tag:blogger.com,1999:blog-39501272024-03-14T05:44:48.400+01:00Euro WatchFollowing The Eurozone EconomyUnknownnoreply@blogger.comBlogger771125tag:blogger.com,1999:blog-3950127.post-40123734565659690012014-09-20T12:45:00.002+02:002014-09-20T12:45:33.424+02:00The Japanisation Of EuropeBy now it should be clear that the monetary experiment currently being carried out in Japan (known as “<a href="http://www.amazon.com/dp/B00L4KTLDM">Abenomics</a>”) is fundamentally different from the kind of quantitative easing which was implemented in the United States and the United Kingdom during the global financial crisis. In the US and the UK QE was implemented in order to stabilize the financial system, while in Japan, and now the Euro Area (EA) the objective is to end deflationary pressures and reflate economies which are arguably caught in some form of liquidity trap.<br />
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In particular it is hard <b>not to draw</b> the conclusion that something structural and more long-term is taking place in Japan, and that that something is only tangentially related to the recent global financial crisis. One plausible explanation is that Japan’s long-lasting malaise is not simply a debt deflationary hangover from the bursting of a property bubble in 1992 but rather with the rapid population ageing the country has experienced. If this is the case then the ongoing economic stagnation in Europe may have a lot more to do with the Japan experience than it does with the recent economic dynamics seen in the UK and the US. The reason for this is simple: Europe’s population is the second oldest on the planet after Japan’s. Certainly at first sight the similarity is striking, especially when it comes to working age population dynamics.<br />
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<b>So is the Euro Area the New "Japan"?</b><br />
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"Europe is becoming Japanese" is an expression that is being used more and more. People saying this normally point to the fact that German 10 year bund yields recently went under 1% (and hence have started to look like 10 year Japan Government Bonds).<br />
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But behind this argument lies some kind 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 bonds. In Europe, on the other hand, the ECB isn't buying Euro Area sovereigns, <b>the markets are</b> in anticipation of QE. So to talk about the Japanisation of Euro Area yields is a little misleading. Bond purchasers and their models are provoking this downward lurch, not the central bank response to weak growth or creeping deflation. To really push Mario Draghi into Japan-style QE in the short term markets would need to move back into risk-off mode on periphery assets, yet there is little appetite to go for what might potentially become another "widowmaker" trade by taking on a powerful central bank. Yet as long as the bond markets remain relatively well behaved Draghi will try to do as little as possible.<br />
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Another argument used to justify the "Japanisation" of the Euro Area idea carries much more clout, and that is the one being used by Paul Krugman based on working age population dynamics. "If you’re worried that secular stagnation might be depressing the natural real rate of interest (the rate consistent with full employment)”, <a href="http://krugman.blogs.nytimes.com/2014/08/13/whats-the-matter-with-europe/?_php=true&_type=blogs&_r=0">he told blog reader</a>s “and you think that demography is a big factor, Europe looks really terrible, indeed full-on Japanese."<br />
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Inflation dynamics in Europe also look strikingly similar to those seen in Japan (but with a 20 year lag, see chart below). <br />
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The basic idea is that working age population dynamics play a big part in determining movements in aggregate demand and hence inflation. This idea received support from a research paper published at the start of August by a group of IMF economists - "<a href="https://www.imf.org/external/pubs/cat/longres.aspx?sk=41812.0">Is Japan’s Population Aging Deflationary?</a>" The first part of the paper abstract runs as follows:<br />
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"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>
Strikingly Japan entered deflation not in 1992, but in 1997/8 at exactly the point the working age population peaked and in the EA it is happening in 2012/13 - just when EA working age population dynamics turned negative. The correlation may be just an odd coincidence, but it is striking.<br />
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<b>Not according to the ECB</b><br />
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Naturally Mario Draghi will have none of this. "I think that the situation in the euro area is quite different from what it was in Japan in the 1990s and early 2000s", he told <a href="http://www.ecb.europa.eu/press/pressconf/2013/html/is131205.en.html">an ECB press conference in December 2013</a>. He then went on to offer five reasons.<br />
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<b>Reason No 1</b>: "we have taken decisive monetary policy measures of great significance at a very early stage, even when, as a matter of fact, inflation was not at the levels at which it is today. It was way higher and way closer to 2% and this did not happen in Japan".<br />
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This<b> is the case</b>, but the vast majority of the ECB's non conventional policy measures were intended to avoid financial instability, not to provoke inflation. The measures were largely liquidity oriented not outright "money printing" ones, so they were mainly addressing the monetary policy transmission mechanism - which was broken - not the fact that the refinancing rate was stuck up against the zero bound. There still hasn't been sufficient analysis of why outright deflation didn't hit the Euro Area sooner, but a big part of the story is probably associated with the presence of excessive rigidity in wages and prices and the constant consumption tax and administrative charge increases put in place as part of the deficit containment exercises.<br />
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It is noteworthy that in Greece, for example, wage costs came down sharply a long time before the CPI began to fall.<br />
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<b><b>Reason </b>No 2</b>: "We are in the process of doing the asset quality review.......the situation in Japan lasted much longer than it should have because the balance sheets of the banking system and the private sector were burdened, and had to be deleveraged and the action to induce this deleveraging lacked for many years."<br />
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Well, maybe, just maybe, the ECB President has his timing a little bit out here. Japan's bubble burst in 1992, and the banks started getting seriously recapitalized in 1998. The global financial crisis hit the Euro Area in 2008, and the AQR - which is supposed to be the prerequisite for realistic recapitalization - is taking place in 2014. The time difference in fact seems to match. So we could also say the necessary action on the part of the ECB also "lacked for many years". Of course, banks in some of the most troubled countries have already been recapitalized once, most notably in Ireland and then in Spain in 2012. But still problems remain, which is why the AQR is taking place. Earlier stress tests have just not been realistic or rigorous enough.<br />
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In a process not too dissimilar to the one taking place at the present time in the EA Japanese banks were recapitalized to the tune of 0.4% of GDP in March 2009, and by another 1.5% of GDP in March 1999. The order of magnitude of these recapitalization is not in any meaningful sense larger than that which is taking place in the Euro Area. Following an AQR type process conducted by the recently formed Japanese Financial Reconstruction Commission non performing loans were systematically identified and banks required to recapitalize accordingly. 14.8% of GDP's worth of NPLs were finally identified, a figure not notably different from the current Euro Area one, and well below the levels prevailing in the worst affected countries like Spain and Italy.<br />
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<b><b>Reason </b>No 3</b>: "the situation of the private sector balance sheets is not at all comparable in the euro area. It is not at all comparable with what it was in Japan at that time."<br />
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I just think Draghi is wrong about this. The level of credit exposure of Japanese banks to the private sector was not *that* different from the EA one in 2008 (see chart below) and as we have seen the level of distressed lending was pretty comparable.<br />
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In effect this whole comparison with Japan in the late 1990s is a
bit flawed, since as will be recalled Abenomics was only introduced in
April 2013. The point being that Japan was still stuck in deflation up to that point (and may still be so <a href="http://edwardhughtoo.blogspot.com.es/2014/06/will-japan-re-enter-deflation-in-april.html">when the effects of the devaluation and the tax hike wear off</a>), and so it is a bit hard to pin all this on a couple of bad decisions in 1997 and 1998. Underlying structural factors are at work (liquidity trap, possibly driven by ultra low fertility) and these may be similar in both the European and the Japanese cases.<br />
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It is true that the bank of Japan underestimated the scale of the problem between 1992 and 1997, but the same sort of accusation can be brought to the door of the ECB. In both Japan and the EA measures were (and are being) implemented to help banks avoid liquidity crunches in the hope that this will encourage lending, but in neither case has (or is) this had/having any evident success. The <a href="http://www.bloomberg.com/news/2014-09-18/ecb-targeted-loans-issued-below-estimates.html">poor initial demand for TLTROs</a> being just one example of this problem.<br />
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<b><b>Reason </b>No 4</b>: "countries in the euro area have made significant progress in addressing their structural weaknesses....that’s the fourth difference between Japan in the 1990s and 2000s and us today."<br />
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Well, as Draghi himself admitted, the structural reform process in Europe is far from complete (France, Italy) and I think he also underestimates the kinds of reforms which were carried out in Japan at the time. The "lifelong employment" tradition, for example, was ended in the late 1990s.<br />
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<b><b>Reason </b>No 5</b>: "if you look at the inflation expectations in the euro area and the corresponding inflation rates you would see that in Japan the inflation expectations were dis-anchored quite significantly, and for a long period of time, which is not something we are seeing here."<br />
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This isn't exactly as straight forward as Draghi makes out either. He himself has accepted in his Jackson Hole speech that EA inflation expectations are not as well anchored as he thought they were, while on the other hand inflation expectations were better anchored in Japan than he seems willing to acknowledge (see chart below showing how 10yr inflation expectations evolved in Japan). That is to say<b> in neither case</b> did the central bank see the problem coming. (Click on image for better viewing)<br />
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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 is steadily becoming one.<br />
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<b> Postscript</b><br />
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The above arguments are developed in detail and at far 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-3950127.post-45034984027106020192014-09-17T13:58:00.000+02:002014-09-17T13:58:40.939+02:00What Is The Risk The Euro Crisis Will Reignite?The euro zone crisis is not back -- at least not yet. <br />
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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 />
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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 />
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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 />
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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 />
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Will we really have to wait till 2015 to see any significant step to try to stop the deflation rot?<br />
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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 />
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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 />
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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 />
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"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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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 />
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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."
