Wednesday, February 04, 2009

The (Credit) Drought In Spain Falls Mainly On The Plane

Maybe many people outside (or even inside for that matter) Spain didn't especially notice the fact, but last Sunday's Barça match with Racing de Santander did not go out on regional TV as planned. This caused a few eyebrows to be raised among football supporters and commentators, but little in the way of serious analysis or comment. But the reason the match wasn't broadcast is perhaps rather more interesting than many imagine, since behind Saturday's blackout lies a dispute between the Catalan regional TV station and Barcelona football club which goes well beyond that sport where 22 able bodied men run up and down a pitch for 90 minutes and the Germans always win. The details of the present dispute are obscure, and this is not the place to go into them, but the nitty gritty is that Barça are asking local channel TV3 for 30 million euros, and the TV people quite simply aren't coughing up. Which is in itself unusual, since it wasn't all that long ago that the then President of the Spanish government, José Maria Aznar, was arguing that football was a question of national strategic interest in Spain. So it is clear (to me at least) that TV3 would pay (at least part of the quantity being asked for) if they could, but they obviously can't. So why can't they pay? This is when it all gets interesting, I think.

Basically, and to cut a long story short, the reason will be that the Catalan regional government, who ultimately pay for the station, and see Barça as more or less the national side we don't have, can't give them the funding they need. And why can't they do this? They can't do it because they themselves don't have the money to do so. So why, then, don't they have sufficient money, we may ask, innocently. Well they don't have enough money because the central government isn't sending money through to them in large enough quantities to meet their spending needs, and the central government isn't sending it since they themselves don't have the money to send, etc etc etc. The drought starts at the top of the mountain and then gradually works its way down to the plane.

So the liquidity drought (which starts in the centre) works its way all the way back up the tubes till it reaches the end of the line (the most peripherical points) and then when you open those taps, the water simply does not flow out, or if it does it is more a trickle than a flood. And the centre is having problems, as we saw in the case of yesterday's €7bn 10 year treasury bond auction (Tuesday) which produced a Spanish yield differential jump at its highest level since the euro came into existence - 137 basis points above the equivalent German Bunds. More ominously, foreign investors were notably absent, leaving Spanish banks to soak up the debt. Which makes all that nonsense Spanish people have been seeing on their TV screens this week about how the banks are not lending enough to households and businesses seem even more ridiculous, since it is the needs of the government itself which is increasingly "crowding out" all the rest.

Now going back to the foorball blackout, normally Spain's regional and municipal governments would plug their funding gap by borrowing, and by doing so from the regional cajas, but of course these entities are precisely among the worst affected by the credit drought, and they themselves are running out of money, and totally dependent on short term funding from the ECB for their immediate liquidity needs. So the bottom line is that people are becoming less and less willing to extend credit, and especially to "bad payers" like the local and regional governments, as we can see in the Barça case.

Another minor but revealing anecdote about all this came my way yesterday afternoon, when a friend of mine who works for the municapal authority in one of Barcelona's "sattelite towns" told me she had just had a frustrating day trying to buy a ticket for a trip to Brussels (you know, to sign something, and appear in the photo) for one of their civic dignitaries. Now the travel agents were quite happy to make the reservation, and prepare the ticket. What they were not willing to do was hand it over. As they said to her "I'm afraid you can only have it after you pay". She was bemused by all this - it isn't really her job to do this kind of thing - so she went to see the responsible parties in the accounts department (the flight is the day after tomorrow) and to her amazement they told her "right now this is impossible, tell them we can let them have the money within two weeks". And you have to remember we are only talking about something like 600 euros here!

So - with budget GDP growth estimates which consistently underestimate the size of the contraction, and tax revenue falling as unemployment payments rise - little by little the money is drying up, and this isn't surprising, since Spain can't print its own euros, and so, given the difficulties of borrowing them externally, liquidity becomes very, very tight. Not desperately so yet, but tight. But it is obvious that if things carry on like this we will begin to see a gradual grinding to a halt of the public sector, and all those "functionarios" and pensioners who have so far been very carefully protected from the crisis will find themselves more exposed to the full force of the crunch.

All of which made me think of Argentina, and the weird and wonderful exotic instruments which they invented in their time of need, like Patacónes, Lecops, Créditos and Argentinos (see appendix below). These were all forms of quasi money (or glorious IOUs) that the local government entities in Argentian issued in a series of ever more desperate attempts to continue paying public employees out in the regions before default finally became inevitable.

Of course, there is another way to go here, we could decide to reduce prices and salaries in the public sector (ie internal deflation as an alternative to devaluation), and bring the budget more back into line with Spain's ability to pay. This is what they seem to be doing in Ireland, although, even there, the prime minister allegedly threatened to call in the IMF if the public sector unions failed to agree on the spot to a five percent salary reduction.

