliare, finanziata con capitali esteri che adesso non arrivano più o peggio stanno tornando da dove sono venuti. Inoltre, visto che la politica monetaria si fa decide a Francoforte, e non a Madrid, la BC spagnola è totalmente priva di mezzi macroeconomici per fronteggiare la crisi bancaria:"
I don't know about the idea of hiring people to give economics classes to Zapatero, but if they are looking for someone, this guy gives effectively a master class in one short paragraph. What he is really saying is that the absence of independent monetary policy meant you had no way to stop yourselves going up, you were simply shot out of the cannon, and now you have no way to stop yourselves coming down just as quickly as you went up. I remind everyone: interest rates at the ECB just went up, not down, and deflation - and possibly a very whopping dose - not inflation, is about to become Spain's problem.
4 comments:
Hi Edward,
do you really think that deflation will bring really prices down (like loaf of bread, tomatoes, restaurants...) How long you think that might take? That would require the whole production/sale chain to be priced down, which is obviously their last wish (not for the consumer claro!). Although deflation would also also lowering down salaries accordingly. Why is that such a bad thing in economic terms? If we aggree that Spain is clearly overpriced, why can't one argue that this would be just a correction to normal trends? That what markets tend to do in the medium term, don't they?
Thanks and Regards
Jaime
Hola again ;)
I forgot this comment
Also, i see in the graph that Bank lensing to households, even slowing down, is stil growing at 10%! Growing at 10 seems a lot to me. From 10% to grow at 0% there is stil a lot to go down, and maybe the credit crunch will not get much worse (or will it?) WHy are not we seing already a negative growth on year over year banking to households?
Regards
Jaime
Hi Jaime,
"Also, i see in the graph that Bank lensing to households, even slowing down, is stil growing at 10%! Growing at 10 seems a lot to me."
Well I try to address this a little in the post, since it is a key point. Economies can only grow in either on of two ways, via internal demand or via exports (investment in plant and machinery is secondary in tyhis sense, since the investment only makes sense to meet the needs of an internal or an external market).
Now Spain has been internal demand driven, with a HUGE (11% of GDP) external deficit.So it needed household lending at 20% y-o-y rate of increase to get 4% GDP growth (and a massive migrant entrance to provide the workforce, plus the finance from the cedulas to make it possible, and energy from the exterior).
That is Spain's natural growth capacity was nowhere near 4% a year. Self sufficiently the growth would be much less, and even keeping your head above water would need to finish all these early retirements immediately, and to get many more people working up to 65 and above. The migrants have basically been subsidising a very low retirement age, and that is now about to change.
Now... the proble with people who live on a strong dose of heroin is that you simply cannot turn off the supply from one day to the next, you need methodone.
10% is still a strong rate, but look at the economic damage which is already happening, so imagine what will happen if at some point we hit zero, and before the adjustment - which will need several years - has taken place. Also remember that 5% of the present growth is to cover inflation, so in real terms lending is only growing at 5%.
What we need to find here is a smooth transition path, not a sudden break.
"do you really think that deflation will bring really prices down (like loaf of bread, tomatoes, restaurants...) "
Well look, food and energy are two things which are going to be hard to predict, since if the emerging economies keep growing while the advanced ones enter stagflation, then we don't know how high inflation will be on these items. But on all the rest, yes: prices are going to have to fall, and probably sharply, becuase overcapacity is going to be significant, and without reducing prices you cannot sell abroad. So prices and wages both coming down, this is what I see.
"Why is that such a bad thing in economic terms? If we aggree that Spain is clearly overpriced, why can't one argue that this would be just a correction to normal trends?"
Of course it is a good thing, since if both wages and prices fall peoples living standards remain the same. Except.....
the people with debts. People who bought house with highly leveraged mortgages made a basically unhedged bet that prices were going to keep on rising to burn off the debt. That bey has just been lost.
So a lot of people are going to be hopelessly in debt, and again, but lets deal with one thing at a time, the government will need to do something about this. The banks will need to take a substantail "haircut" on the book value of their mortgages. But they cannot do this and refinance the cedulas at the same time, otherwise they will be doubly broke. You see, there is method in edward's madness :).
This is why all of this needs to be done step by step. The plan I have advanced is viable at this point, if Brussels is ready and willing. My guess is that in 3 months it will already be too late for this, and one or other of the firewalls will break, and we will move on to much bigger things. At that point the plan will need reformulating, and so on.
The think is, inflation favours borrowers and harms lenders. That is why everyone was so happy in Spain to be in debt, have inflation, and borrow the money from foreigners. This is normally a third world problem, but the eurozone, and investment grade rated mortgage backed securities have brought it right to the heart of Europe.
Keynes and Irving Fisher famously studied these problems, especially Keynes in his tract on monetary reform. This then led us on to Franco Modilgiani (he would be an Italian, wouldn't he), and the question of "inflation illusion".
Basically falling prices increase debts (this has been Japan's problem) and are good for savers, providing the borrowers don't keep forcing you to accept haircuts. I mean, all those young people are going to have to pay increased mortgages with lower salaries: those of them that have jobs that is.
The problem is really inflation.Superlow interest rates in Europe and USA has generated inflation wawe, which is cuurntly entering price-wage vicious cycle. Inflation is rising everythere and Central Banks are passing the buck! A la Chinese demand. Inflation cycle need to be broken . ECB should rise rates 5-6% and start deflating inflation bubble,otherwise a years time we have to use double digit price rises in Europe.
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