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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 />
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<b>So Which Way For The ECB?</b><br />
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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 />
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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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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 />
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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 />
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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 />
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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 />
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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 />
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<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-3950127.post-48653422137871423582013-05-12T19:58:00.001+02:002013-05-12T21:29:33.957+02:00Does Portugal Have Its Own “Shortage Of Japanese" Problem?In a number of posts recently I have highlighted the impact of declining workforces on economic growth (<a href="http://www.economonitor.com/edwardhugh/2013/02/24/the-shortgage-of-bulgarians-inside-bulgaria/">here</a>, for example, or <a href="http://www.economonitor.com/edwardhugh/2013/02/15/hungarys-matolsky-joins-japans-abe-in-practicing-the-ancient-art-of-vebal-intervention/">here</a>, or <a href="http://www.economonitor.com/edwardhugh/2013/05/07/the-suitcase-mood/">here</a>) and the way the policies persued to address the Euro debt crisis are having the impact of accelerating the movement of young people away from the periphery and towards the core (<a href="http://www.economonitor.com/edwardhugh/2013/03/26/748/">here</a>, or <a href="http://www.economonitor.com/edwardhugh/2013/03/09/the-great-portuguese-hollowing-out/">here</a>) thus accelerating the decline in their working populations and exacerbating their growth problem. This issue has been already highlighted strongly in Japan's ongoing crisis, and has to some extent come to be known as the "shortage of Japanese" problem following <a href="http://krugman.blogs.nytimes.com/2013/02/05/the-japan-story/">Paul Krugman's memorable use of this expression</a> to explain <a href="http://www.economonitor.com/edwardhugh/2013/02/12/japans-looming-singularity/">why Japan's economic performance seemed so poor to so many</a>.<br />
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Recently I came across <a href="http://mais1economistadebancada.blogspot.com.es/2013/05/portugal-tem-falta-de-japoneses-versao.html">a post by Portuguese blogger Valter Martins</a>, where he looks in some depth at what is happening in Portugal. Really, despite the use of some technical details his argument is extraordinarily straightforward, in fact it is as elegant as it is simple. What he points out is that population growth rates serve as some kind of "quick and dirty" proxy for GDP growth rates, and growth in working age population serves equally well as a quick proxy for growth in GDP per capita. Any simple growth accounting process breaks growth down into a labour input component and a productivity component, so if your labour component turns negative, even to get the same growth your productivity component has to be greater. For societies that have considerable difficulty raising productivity in the first place this process of working population decline is going to make an already Herculean task even more difficult.<br />
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In addition Valter picks up a point few researchers seem to have noticed up to now, that working age population in Portugal just surprisingly peaked. Natural population dynamics have long been stationary in Portugal, and emigration has long-standing and deep roots. During the first eight years of this century the population loss caused by emigration (nearly all young educated Portuguese) was masked by the steady influx of immigrants looking for work. But now the country is in deep recession the immigrants aren't coming. Indeed some are even leaving, while the rate of emigration by Portuguese nationals has accelerated and continues to accelerate, sending working age population (and just as importantly its age distribution) on an increasingly negative path.<br />
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During the years of austerity we have become familiar with the phenomenon that as fiscal spending is cut growth falls making the achievement of fiscal targets even more difficult. Well something similar seems to be happening with migration movements, as part of the benefit to long term growth that accrues from making structural reforms disappears on the other side of the ledger as the workforce shrinks. Again we are in danger of running round and round in ever diminishing circles.<br />
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Reading Valter's post I became impressed with the power of his argument and was struck by the importance of what he had discovered. I therefore took the unusual step of asking him to translate the piece and offering to publish it on my blog. So, without more ado, here is:<br />
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<strong>Is Portugal Facing A “Shortage Of Japanese"?</strong><br />
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Guest Post by <a href="http://mais1economistadebancada.blogspot.com.es/">Valter Martins</a><br />
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“<em>So, about the slow growth/debt connection: I’ve done a quick and dirty mini-RR for the period 1950-2007 ……focusing only on the G7……and if you look at it, you see that most of the apparent relationship is coming from Italy and Japan……And it’s quite clear from the history that both Italy and (especially) Japan ran up high debts as a consequence of their growth slowdowns, not the other way around</em>.” – Paul Krugman, <a href="http://krugman.blogs.nytimes.com/2013/04/16/reinhart-rogoff-continued/">Reinhart-Rogoff, Continued</a> <br />
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Despite so much intense debate about the ailment from which Portugal suffers, and the mountain of sacrifices currently being borne by the Portuguese people one fact has gone virtually unnoticed in amongst all the noise - for the first time, at least in the modern era, Portugal’s working age population has started to shrink. Demography and its possible impact on economic growth is a topic which has been largely ignored by practitioners of economic science in recent decades as population growth has by-and-large been on an upward trend. However, as we enter a new period in human history, one in which the upward trend has shifted towards stagnation or even in some cases towards long run decline, the economic and financial implications of this transformation can no longer be ignored. As Nobel economist Paul Krugman indicates in the above quote, some countries have large debt simply because they have low growth. <br />
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So what is the common thread that runs through these low-growth high-debt countries? Could it be decelerating labour force growth and eventual labour force contraction? The cases of Italy and Japan are well known. In the case of Portugal, it will be argued here, demographic trends can not only explain a significant part of the slow economic growth the country experienced during the first decade of this century, they can also help us understand the depth of the current recession. More important still, we need to think about the consequences of this continuing lose-lose dynamic for the country’s future in both the short and much longer term.<br />
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Economists didn’t always take the view that population dynamics were irrelevant to economic performance. The 1930s gave birth to a serious debate about the possible problem that would arise if many decades of strong population growth were followed by population stagnation and then decline, a debate which was provoked by the fact that birthrates in a number of countries fell below replacement level for the first time in human history during the economic depression. And among the names of those economists who took the problem seriously enough to think and write about it was none other than John Maynard Keynes.<br />
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“<em>There are, indeed, several important social consequences already predictable as a result of a rise in population being changed into a decline. But my object this evening is to deal, in particular, with one outstanding economic consequence of this impending change; if, that is to say, I can, for a moment, persuade you sufficiently to depart from the established conventions of your mind as to accept the idea that the future will differ from the past</em>.” <strong>J.M. Keynes</strong>, <a href="http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2985686/pdf/eugenrev00278-0023.pdf">Eugen Rev. 1937 April; 29(1): 13–17</a>.<br />
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While the phenomenon has arrived largely unnoticed Portugal’s total population has long been near to stationary.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXsSMQNC_Acwd8eK6U_XJbBf128RLVX6QdnrEAguk0WcKgpyY_94FRg7Qu2dLIdVlUQ0TAIqK7fGLUVyj6LcE0zME78EM_iu4xrijQzAg3EuYRFdyW9qKuCErYVqN0ihCu0FQZjg/s1600/One.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="123" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXsSMQNC_Acwd8eK6U_XJbBf128RLVX6QdnrEAguk0WcKgpyY_94FRg7Qu2dLIdVlUQ0TAIqK7fGLUVyj6LcE0zME78EM_iu4xrijQzAg3EuYRFdyW9qKuCErYVqN0ihCu0FQZjg/s320/One.png" width="320" /></a></div>
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As can be seen in the above chart, Portugal’s population has been struggling to find growth momentum since the mid 1980’s (the first time numbers actually dipped downwards) but the years 2010/2011 seem to mark a more fundamental turning point, since it was in that time interval that Portugal’s population started on a long, and possibly irreversible, <a href="http://www.presseurop.eu/en/content/article/2364411-will-portuguese-be-extinct-2204">path of decline</a>. Having long had a total fertility rate of below 1.5 this was a more than predictable outcome, and one that should have been expected ever since <a href="http://www.oecd.org/els/family/40192107.pdf">the total fertility rate fell (and stayed) below the 2.1 replacement level in 1982</a>.<br />
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As is well known, population change is comprised of two major components: natural growth and net migration. Natural growth, births minus deaths, became negative in 2007 and thereafter population growth has become exclusively dependent on having sufficient positive net migration. Up to 2010 this condition was satisfied given the continuing influx of immigrants into the country as can be seen in the chart below.<br />
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However, since the onset of the 2008 recession, not only have the immigration flows reversed completely, but emigration has started to increase again, thus reanimating a trend that has been constantly present in <a href="http://www.migrationinformation.org/feature/display.cfm?ID=77">Portuguese history over decades, even centuries</a>. This is perhaps the most critical factor driving the recent population decline. In fact the decline would have occurred much earlier had it not been for the return of thousands of refugees from the Portuguese colonies in the 1974-1981 period.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSrcqRwhpChM2SPYPRs7znsmsezbwgUtEraNvqnObIm-xQ2ObowCHElsjyV6WRFcGZQczQF8wBpJDMCD1NwKENpoIhABHJRpoINolvZz4mtVE9bLmftkZ5HuAHESojG4arewO6tw/s1600/four.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="126" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSrcqRwhpChM2SPYPRs7znsmsezbwgUtEraNvqnObIm-xQ2ObowCHElsjyV6WRFcGZQczQF8wBpJDMCD1NwKENpoIhABHJRpoINolvZz4mtVE9bLmftkZ5HuAHESojG4arewO6tw/s320/four.png" width="320" /></a></div>
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According to the European Commission's <a href="http://ec.europa.eu/economy_finance/publications/european_economy/2012/pdf/ee-2012-2_en.pdf">2012 Ageing Report</a>, projections for the Portuguese population during the period 2010 - 2060 anticipated that population would peak in 2034, but as we have seen, the latest data show the population unexpectedly reached its peak in 2010 (total population, previous chart), the year in which the population began to decrease (a similar phenomenon seems <a href="http://www.theglobeandmail.com/report-on-business/economy/economy-lab/population-drop-in-spain-a-bad-omen-for-europe/article11533946/">to have occurred in Spain in 2012</a>, with again a reversal in migrant flows in an otherwise stagnant population being the trigger). This fact that this turnaround comes as a surprise is clearly the result over optimistic assumptions on the net migration front since the numbers for natural growth are well known and change little (although birth numbers are now dropping in many EU countries <a href="http://epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KS-SF-13-013/EN/KS-SF-13-013-EN.PDF">under the impact of the long recession</a>). Clearly the unexpected factor here is the severity of the recession from which the country is suffering and the size of the exodus of young people who are leaving.<br />
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Just to highlight even more the <strong>speed</strong> with which all this is happening, in Japan, the interval between the beginning of the decline of the working age population and the beginning of total population decline was a full decade. In Portugal this interval was <strong>only two years</strong>.