But the debate which is going on in Spain about the current crisis is still light years away from the country's rapidly evolving reality, so the question which keeps going round and round in my head is: just how long will it be before some crazy politician out there in one of Spain's minor autonomous communities starts proposing to issue regional IOUs/quasi money of the Argentinian type. If and when this does happen, then we will know that the end is well and truly begining (ie that the point of no return has been passed), and if you like we could treat such a hypothetical event as an early potential indicator of impending disaster.

Obviously I hope such a day will never be reached, and that Spain's political class will finally se the light before it is too late, but the following statement by the "semi-serious" Spanish politician Miguel Sebastian - which to my mind comes straight out of the Argentina playbook - makes me very nervous, and leads me to think that that horrid day may be a little bit nearer than I had actually imagined, and that, even worse, we may not only be talking about minor regional politicians.

The Spanish government is losing patience with the failure of the country's
banks to provide credit to the economy and could take measures, the industry
minister said on Tuesday in remarks quoted on local media. "The government is
losing patience with the banks," Industry Minister Miguel Sebastian told Antena
3 television, according to newspaper El Mundo. "We're going to keep an eye on
them and will act accordingly if the banks don't do their bit."

No serious politician can threaten the banks in this way and hope to maintain investor confidence. Maybe even more worrying is the fact that Zapatero has not already "corrected" him. This kind of statement is a declaration of weakness and not one of strength.

And this is not the first such "faux pas" we have seen from Sebastian, since only last week he was arguing that Spain urgently needs to cut its imports (not increase its exports) to correct its trade deficit. "There is no other country in Europe with such a significant and urgent need to reduce its imports," Socialist Miguel Sebastian wrote in an article in right-of-centre daily La Razon. Wrong Señor Sebastian, "there is no other country in Europe with such a significant and urgent need to increase its exports and make its domestic industry more competitive so it becomes more attractive to buy domestically produced products". Not only are Sebastian's arguments pathetic, they are also dangerous in a year when the International Labour Organisation estimates a minimum of 50 million people will lose their jobs globally. And as well as being pathetic and dangerous, they also end up in absurdity. Do Spain a favour everyone, keep reading the Financial Times!

"Right now," Mr Sebastián said, "there is something that our citizens can do for their country: bet on Spain, bet on our products, our industry and our services - bet, in short, on ourselves." Consumption was ex-pected to fall by €7bn (£6.6bn) this year, with the loss of 120,000 jobs. If each citizen bought just €150 of Spanish-made suits or toys instead of foreign goods, those jobs would be saved. "In other words, you could cancel a subscription to the Financial Times or the Wall Street Journal instead of cancelling Expansión or Cinco Dias".

Appendix: Forms Of Quasi Money Proposed in Argentina in 2001

The following descriptions (which all come from Wikipedia, as linked above) refer to a variety of local bonds and other instruments issued or planned in Argentina in 2001, after the last IMF loan in January and before final default in December.

The Patacón (officially called Letra de Tesorería para Cancelación de Obligaciones de la Provincia de Buenos Aires) was a bond issued by the government of the province of Buenos Aires, Argentina, during 2001. The patacones were used to pay government bills, including state employees' salaries during a period when the economic crisis caused regular currency (Argentine pesos) to be scarce. Patacones then circulated in the economy in much the same way as pesos.

First issued during the peso/U.S. dollar convertibility regime, just like other complementary currency Patacones could be attractive due to a revenue scheduled for payment in 2003 in pesos (practically equivalent to dollars). When the convertibility was abandoned amid fears of hyperinflation, the attractive of this revenue practically disappeared. The basis for the acceptability of complementary currency shifted to their use to pay taxes.

However, the value of Patacones became eroded as the series "B" was issued because as a way to put pressure on the Government to cancel a large debt, the company that printed them eliminated many safety features deemed too expensive, thus making them easier to counterfeit. Also, the revenue of series "B" was scheduled for payment just in 2006. The economic importance of Buenos Aires province ensured the acceptability of Patacones because there were plenty of large companies that found use for them as payment of provincial charges. Patacones were accepted outside the Buenos Aires province and eventually circulated (albeit informally) in border areas of neighboring countries.

The name patacón is derived from a former Argentine national currency. It was colloquially or jokingly used as a synonym of "money". The popular comic hero Patoruzú had revived the use of this word -a wealthy, generous Indian ever ready to hand large heaps of bank notes to anyone in need, urging them to accept "these Patacones".

The LECOP was a bond issued by Argentine national government. LECOP (sometimes written as a common word, Lecop), stands for Letra de Cancelación de Obligaciones Provinciales ("Letter of Cancellation of Provincial Obligations").