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Even more relevant than the decline in total population for the purpose of the present discussion is the decline in the working-age population. <strong>While the former gives us a good proxy for domestic consumption, it is the later which is important in terms of potential national output. All other things being equal a reduction in the working-age population means a reduction in output</strong>. Therefore, the most important detail to catch from the chart above is that the working-age population, defined as the population with ages ranging from 15-64, <strong>declined</strong> for the <strong>first time</strong> in Portugal <strong>between 2008 and 2009</strong>. As highlighted by both <a href="http://www.project-syndicate.org/commentary/the-japan-myth">Daniel Gros</a> and <a href="http://krugman.blogs.nytimes.com/2012/01/09/japan-reconsidered-2/">Paul Krugman</a> if you want to compare economic growth performance as between countries with growing populations and those with declining ones the best indicator to use is undoubtedly GDP per Working Age Person (GDP/WAP).
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In the Portuguese case if we take this ratio and compare it with both Real GDP growth and Working Age Population change (my calculations VM), we can get an impression of how variations in the Working Age Population affect the economic growth of a country. Surprisingly or otherwise, the data for Portugal viewed graphically not only confirms the existence of the “workforce effect” – the relationship seen between Real GDP and GDP/WAP - but also suggests that Portugal has already passed the point where this effect is beginning to have a negative impact on GDP growth.
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As can be seen in the above chart, until 2008 the growth rate of Real GDP was always higher than the rate for GDP/WAP offering a strong suggestion that labour force growth was having a positive impact on GDP growth. It is noteworthy, however, that both in the period 1986 - 1991 and in the period 2003 - 2008, the growth rates of Real GDP and GDP/WAP almost overlapped. This phenomenon coincided with very low or zero rates of working age population growth and as such the “workforce effect” was mostly neutral. The first of these periods, 1986 - 1991, the stagnation in the workforce was the direct result of the increase in emigration that followed the entry of Portugal in the European Union. The second one coincides with the arrival of the turning point in long term WAP growth, as the size of the working age population irrevocably turns negative.
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Indeed, during this early period of emigration towards the EU Portugal’s total population decreased, as shown in the chart <strong>Population by age group</strong> (above, blue line), but at the time, since the population in general was much younger, and many more new labour force entrants were arriving at working age, the growth rate of the workforce remained slightly positive. In other words, there were still enough Portuguese entering the labour market to replace those who were leaving it (either to retire or to seek a future abroad). In the second period, 2003 - 2008, the large exit of Portuguese nationals, <a href="http://theportugueseeconomy.blogspot.com/2010/06/700000-new-emigrants.html">about 700,000 between 1998 and 2008</a> according to research by the now Economy and Employment Minister Álvaro Santos Pereira, was to some extent offset by an inflow of immigrants, but these were only sufficient in number to maintain the workforce at a stationary level.
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All this calm and stability disappeared, however, after 2008 when the growth rate of Working Age Population turned negative, i.e. the labour force began to decline (see graph below). Where the growth rates of Real GDP and GDP/WAP overlap we can surmise that working age population change is having no effect on real GDP growth. Subsequently, however, the growth rate of GDP/WAP becomes higher than the growth rate of Real GDP and thus the "workforce effect” starts to act as a drag on the economy steadily bringing the potential overall growth rate down. In other words, Portugal is now suffering from a "Shortage of Japanese" as <a href="http://fistfulofeuros.net/afoe/the-great-portuguese-hollowing-out/">Edward Hugh</a> has called the phenomenon, after <a href="http://www.bloomberg.com/news/2013-02-05/krugman-sees-japan-s-shrinking-population-as-crimping-growth.html">Paul Krugman</a> originally coined the term to describe the underlying problem which has been afflicting the Japanese economy since the mid-1990s.<br />
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The fact that the three lines in the above chart happen to intersect at zero is perhaps just an unfortunate coincidence but is consequences are disastrous, since the downward trend that was already evident accelerated greatly after the onset of the recession. The resulting rise in unemployment not only caused a collapse in the immigration flow, it also led to a sharp increase in emigration. As a result workforce shrinkage intensified even further, as can be seen in the above chart by looking at the growing distance between the Real GDP and the GDP/WAP lines. That is, if the workforce had remained stationary the economy would be growing at similar rates to the GDP/WAP, i.e. above the current level as indeed happened in the period 2003 – 2008.<br />
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Naturally, the argument can be advanced here that the recession is a cyclical phenomenon, and this is surely true, there is an ongoing cycle, but the argument being used refers to long term trends – a reversal in direction (or change of sign) for inputs from the labour force component brings down the overall trend growth rate making booms weaker and recessions deeper, all other things being equal. This would seem to be a simple conclusion which stems from elementary growth accounting theory. Naturally, there are other factors which contribute to growth, like multi factor productivity, but again other things being equal you would need more of this to achieve the same growth rate as before under conditions of weakening in the labour force growth component. <br />
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Thus the argument is not that economic growth becomes impossible with a stagnant or slowly declining workforce, but simply that it becomes harder to achieve because it relies more on other factors, such as productivity and raising participation rates, but these change slowly over time, and more so in already developed countries. As such trend growth will surely steadily fall. This can be clearly seen in the following chart: while workforce growth was an important source of growth when Portugal was a developing country, its importance fell back as the workforce started to stagnate even as Portugal was approaching converge with other developed countries in terms of productivity. Other factors took over and increased their importance steadily as the economy started to converge with more advanced ones. Now that this catch up process seems to have come to a standstill as well the economy simply can’t growth, at least at rates considered normal. With a stagnant workforce, low growth or no growth is the new normal. <br />
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Following standard growth accounting procedures, during the 1970s workforce growth accounted for more than half of Portuguese economic growth (see chart above, my calculations VM), and this contribution had fallen to only 16% in the first decade of this century. However, since 2008 not only has this contribution reversed sign but also the magnitude of the negative effect has begun to increase rapidly. Such that, by 2011 the “workforce effect” could be considered to explain more than 29% of the GDP decline. This “negative drag” will continue, and the effect possibly become greater, as the working age population shrinks further. Had the workforce remained stationary we could surmise the 2010 recovery would have been more pronounced and the 2011 recession wouldn’t have been so deep. This is the principal reason why official growth forecasts have been being constantly revised to the downside, and this will continue to happen until the models the forecasters use adequately incorporate the effects of population decline on economic growth. Adding insult to injury, ignorance of the existence of such effects recently led Portugal’s Prime Minister Pedro Passos Coelho <a href="http://www.ft.com/intl/cms/s/0/67d4921a-beb6-11e1-b24b-00144feabdc0.html#axzz2SxcK6ZUM">to suggested young unemployed Portuguese resort to emigration as an escape route from the crisis</a>, advice thousands have now followed thus making a bad situation even worse.<br />
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Economic growth in Portugal appears to be on a long downward trend, a trend which will only be made worse by the onset of the decline in its working age population. Economic output is now at 2001 levels and thus we can now conclude that the last decade has been completely lost. More worryingly though, is that after such a bad start to this decade, it might not be unreasonable to conclude that this one is also in the process of being lost too. <br />
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At best the economy will stagnate in the years to come but the possibility is there that it will continue to regress – especially if nothing is done to stem the outflow of young educated people - and by 2019 it might even be back somewhere in the 1990’s. This is scenario simply cannot be excluded since, in addition to all the other problems the country faces, a situation that would be in any circumstance challenging is now being aggravated by one more variable whose contribution cannot be easily reversed in the short term – the decrease in the working age population. More than the fact in itself, it is the speed at which this is happening which is alarming, and the fact that policymakers appear unaware of the problem. In analyzing the low Portuguese economic growth issue the decrease in the country’s working age population can no longer be ignored! Or at least it is hoped that this will be one of the outcomes of this short report.<br />
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To return to where we started, <a href="http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2985686/pdf/eugenrev00278-0023.pdf">Keynes concluded in his pioneering presentation</a> that a stationary or slowly declining population could increase its standard of life while preserving the institutions society values most if, and only if, the process was managed with the necessary strength and wisdom. On the contrary, he argued, a rapid decline in population, of the kind that we are seeing in Portugal today, would almost inevitably result in a serious decline in living standards and a breakdown in highly valued social security mechanisms. The distinction Keynes drew some 80 years ago between rapid and managed rates of decline seems plausible, reasonable and highly relevant today. What we now need to see are urgent measures taken – initiated by the EU and the IMF - to counter the exodus which lies behind this dramatic decline which is occurring before our eyes, measures which at least try to decrease its speed, because once a process like this gains full velocity it will be very difficult to stop, and we have already seen it gather considerable traction. <a href="http://wiki.dickinson.edu/index.php/History_of_Irish_Depopulation:_1815-1913">Ireland</a> is a pointer and a great example to learn from, since it took that country more than a century to recover the population decline precipitated by the natural disaster which hit the country in the middle of the nineteenth century.
<b>Postscript From Edward</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 the issue of emigration from countries on Europe's periphery 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.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3950127.post-21264707306484847532013-04-28T21:29:00.000+02:002013-04-28T21:29:03.465+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 />
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<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>
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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 />
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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.
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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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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 />
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<strong>A well-oiled crisis</strong><br />
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<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?”
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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 />
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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 />
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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 />
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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 />
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<strong>Ignoring the obvious</strong><br />
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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 />
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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 />
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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 />
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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 />
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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 />
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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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<strong>The lessons learned from inaction</strong><br />
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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 />
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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 />
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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 />
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<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 />
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<strong>Following in the Footsteps of Japan?</strong><br />
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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 />
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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 />
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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 />
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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-3950127.post-52116830183579771392013-03-26T09:55:00.002+01:002013-03-26T09:55:32.122+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>
<br />
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 />
<br />
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 />
<br />
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/AVvXsEgGUr1Us6ZDm4odVSVYEa95SMXPmi0o0zeKnLT6iKIfW6Ub_-vLUW8KFcAW7HdqmLPxnVOdH6b9bxQb9kSdcz9u2hyuKbOVXQf1XtBsb35qjyEzeliVsebmhjGKbRtuLqzEeufF/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/AVvXsEgGUr1Us6ZDm4odVSVYEa95SMXPmi0o0zeKnLT6iKIfW6Ub_-vLUW8KFcAW7HdqmLPxnVOdH6b9bxQb9kSdcz9u2hyuKbOVXQf1XtBsb35qjyEzeliVsebmhjGKbRtuLqzEeufF/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/AVvXsEi0JaQmDj_6PD37Bi3w9P3I1vh-wg8iyKt5w1L8ya399CVKHsQ5OjV2UzuouZDGMKzhJJ1vBdKPzXJ8-XisJ22pZqzCB1_8fSfX75LUBmwk91MM884-RMqy1bD6BoY_JFG-c946/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/AVvXsEi0JaQmDj_6PD37Bi3w9P3I1vh-wg8iyKt5w1L8ya399CVKHsQ5OjV2UzuouZDGMKzhJJ1vBdKPzXJ8-XisJ22pZqzCB1_8fSfX75LUBmwk91MM884-RMqy1bD6BoY_JFG-c946/s320/2013-03-06_083406.png" width="320" /></a></div>
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<br />
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.
<br />
<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/AVvXsEj2DSxIkf2WTKJBBw9UbQFbQfnQevsvZB0lyxawg3Hw_K67b31wvmRIYeUUCfcNS-0gHmnbuXNe0dSe_w5mYCgJSKGWlhLAr4_Eio6OozhjX19jlk788jzUdNZDYjXD6cy48l-Y/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/AVvXsEj2DSxIkf2WTKJBBw9UbQFbQfnQevsvZB0lyxawg3Hw_K67b31wvmRIYeUUCfcNS-0gHmnbuXNe0dSe_w5mYCgJSKGWlhLAr4_Eio6OozhjX19jlk788jzUdNZDYjXD6cy48l-Y/s320/2013-03-06_083438.png" width="320" /></a></div>
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<br />
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/AVvXsEgaOjGI4hTS_a5S1VPhIFRhAtoQInTLxozJwbkhwSNeJOU2otkBIREAJKTjg6R50dzc4kZtt3OPN4d87gKXV1_x6cC8Dvot3BAj38QTJaZ_z9cIe2_TxVMhvjPVoYW0D8IcpP50/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/AVvXsEgaOjGI4hTS_a5S1VPhIFRhAtoQInTLxozJwbkhwSNeJOU2otkBIREAJKTjg6R50dzc4kZtt3OPN4d87gKXV1_x6cC8Dvot3BAj38QTJaZ_z9cIe2_TxVMhvjPVoYW0D8IcpP50/s320/Spain+Net+Migration.png" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLs9fUu8zHE3xtE-_xg_vpqO3NU3-bVkCpcOyyoz_YL8U9WWfbrJVmWPV0GkTC38O3Xok7BgByNtEpE2q_HY0zY1QmYNJ1cfyR6cdwXvybi7M4np2yTrVC0CNqD0k7ZtmxrgHy/s1600/Spain+Afiliados+-+English.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><br /></a></div>
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/AVvXsEj5icBHEzDUZtdJbBfImuwzrR33El0y0gBjroABGLFsrK87lvpLr9vamHNnwxG7N89HuS27XxsYo-M88VVW3WQm93Ke-UMZBOBL6qdd90PKASVdetJtpxeXnq5EduIkqCtmx9rH/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/AVvXsEj5icBHEzDUZtdJbBfImuwzrR33El0y0gBjroABGLFsrK87lvpLr9vamHNnwxG7N89HuS27XxsYo-M88VVW3WQm93Ke-UMZBOBL6qdd90PKASVdetJtpxeXnq5EduIkqCtmx9rH/s320/Spain+Population+Growth+and+Productivity.png" width="320" /></a></div>
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<br />
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/AVvXsEjoognkT9JGoFobQMxUOY8wLFgH_XoC-NRCgEJxVmz_qwBlvb3jG2pscLbBimTGIKanYolGet5yHblmItbEHH2u69C69H3supgZ9-5gcCiEe99_PodJl6hRvvOsZel_DukHNf7h/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/AVvXsEjoognkT9JGoFobQMxUOY8wLFgH_XoC-NRCgEJxVmz_qwBlvb3jG2pscLbBimTGIKanYolGet5yHblmItbEHH2u69C69H3supgZ9-5gcCiEe99_PodJl6hRvvOsZel_DukHNf7h/s320/Spain+population+pyramid+INE.png" width="320" /></a></div>
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<br />
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/AVvXsEj7NlWCZ49_zrJsP5toSwP3F8v9YNjU_dXk9OKQaSwCInBCA9G9DiFbVlplP34B3HExVzjO-zXxO1kP2O4thxV3sAPfnzRDn4PTogZVOFUgXOJIcOabyS_mP3b6E-89HMH46B3r/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/AVvXsEj7NlWCZ49_zrJsP5toSwP3F8v9YNjU_dXk9OKQaSwCInBCA9G9DiFbVlplP34B3HExVzjO-zXxO1kP2O4thxV3sAPfnzRDn4PTogZVOFUgXOJIcOabyS_mP3b6E-89HMH46B3r/s320/Spain+Current+Account+1999+to+2006.png" width="320" /></a></div>
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<br />
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 />
<br />
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/AVvXsEgbflM3oA8HNgq3RoDyJ344HqBHORc1VOWHizmw144ihnMVKPHDEX0k1oOmifW8PzTq7qEaWJjQSZ732MkC23GvESW21DYJcSOdjWShHvJUsBchI-hIficma5yXuqqavMq26ZcC/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/AVvXsEgbflM3oA8HNgq3RoDyJ344HqBHORc1VOWHizmw144ihnMVKPHDEX0k1oOmifW8PzTq7qEaWJjQSZ732MkC23GvESW21DYJcSOdjWShHvJUsBchI-hIficma5yXuqqavMq26ZcC/s320/2013-03-06_083505.png" width="320" /></a></div>
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<br />
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:
<br />
<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 />
<br />
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/AVvXsEh36bS5oC_z_9w81NQtRiI6OP_cy21Yk_tgqg0eT8_U7PJE06mNR9OQbHhaqZbem8EqmROLMlktEX4HsTipUnHUAl1A2ttnFftWBa4_GGZmDpN-3JoS8sbTvC4uIW-dX5F-tNRe/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/AVvXsEh36bS5oC_z_9w81NQtRiI6OP_cy21Yk_tgqg0eT8_U7PJE06mNR9OQbHhaqZbem8EqmROLMlktEX4HsTipUnHUAl1A2ttnFftWBa4_GGZmDpN-3JoS8sbTvC4uIW-dX5F-tNRe/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 />
<br />
"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 />
<br />
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 />
<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-3950127.post-79718475466061006422013-03-12T17:21:00.000+01:002013-03-13T06:23:18.451+01:00When Is A Promise Not A Promise?Mario Draghi is proving to be a man of his word. <a href="http://www.economonitor.com/edwardhugh/2012/10/22/taking-a-man-at-his-word/">He said he would do whatever he needed to do to hold the Euro together</a>, and - so far so good - he has. Up to now of course some would say his will has not been truly tested, since all he has had to is sit there and twiddle his thumbs, and that has worked. It seems to have been the subliminal symbol the markets were waiting for.<br />
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But now he has added to his repertoire, and gone one stage further. This time he really did do something. Last Thursday he openly and publicly turned a blind eye to a blatant example of monetary financing being carried through out there adjacent to the flagship's starboard bow. Like Nelson peering along the length of his telescope at Trafalgar, he saw no monetary financing activity in Ireland. The reason he didn't see it was because he simply didn't look. Naturally he did tell curious journalists last Thursday that someone one day would do so, but such was his control of the situation he even feigned he couldn't remember the date when they would take that look. Nice one Mario.<br />
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Thus he kept to his promise, while allowing the Irish government to sharply revise down the net present value of one of theirs. <br />
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The really impressive part in the performance was the extraordinarily skillful way in which the ECB's very own Lord High Admiral managed to navigate his flagship through the tiny skiffs of the assembled press corps. At one point he almost taunted them with their own impotence, appealing to some seemingly innate masochistic tendency they share by giving them a dressing down for the way in which they constantly get things out of proportion while jocularly drawing their attention to how they were prone to a sort of “angst of the week” syndrome. It always helps when you want to insult someones intelligence if you start off by saying, "let me tell you a joke."<br />
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What he had in mind were things like, well you know, the size of the ECB balance sheet (what a thing to fret about), the value of the Euro, the threat of currency break up, deposit flight from the periphery, the hawkish Bundesbank etc etc. The list of causes for such childlike angst could be very, very long. When all is for the best in the best of all possible worlds, what on earth could reasonable men and women be doing worrying their silly little heads about so many and such varied topics? These things are better left in the capable hands of the big boys over on the ECB governing council who, self evidently, know exactly what they are doing. Another nice one Mario.<br />
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Curiously though one "angst of the week" the journalist didn't seem to be suffering from at last Thursday's press conference was whether or not "monetary financing by stealth" might be going on in Ireland. After all, why should they have been, it's such a trivial item. <br />
<br />