These bonds were circulated at a substantial discount from their face value, so anybody accepting was bound to experience devaluation (or inflation). While LECOPs were intended as a means to replace legal currency (Argentine pesos) at a time when cash was scarce, there were occasions in which LECOPs were not accepted as valid means of payment — most notably, most taxes could only be paid in pesos, or only partly paid in LECOPs. Public utility companies generally restricted the percentage acceptable to a 70-30 ratio, sometimes further limiting LECOP usage to 15% of the total bill.

The Crédito was a local currency started on 1 May 1995 in Bernal, province of Buenos Aires, Argentina, on a garage sale, which was the first of many neighbourhood barter markets (mercados de trueque) that emerged in Argentina during the economic crisis.

The operator of this currency was the Red Global de Clubes de Trueque Multirecíproco (RGT), literally "Global Network of Multi-Reciprocal Exchange Clubs" or more simply the "Global Exchange Network" (GEN).

The currency started as a Local Exchange Trading Systems (LETS) system but was soon replaced by a number of printed currencies and, after further experimentation with a LETS called nodine (from no dinero, "not money"), finally became the Crédito, a printed currency again.

The RGT was organized as a chaordic network of barter clubs, which had a clientele from a well educated middle class that had fallen into unemployment during the Argentine recession of the late 1990s.

The clubs of the RGT had no central organ, no central administration and no legislation. Clubs decided for themself to accept the Créditos of other clubs and not all clubs issued their own Créditos. Clubs that did usually issued between 30 and 50 Créditos per participant. In a later phase some of the clubs joined zones or networks and zones became the issuers of Créditos instead of individual clubs. The chaordic structure allowed the system to grow quickly but also left the system vulnerable to fraud.

The Crédito was an interest-free currency and was pegged to the Argentine peso, which in turn was pegged to the U. S. dollar at the time. An estimated $400 million in goods and services were traded in 2000. A survey conducted by members of the economics department of Harvard University reports a personal exchange rate of about two Créditos for one peso during 2002-2003 by individuals who offered goods or services in both currencies. [2]

By July 2002 the unemployment rate in Argentina was in excess of 20% and approximately 7% of the population participated in the RGT. Argentina had already had a high unemployment rate of about 17% for six years previously.

The system was used all over Argentina and worked reasonably well for a time but, as things worsened in the formal economy, more and more people joined the RGT clubs, and a growing percentage of people spent their Créditos without offering sufficient skills or trade in return. The system suffered from hyperinflation and from counterfeiting. Between 2002 and 2003 the government made unemployment insurance available to 2.5 million people, compared to 0.2 million people previously, and thereby increased the availability of the peso to the population stratum using the Crédito, which had an 89% preference [3] for Pesos over Créditos.

The Argentino was a complementary currency in Argentina announced by then-president Adolfo Rodríguez Saá on December 26, 2001 towards the end of the Argentine economic crisis, but he resigned on December 30, 2001 and this plan was never implemented.


toronto condos said...

Long but interesting reading. I have a question: why would be the introduction of so called quasi-money in Spain the point of no return? Take care,

Edward Hugh said...

Hello Julie,

Well basically Spain has already had one credit downgrade (not very important, but it is a start). This year the deficit could be around 9% GDP on my estimates (I am expecting a rather stronger contraction than consensus analysts), say 5%), then we will see another one in 2010, after that the downgrades will come thick and fast.

In 2011 the big defaults will come, and large private sector and bank refinincing issues will arrive. So either the EU issue collective bonds, or Spain gets onto a default inevitable course.

The issue of quasi money would be like having a dual system, with one foot out of the euro zone, it would also be an attempt to maintain fiscal excess in the face of unsound fundamentals. This only ever ends one way. Especially if you have a large current account deficit too.

These kind of things only happen once people get desperate, and if you are desperate and don't take sound measures then things simply go from bad to worse.

Basically we would see a flight to euros, with people hoarding ever more of the things (remember at this point we will also have price deflation), and the crisis of euro liquidity would simply get worse and worse, as is happening with ruble liquidity and dollars in Russia now. Looks to me like there is a pretty strong chance of Russia having to default again this year or next.

This is all very complex, and obviously I am building in a lot of assumptions that many won't accept, but none of this is implausible, not with what we have already seen.

CCz said...

Very interesting reading. Being Portuguese I see our "backs" when I look to our Spanish neighbours "backs".
We too are also ruled by politicians used to spend and spend and spend.
Take care.

toronto real estate said...

Hello Edward,
Thank you for your explanation. Let me summarize to see if I got it right: if Spain does choose the path of quasi-money, it will lead to leaving the EURO zone, right?

Is there any other country in similar risk?

Thanks, Julie