However, surely even those with the shortest of <b>short memories</b> must somehow or another be able to recall <a href="http://uk.reuters.com/article/2013/02/07/uk-ireland-bank-ecb-idUKBRE9151EQ20130207"> that notorious Irish Promissory Notes issue</a>. This certainly was fret of the week in February, but had somehow - apart from one isolated question - conveniently slipped off the radar by the time we got to March. But just as a reminder, here's the story so far. <br />
<blockquote class="tr_bq">
<b>February Press Conference</b><br />
<br />
<b>Question</b>: Unfortunately, I have one more question about Ireland. You said that it is a decision of the Irish government and probably the Central Bank of Ireland, and not your problem. But, at some point, I guess it could still be a Eurosystem problem because, as I understand it, the Central Bank of Ireland is now the owner of a promissory note, or something else, maybe government bonds with longer durations, which should be part of the so-called ANFA assets. I know that there are certain rules which cap these assets so, at some point this year, you have to look at that. Do you have any proposals for the Central Bank of Ireland to reduce that?<br />
<br />
<b>Draghi</b>: You are running too fast, you are running ahead. We will certainly review the situation in due course. I am not saying that this is the last word on this. I am only saying that, today, the Governing Council unanimously <b>took note of the Irish operation</b>. So I have to say that this is certainly not the last word. We will come back to this.</blockquote>
Fine, we don't want to precipitate things. We need to consult so for the moment we are only taking note with no further comment. But what a difference a day makes, come March they were not even taking notes. Poor Mario couldn't even remember the date when the Governing Council was planning to come back to the matter. Curious..................<br />
<blockquote class="tr_bq">
<b>March Press Conference </b><br />
<br />
<b>Question</b>: Last month you said that we have not heard the last word on the Irish promissory notes. So, I wonder, when will we hear the last word?<br />
<br />
<b>Draghi</b>: We periodically review compliance with Article 123 by all countries. If I am not mistaken, the review should happen at the end of the year, but the Governing Council will decide in complete independence when to have this review, or a review of similar situations. I do not have a date to give you now. I think there is a date when this is going to be done, and I believe it is at the end of the year, but I cannot let you know for sure .</blockquote>
Now for those who need reminding <a href="http://www.lisbon-treaty.org/wcm/the-lisbon-treaty/treaty-on-the-functioning-of-the-european-union-and-comments/part-3-union-policies-and-internal-actions/title-viii-economic-and-monetary-policy/chapter-1-economic-policy/391-article-123.html">Article 123 of the EU Treaty</a> is the one which explicitly prohibits monetary financing by either the ECB or national central banks. The agreement reached between the Irish central bank and the Irish government would certainly appear to breach the letter of that article, and given the way the Bundesbank has voiced such concerns over the months about anything that even vaguely smack of it, you'd have thought it would have been a hot topic.<br />
<br />
Under the agreement, the Irish Central Bank agreed to assume full ownership of the 25 billion Euros in in promissory notes issued by the Irish government when it bailed out Anglo Irish bank. Subsequently these notes were exchanged for Irish sovereign bonds with maturities of up to 40 years. The first principal payment is not due till 2038 and the last payment will be made in 2053.<br />
<br />
In addition the average interest rate was massively reduced. Interest on the new bonds will begin at just over 3%, compared with well over 8% on the promissory notes.
Evidently the Irish government has just been relieved of a short term burden on its finances to the tune of over 2 billion Euros a year. This money can now be put to use stimulating the Irish economy, avoiding damaging cuts as the fiscal deficit is steadily reduced. If this isn’t monetary financing, then it isn’t exactly clear what would be.<br />
<br />
<span style="font-size: large;"><b>Growing Weariness At Both Ends Of The Curve</b></span> <br />
<br />
So what happened between the two press conferences? The Italian elections happened, that's what happened. What the Italian election outcome suggests is not just that Italy won't find it easy forming a government, that part is obvious. More importantly there is a growing recognition that even after a government is formed, twisting its arm to push through a hefty reform programme is going to be difficult, and in the meantime Italy's debt to GDP ratio is simply going to keep going onwards and upwards (it was near 130% by the end of 2012, and rising), no matter how much soothsaying goes on about how the country now has a primary balance.<br />
<br />
So at some point this surge in the debt level will need to be capped, and I think there is a growing resignation about this fact in Brussels, Berlin and Washington. It is this resignation that the markets are sniffing, when they aren't taking the appropriate advisers out to lunch to get them to spill the beans, and this is why the periphery bond spreads are reacting so calmly to almost anything.<br />
<br />
Italian debt will need to be restructured, or at least "re-profiled" (that basically means extending the term of the debt say to 30 or 50 year bonds in a way the the Net Present Value is significantly reduced), just like that of its Greek peer. But hey, isn't that just what the Irish government got the Irish central bank to sign up to and, as<a href="http://www.ft.com/intl/cms/s/0/6bd34000-6a32-11e2-a7d2-00144feab49a.html#axzz2ND6eeSXC"> John Dizard points out,</a> didn't Maria Cannata, director-general of public debt in Italy, recently go so suggest that<a href="http://www.independent.ie/business/italy-to-launch-longterm-bonds-despite-political-uncertainty-29113695.html"> the country might soon be issuing bonds in the 30 to 50-year range</a>? "We intend to restart with the lengthening of the duration in the average life of our debt," she told an investor conference in London recently. "We are ready to launch also a new 30-year (bond) as soon as possible."<br />
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So while Europe's central-bank-watching journalists may momentarily have lost sight of the problem, hedge fund research teams surely haven't, indeed I think it would be pretty difficult to understand why markets are responding so calmly to the absence of even the first signs of a stable government in Italy. Somehow or another one gets the feeling that none of this now matters, risk premia will come down regardless.<br />
<br />
Something similar seems to be happening in the case of Spain. At the end of last week Spanish 5 and 10 year bonds <a href="http://www.bloomberg.com/news/2013-03-09/spanish-bonds-gain-on-economy-debt-auction-optimism-bunds-fall.html">reached their lowest yield level since November 2010</a>. And this in a week when credit rating agency <a href="http://cincodias.com/cincodias/2013/03/07/mercados/1362682339_494530.html">Moody's announced they had identified 200 billion euros worth of badly classified property assets</a> in Spain's bank balance sheets, assets which had not been specially provisioned for. Isn't financial sector risk supposed to be one of the main risks to Spanish debt and solvency? How come the stock market continues to go up even as almost every real economy indicator deteriorates. A combination of reform weariness on the periphery and bailout weariness in the core is producing what many perceive as being the perfect storm. A world where almost nothing can go wrong, unless that is you are in Spain or Greece and searching for a job. In fact it is now starting to look increasingly unlikely that Mariano Rajoy will ever ask for those famous Outright Monetary Transactions bond purchases ever to be implemented. Landon Thomas - like many of us - <a href="http://www.nytimes.com/2012/10/16/business/global/spain-may-pay-price-for-delaying-aid-request.html?pagewanted=all&_r=0">had it wrong</a>, the world wasn't waiting for Mariano, it was waiting for Mario to see if he would just keep twiddling his thumbs.<br />
<br />
<span style="font-size: large;"><b>Will The National Central Banks Support The Bond Markets No Matter What? </b></span><br />
<br />
Naturally this is a win win solution - for the ECB, the Bundesbank and for Angela Merkel who won't have to keep going to the German parliament to get authorisation for yet more bailout money. So maybe this is an important moment in the crisis. The moment when you can say that one stage is over, and another, the one Citi Chief Economist Willem Buiter once called the Rubelisation of the Euro Area , about to begin. Now it could be that national central banks rather than the ECB will become the focus of attention, at least in terms of assuming the risk of growing debts in countries that are going to have trouble ever paying it all back. <br />
<br />
As I said<a href="http://www.economonitor.com/edwardhugh/2012/10/22/taking-a-man-at-his-word/"> in this post</a> back in October last year:<br />
<blockquote class="tr_bq">
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 [Dalio] 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.</blockquote>
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<a href="http://ftalphaville.ft.com/2013/03/06/1412822/the-age-of-infinite-equity/">FT Alphaville's Izabella Kaminska also senses it</a>, "Something very important has changed, which makes this a very different type of bubble.The government will continue to support the market no matter what....The crisis happened precisely because there weren’t preset expectations of government support."<br />
<br />
Izabella is of course talking about the United States government, but the point is generalizable. The Euro crisis broke out precisely because there weren't expectations of collective support for the struggling countries. <a href="http://fistfulofeuros.net/afoe/total-eclipse-of-the-sun-hits-dubai-world/">As I pointed out at the time</a>, the Greek crisis broke out in the wake of what happened in Dubai, where markets started to doubt that big brother Abu Dhabi would bail the country out. The same thing happened to Greece, expectations of German government support dwindled largely because the government itself was denying it would. But now, four years later a formula has been found: march together but strike separately, or something like that.<br />
<br />
So it is to Mario Draghi's credit that he has shifted that perception, he vowed he would save the Euro no matter what, and now inadvertently the Irish government have offered investors a blue print of how it might all work. The national central banks will support their sovereign bond markets, no matter what. After all, isn't that just what the new Japanese Prime Minister Shinzo Abe has said he is going to do, and aren't the global financial markets whirring resplendently with joy just hearing him saying it.<br />
<br />
Why in the end should Europe be so different? Maybe <a href="http://www.economonitor.com/edwardhugh/2013/02/12/japans-looming-singularity/">it will all end in tears</a>, but it will be fun while it lasts.<br />
<br />
So we are off on a splendid monetary experiment, with Japan leading the pack. As Paul Krugman so aptly puts it it in the title of a recent article - "<a href="http://krugman.blogs.nytimes.com/2013/01/11/is-japan-the-country-of-the-future-again/">Is Japan The Country of the Future Again.</a>" And the moral - "It will be a bitter irony if a pretty bad guy, with all the wrong motives, ends up doing the right thing economically, while all the good guys fail because they’re too determined to be, well, good guys."<br />
<br />
He wasn't by any chance talking about Silvio Berlusconi, was he?
<br />
<br />
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-3950127.post-63654809494712119862013-03-09T08:06:00.000+01:002013-03-09T08:06:32.258+01:00The Great Portuguese Hollowing Out<b>With every passing day Portugal has less and less economy left, while fewer and fewer people remain to try to pay down the debt.</b><br />
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As Portuguese President Aníbal Cavaco Silva <a href="http://algarvedailynews.com/news/8007-portugals-birth-rate-decreases-further">once put it</a>, "A country without children is a nation without a future." He was, of course, referring to his country’s ultra-low birth rate, which is just over 1.3 (Tfr) and has been below replacement level (2.1Tfr) since the early 1980s.<a href="http://portuguese-american-journal.com/2012-birth-rate-negative-decreases-further-portugal/"> In 2012 only just over 90,000 children were born in the country</a>, the lowest number in more than a century – you need to go back to the nineteenth century to find numbers like the ones we have been seeing since the crisis really took hold.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj96QhDJqbn_Dvoy_KBFIkbhPg6-GEtYWArNdM69ScDUqI-kyS5FcVvhaSJ1LNVF8aJcIuGf2sMNQKiDPnJogzTArrnHw6enE5Gydf-qUEZuhTslCgrU3_VmlqPr0SHfTK-UaGRdQ/s1600/Portugal+Fertility.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="169" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj96QhDJqbn_Dvoy_KBFIkbhPg6-GEtYWArNdM69ScDUqI-kyS5FcVvhaSJ1LNVF8aJcIuGf2sMNQKiDPnJogzTArrnHw6enE5Gydf-qUEZuhTslCgrU3_VmlqPr0SHfTK-UaGRdQ/s320/Portugal+Fertility.png" width="320" /></a></div>
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But added to this longstanding, yet unaddressed, problem there is now another, just as dangerous, one. High unemployment levels and the lack of job opportunities are leading <a href="http://portuguese-american-journal.com/emigration-over-one-million-left-the-country-in-the-last-14-years-portugal/">an ever increasing number of young Portuguese to emigrate</a>. The numbers are large, possibly a million over the last decade, victims of the country’s ridiculously low growth rate – under 1% a year. And the departures are accelerating. Jose Cesario, secretary of state for emigrant communities, <a href="http://www.bbc.co.uk/news/world-21206165">estimated recently</a> that up to 240,000 people may have left since the start of 2011.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvLWg6Pj_16VENu1f2AqHYghj3mbk9P9iGSkJcpuwyrRCz99xhZRnigwT9b3oyslLZcTLvybDF_jDHAyPBdOWRydZ_GTbsp0KG7AorOJ2J9SI8LMVsVjO7lBqhpMxkpXEOxBNXEQ/s1600/Portugal+unemployment.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="182" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvLWg6Pj_16VENu1f2AqHYghj3mbk9P9iGSkJcpuwyrRCz99xhZRnigwT9b3oyslLZcTLvybDF_jDHAyPBdOWRydZ_GTbsp0KG7AorOJ2J9SI8LMVsVjO7lBqhpMxkpXEOxBNXEQ/s320/Portugal+unemployment.png" width="320" /></a></div>
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Naturally this is one of the reasons why Portuguese unemployment numbers haven’t hit the Spanish or Greek heights. According to <a href="http://portuguese-american-journal.com/emigration-more-unemployed-are-leaving-the-country-portugal/">data from the Portuguese Institute of Employment and Professional Training</a>, during the first nine months of last year 24,689 people cancelled their unemployment registration due to a decision to emigrate. This compares with 16,977 in the first nine months of 2011. In September alone, 2,766 people signed off for the same reason, a 49% increase on September of 2011. Yet between January and September Portugal’s EU harmonized unemployment rate rose from 14.7% to 16.3%, suggesting that without so many people packing their bags and leaving the figure would have been significantly higher, and offering some explanation as to why government officials don’t do more to try and stop the flow.<br />
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Nobel economist Paul Krugman recently suggested that among the ailments Japan was suffering from was a <a href="http://krugman.blogs.nytimes.com/2013/02/05/the-japan-story/">shortage of Japanese</a>. Or put another way <a href="http://www.japantimes.co.jp/news/2013/02/07/business/krugman-fewer-people-less-growth/#.USTUIVcrE5M">Japan’s slow growth is partly a by-product of the country's ageing and shrinking workforce</a>. Looking at the country’s population dynamics Portugal certainly looks a likely candidate to catch this most modern of modern diseases. Not only does Portugal have the key ingredient behind the Japanese workforce shrinkage – long term ultra-low fertility – it has some added issues to boot. Japan may be immigration averse, but its inhabitants aren’t fleeing in droves.<br />
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Of course, a shortage is always relative to something. Many hold that the planet is overpopulated, and that energy constraints mean fewer people would be better. So shouldn’t we be celebrating all these children who aren’t getting born?
Well, no, at least not if you want sustainable pension and health system, and that is what the developed world sovereign debt crisis is all about, how to meet implicit liabilities for an ever older population. One thing Portugal won’t have a shortage of is old people, since the over 65 age group is projected to grow and grow, even as the working population shrinks and shrinks. No wonder the young are leaving, even if the youth unemployment rate wasn’t 38.3%, just think of all the taxes and social security contributions the remaining young people are going to have to pay just to keep the welfare ship afloat. Patriotism at the end of the day has its limits.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKeKxGtsX3XETXLLwQYCq8bQIv_DUkREZqJiMDS77tnuDDYBtymEbn6H06weyyQWkJdSgBw00ptogahyphenhyphenUtcZ6ASidV_FlxTy_lywjBMqYmbRS3gH3uuRP3I0Nsivvs1ixFRWpF8w/s1600/Portugal+Age+Pyramid.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="171" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKeKxGtsX3XETXLLwQYCq8bQIv_DUkREZqJiMDS77tnuDDYBtymEbn6H06weyyQWkJdSgBw00ptogahyphenhyphenUtcZ6ASidV_FlxTy_lywjBMqYmbRS3gH3uuRP3I0Nsivvs1ixFRWpF8w/s320/Portugal+Age+Pyramid.png" width="320" /></a></div>
Unfortunately population flight and steadily rising unemployment aren’t the only problems the country is facing. The economy is also tanking, and getting smaller by the day.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtNUlcCrWTPpClEGVgA4X2eQG9T9DCwB7I8mTbjOkYsf8EP_58abXa1JOBKEEzji0MdZ7KgxUDICLSaPCZYbzVtEDgkXar4K_5i0alh_XKFOy7UoDR-TWD9olcogtU6ZLraIKq0Q/s1600/Portugal+Constant+Price+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="193" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtNUlcCrWTPpClEGVgA4X2eQG9T9DCwB7I8mTbjOkYsf8EP_58abXa1JOBKEEzji0MdZ7KgxUDICLSaPCZYbzVtEDgkXar4K_5i0alh_XKFOy7UoDR-TWD9olcogtU6ZLraIKq0Q/s320/Portugal+Constant+Price+GDP.png" width="320" /></a></div>
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Far from the recession getting milder as last year progressed it actually accelerated, and there was a 3.8% output drop in the three months to December in comparison with a year earlier.
Naturally, it isn’t all bad news. Exports are doing extremely well. They were up by 5.8% during the course of 2012, and the really good news was an increase of almost 20% in shipments outside Europe - exports to countries outside the EU jumped 19.8% to13.1 billion euros. These now constitute nearly 30% of total exports, up from just over 25% in 2011. In contrast exports to other EU countries – where domestic demand is contracting rather than expanding - were up a mere 1%.
In contrast retail sales were down nearly 10% on the year, construction output 15%, and industrial output 5%.<br />
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This is a familiar picture across Europe's southern periphery, where positive export performance does not compensate for shrinking domestic demand due to the smallish size of the export sector, generating a negative environment which ongoing reductions in government spending do nothing to assuage.<br />
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And next year it looks set to get worse. The Bank of Portugal is now forecasting a GDP drop of 1.9% in 2013, compared with earlier expectations for a much softer fall. As recently as last October the IMF was expecting only a 1% drop. In any event it will be the third consecutive year of decline, making for five out of the last six years where the Portuguese economy has gone backwards following the best part of a decade where it scarcely moved forwards.<br />
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But if there is a shortage of both growth and young people, there is no shortage of debt. Gross government debt as a percentage of GDP hit the 120% of GDP level last year. And it isn’t only public sector debt, the Portuguese private sector owed some 250% of GDP at the end of last year, according to Eurostat records, one of the highest levels in the EU.<br />
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Worse still the country’s net international investment position had a negative balance of nearly 110% of GDP, the worst in the EU.<br />
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This last detail is important, since according to conventional economic theory it is by drawing down on overseas assets (which have been acquired by pensions and other saving) that elderly societies can help meet their pension and health liabilities (the Japan case). But in Portugal far from reaping returns on this account, paying down these debts, or interest on them, will be a drain on public resources for many years to come.<br />
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So with less people working and paying into the welfare system, less GDP, and huge debts the numbers simply don’t add up. This year we will see GDP levels last seen in 2000. Yet in <a href="http://www.imf.org/external/np/sec/pn/2013/pn1307.htm">their latest Article IV consultation report the IMF</a> Executive Directors actually “welcomed the [Portuguese] authorities’ impressive policy effort to gradually reverse the accumulated imbalances and prevent future crises”. How they can say this and keep a straight face when talking about a country which is actually travelling backwards in time is hard to understand. It looks increasingly like the Fund is suffering from “integrity flight” and relegating itself to the role of a public relations body for a group of fumbling European politicians.<br />
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The depth of ignorance which exists on the challenges the country faces was revealed last year when Prime Minister Pedro Passos Coelho actually said that <a href="http://www.ft.com/intl/cms/s/0/67d4921a-beb6-11e1-b24b-00144feabdc0.html#axzz2LQX37wGF">the best solution to youth unemployment problem was for young people to emigrate</a>. We are increasingly handling the new and complex problems presented by the 21st century with the aid of simplistic formulas derived from 20thcentury textbook economics. It’s time for someone somewhere to wake up to the fact that the old models don’t work, because there are growing number of key factors they simply don’t capture. The poor performance of economists using these models is increasingly getting the profession a bad name among the public at large. Mr Draghi’s outright monetary transactions programme may well be doing a marvelous job of addressing the issue of financial capital flight but it offers few solutions to the human capital one. In the absence of policies which acknowledge these issues exist and then address them none of the sustainability analyses – debt, financial sector, whatever – are worth the paper they have been written on.<br />
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<b>Postscript</b><br />
<br />
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-3950127.post-29438506252427269092013-02-25T17:04:00.000+01:002013-02-25T10:16:28.538+01:00The Shortgage of Bulgarians Inside BulgariaOh, there's a hole in my bucket, dear Liza, a hole......<br />
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Wenn der Beltz em Loch hat -<br />
stop es zu meine liebe Liese<br />
Womit soll ich es zustopfen -<br />
mit Stroh, meine liebe Liese<br />
<br />
According to Angela Merkel, <a href="http://www.bloomberg.com/news/2013-02-18/merkel-cites-east-german-lessons-for-crisis-wracked-euro-states.html">speaking in the German city of Mainz in mid February</a>, European countries struggling with the fallout of the euro-area debt crisis have much to learn from East Germany’s experience with economic overhaul following the fall of the Berlin Wall. In the main she was speaking about the need for reform, something on which we can all agree. “At the beginning of the 21st century", she said, "Germany was the sick man of Europe and that we are where we are today also has to do with reforms we carried out in the past. That’s why we can say in Europe that change can lead to good.”<br />
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But there was one tiny little detail she forgot to mention. During the post unification period East Germany's population went into melt-down mode. New York Times Columnist Nicholas Kulish <a href="http://www.nytimes.com/2009/06/19/world/europe/19germany.html?_r=0">put it like this</a>:<br />
<blockquote class="tr_bq">
Unemployment in the former East Germany remains double what it is in the west, and in some regions the number of women between the ages of 20 and 30 has dropped by more than 30 percent. In all, roughly 1.7 million people have left the former East Germany since the fall of the Berlin Wall, around 12 percent of the population, a continuing process even in the few years before the economic crisis began to bite.<br />
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And the population decline is about to get much worse, as a result of a demographic time bomb known by the innocuous-sounding name “the kink,” which followed the end of Communism. The birth rate collapsed in the former East Germany in those early, uncertain years so completely that the drop is comparable only to times of war, according to Reiner Klingholz, director of the Berlin Institute for Population and Development. “For a number of years East Germans just stopped having children,” Dr. Klingholz said.<br />
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The newspaper Frankfurter Allgemeine Zeitung reported recently that although 14,000 young people would earn their high school diplomas this year in Saxony, only 7,500 would do so next year. Since 1989, about 2,000 schools have closed across the former East Germany because of a scarcity of children. </blockquote>
Now this situation is quite serious, and needs a long term solution, but it is not as serious as what is currently happening to Latvia, or Bulgaria, or a number of the other former communist states. Unless, of course, the lesson Angela would like to draw our attention to is that East Germany managed to salvage something from what would otherwise be population wreckage by sneaking in under the shelter of another state, with a centralized system of support for pensions and health care. Somehow I doubt it, but perhaps this is what we need to think more about. The EU needs a pan European health and pension system, to distribute the burden equitably. This is the conclusion I reached during <a href="http://es.slideshare.net/Edwardhugh/latvias-demographic-future">my last visit to Riga</a>. It isn't just a Euro related issue, it is to do with having a unified labour market, with people able to move to where the jobs exist, and the pay is better. For years people complained about the absence of labour mobility in the EU. Now we have it, the flaw in the institutional infrastructure is obvious.<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 out of an ever older EU altogether. This has the simple consequence that the deficit issues in the core are reduced, while those on the periphery only get worse as health and pension systems become ever less affordable. Meanwhile, more and more young people 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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I am sufficiently concerned about this issue, which I think ultimately endangers possibilities of economic recovery all along the periphery, to have created <a href="http://www.facebook.com/PopulationLossOnTheEuropeanPeriphery">a dedicated facebook page</a>, campaigning for one single issue - that the EU Commission and the IMF give a greater priority to trying to measure these flows, and understand their consequences. I am simply asking that they pressure EU member states to improve their statistics gathering, treat the issue as a priority, and identify an indicator to incorporate in the <a href="http://epp.eurostat.ec.europa.eu/portal/page/portal/excessive_imbalance_procedure/imbalance_scoreboard">Macroeconomic Imbalance Procedure (MIP) Scoreboard.</a> Really it doesn't matter whether you are in favour of austerity, or against it, feel more Keynesian than Austrian, or vice verse, all I am asking for is that this problem be taken more seriously, measured and studied.<br />
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<span style="font-size: large;"><b>Bulgaria The Classic Case?</b></span><br />
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Really there has been a before and after to the financial crisis, at least insofar as awareness of the demographic dimension is concerned. Really, before the onset of the crisis very few people really attached much importance to the question. Since the arrival of the European sovereign debt crisis, and the fiscal cliff debate in the United States, awareness has grown that population ageing probably will slow economic growth, and that previous expectations about levels of pension and health care provision may have been way too optimistic. The latest example of this has been Nobel Laureate Paul's Krugman's comments on how <a href="http://www.bloomberg.com/news/2013-02-05/krugman-sees-japan-s-shrinking-population-as-crimping-growth.html">Japan's demographics may be influencing its growth rate</a>. In a tellingly graphic expression he explains that <a href="http://krugman.blogs.nytimes.com/2013/02/05/the-japan-story/">the root of Japan's ailment</a> might be that the country is suffering from a growing "shortage of Japanese".<br />
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Once you realise that population shortage may be a problem in Japan, you start wondering where else it might be one. And then, once you begin to look you start seeing the issue springing up like mushrooms all over the place. In Bulgaria for example. <br />
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<a href="http://www.euractiv.com/socialeurope/bulgarias-population-shrinking-a-news-503814">According to the 2011 census</a>, Bulgaria has lost no less than 582,000 people over the last ten years. In a country of 7.3 million inhabitants this is a big deal. Further, it has lost a total of 1.5 million of its population since 1985, a record in depopulation not just for the EU, but also by global standards. The country, which had a population of almost nine million in 1985, now has almost the same number of inhabitants as in 1945 after World war II. And, of course, the decline continues.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEikK3jKQjVg8V90Da29QKV_kjNHtefQ4V-oRI1FQ0LHZ0Q1UiYYhB-0A41KzlqmIvorSyAPqMrBPTsAShzAM3Fu_Ji4ox8uZ8wYDmeMA2o0H5iwktN5Q8fbykJheosXGL-61zL6/s1600/Bulgaria+Population+Pyramid.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="202" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEikK3jKQjVg8V90Da29QKV_kjNHtefQ4V-oRI1FQ0LHZ0Q1UiYYhB-0A41KzlqmIvorSyAPqMrBPTsAShzAM3Fu_Ji4ox8uZ8wYDmeMA2o0H5iwktN5Q8fbykJheosXGL-61zL6/s320/Bulgaria+Population+Pyramid.png" width="320" /></a></div>
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As well as shrinking the population is ageing. In 2001 16.8% of the population were over 65. Just 10 years later the equivalent figure had risen to 18.9%. Naturally this means the median population age is rising steadily. It is precisely part of my argument that this surge in median age over 40 has important consequences for saving and borrowing patterns at the aggregate level, patterns which have not yet been adequately measured and identified. Thus the macroeconomic dynamics of a country change. The impact of these changes has not yet been incorporated into the traditional models most analysts use in forecasting.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgIs4h7izohI8Nc1vENCqF9LDbeADC7LpGQ-wMrgyOuzJkYxUKdq3aLyZYzqt-tSEBPn4J01gBQGr8_YFhYAytZGDgJK0RV1ZpoW2rtKB2eHP6BqC4NimCMLGAv4J4cOEHOd3z2/s1600/Bulgaria+Median+Age.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="184" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgIs4h7izohI8Nc1vENCqF9LDbeADC7LpGQ-wMrgyOuzJkYxUKdq3aLyZYzqt-tSEBPn4J01gBQGr8_YFhYAytZGDgJK0RV1ZpoW2rtKB2eHP6BqC4NimCMLGAv4J4cOEHOd3z2/s320/Bulgaria+Median+Age.png" width="320" /></a></div>
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Naturally the workforce itself is in rapid decline.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvEj6kgyZY1TaAC2NMJ-rnhgE8iaAC5d4SmqayPsEBKLqfGEBvuI3PZdaLXH2W4hopGb9p2RZh0szELVZP8JcKp_91lyUQPdQH-2b7QbS5KMhpAcWIKC4YcyzTE8fz5vlLMGJ0/s1600/Bulgaria+Labour+Force.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="163" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvEj6kgyZY1TaAC2NMJ-rnhgE8iaAC5d4SmqayPsEBKLqfGEBvuI3PZdaLXH2W4hopGb9p2RZh0szELVZP8JcKp_91lyUQPdQH-2b7QbS5KMhpAcWIKC4YcyzTE8fz5vlLMGJ0/s320/Bulgaria+Labour+Force.png" width="320" /></a></div>
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The causes of Bulgaria's rapid ageing and shrinking population problem are twofold, low fertility and emigration. This is what makes the country look more like the old DDR and less like Japan. In fact Bulgaria's situation is an extreme case of what is happening in many East European countries, especially Romania and the Baltics. If you want another reference point, Ukraine would be in this group, but even worse, since it is even outside the EU. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVnqhqLptA5_rjrQ8lHlEzgQkWG8etck0XB7rR4mmnVJu6OnPkbi6b0NyXHDptZEKq9Zps_56JIt9U5UQPav0JFeoPVUFALsCFlT3cpX4pUj-2c9KNsJxPOXbbte2VnIiMpDyg/s1600/Bulgaria+Fertility.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="175" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVnqhqLptA5_rjrQ8lHlEzgQkWG8etck0XB7rR4mmnVJu6OnPkbi6b0NyXHDptZEKq9Zps_56JIt9U5UQPav0JFeoPVUFALsCFlT3cpX4pUj-2c9KNsJxPOXbbte2VnIiMpDyg/s320/Bulgaria+Fertility.png" width="320" /></a></div>
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Details of migrant numbers are scarce, and at best hedgy. The data we have is surely a significant underestimate, <a href="http://www.oecd.org/els/mig/IMO%202012_Country%20note%20Bulgaria.pdf">as the OECD pointed out in its latest country migration report</a>:<br />
<blockquote class="tr_bq">
Figures on declared emigration show an increase from 19 000 in 2009 to 27 700 in 2010. However, actual outflows are considered to be much greater, based on immigration statistics of th e main destination countries. Spain, the most important destination country in recent years, recorded 10 400 Bulgarians entering in 2010, 7% more than in 2009. Outflows of Bulgarian citizens from Spain also increased in 2010, to 7 600 from almost 5 000 in the previous year (+52%). The number of Bulgarians in Spain increased by 14 500 in 2010, and a further 13 000 in 2011. There are no consistent data for Greece, the second main destination of Bulgarian immigrants in recent years, but it seems that the stock increased less in 2010 than in previous years. </blockquote>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpOwxo8Cfm5LrLYCY0uaNvoXfNzuS_uGV856uUUhvYFHkVHnYSz3pFwUuWSjPWFQpNx7pev1at1vJTist8Mnc3TN7OEbkJEbZeIZLMKGLV9q30pJ6IWhdrECSpqnMS9zAhQLiq/s1600/Bulgarians+in+Spain.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="183" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpOwxo8Cfm5LrLYCY0uaNvoXfNzuS_uGV856uUUhvYFHkVHnYSz3pFwUuWSjPWFQpNx7pev1at1vJTist8Mnc3TN7OEbkJEbZeIZLMKGLV9q30pJ6IWhdrECSpqnMS9zAhQLiq/s320/Bulgarians+in+Spain.png" width="320" /></a></div>
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Remittances data gathered by the World Bank give the general picture. Basically there was a large surge following the severe crisis of the late 1990s, and since that time the level of payments has only weakened slightly, on the back of the severity of the crisis in the main destination countries. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBdbIqkpv9TAPisXGoCg2WB3TPjg5X9Alq_BU5tLgX44Un9F9EFD3Hg8DERA0u6QiKSNKCxs0sMFRayDOEXz6WkjJCIfRh3_l0kgT4CB_04xkQfOtZAb2njB0KfI6UsxweWrqv/s1600/Bulgaria+remittances.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="181" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBdbIqkpv9TAPisXGoCg2WB3TPjg5X9Alq_BU5tLgX44Un9F9EFD3Hg8DERA0u6QiKSNKCxs0sMFRayDOEXz6WkjJCIfRh3_l0kgT4CB_04xkQfOtZAb2njB0KfI6UsxweWrqv/s320/Bulgaria+remittances.png" width="320" /></a></div>
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Bulgaria is also pretty much what the old DDR would look like if it hadn't fused with Western Germany, namely it much more similar to Hungary than it is to Japan (in the sense I discussed <a href="http://hungaryeconomywatch.blogspot.com.es/2013/02/hungarys-matolsky-joins-japans-abe-in.html">in this post</a>) as it has a significant negative balance on the net international investment position (though not as large as Hungary's), which means as well as being quite poor it is totally unprepared for rapid population ageing (since the text book way to sustain pension and health benefits in a context of increasingly weaker headling GDP growth is normally thought to be to draw down on overseas assets).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjX3XYRTgT3VHTB5QSZ7oaxkEKlDd4owvLotIol3_D7-0GrCwsTIUmrkO8jwlbfB13GZfP2sF48z2QcdNysyT8eMNTm6tVV_ReuJjPR2k8HtZBrzKuJ1tETHBpKZV7Rls31Zgb3/s1600/Bulgaria+NIIP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="181" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjX3XYRTgT3VHTB5QSZ7oaxkEKlDd4owvLotIol3_D7-0GrCwsTIUmrkO8jwlbfB13GZfP2sF48z2QcdNysyT8eMNTm6tVV_ReuJjPR2k8HtZBrzKuJ1tETHBpKZV7Rls31Zgb3/s320/Bulgaria+NIIP.png" width="320" /></a></div>
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Bulgaria also bears comparison with Hungary for the way it has carried out a rapid correction on its external position. This is due largely to remittances and services exports, since the goods balance is still in deficit. But still, the turnround is impressive.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhccWttbSalR6cy1zZeBBhHnrFT1bBk0CmizKnyoDne0y2-e0taJtrRo4gUqLnPQ2Ilrr6FwG78EzZFEzgPqhi0nAIPrHj1EzkNl6vQoluoIgFKHjylvSd2ydoT1sWO4NiRjlGN/s1600/Bulgaria+Current+Account+Annual.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="178" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhccWttbSalR6cy1zZeBBhHnrFT1bBk0CmizKnyoDne0y2-e0taJtrRo4gUqLnPQ2Ilrr6FwG78EzZFEzgPqhi0nAIPrHj1EzkNl6vQoluoIgFKHjylvSd2ydoT1sWO4NiRjlGN/s320/Bulgaria+Current+Account+Annual.png" width="320" /></a></div>
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As elsewhere exports have performed very strongly.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDZNEmsS6ptZzncxy5oAITBFtZZZzfv2Vj2OvLeZo6pEKrtHk0_2nRX5Z2Vaajuf0niNSjGUujTdRwYAi1rru_J5ZhoXUjON7pixo4Ucmyh3K_Sm30-TTQUS7VAzYY8nDCHUw-/s1600/Bulgaria+Constant+Price+Exports.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="191" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDZNEmsS6ptZzncxy5oAITBFtZZZzfv2Vj2OvLeZo6pEKrtHk0_2nRX5Z2Vaajuf0niNSjGUujTdRwYAi1rru_J5ZhoXUjON7pixo4Ucmyh3K_Sm30-TTQUS7VAzYY8nDCHUw-/s320/Bulgaria+Constant+Price+Exports.png" width="320" /></a></div>
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But again to no real avail, since domestic demand is deflating so strongly that the economy struggles to find air...... and growth. In this sense it is hard to agree with the IMF Executive Directors when they state in their latest <a href="http://www.imf.org/external/np/sec/pn/2012/pn12140.htm">Public Information Notice,</a> following conclusion of the Fund's 2012 Article IV consultation, they "broadly agreed that the currency board arrangement has served Bulgaria well". If allowing a country to drift towards long term melt-down is doing well, I would hate to see what something which they thought was an impediment would do! Some thing is rotten in the state of Denmark, and that something isn't being identified or dealt with.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9GwKE_QImJYTxZVj2A0oT3M0abi9yd-NDoTK040ATfz_RXcolDqp5P3Ocedet567qbkrA4piOPexY5RXtGA2DwYH4-wHtOHnmOunE5_kW-VFjBupxy30iAf62y_OAPAN4J50x/s1600/bulgaria+retail+two.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="173" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9GwKE_QImJYTxZVj2A0oT3M0abi9yd-NDoTK040ATfz_RXcolDqp5P3Ocedet567qbkrA4piOPexY5RXtGA2DwYH4-wHtOHnmOunE5_kW-VFjBupxy30iAf62y_OAPAN4J50x/s320/bulgaria+retail+two.png" width="320" /></a></div>
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Naturally part of the problem is that the flow of credit has dried up.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhoBIIct0YjczBW8nZYvJoqGGav1FCEBP9oLwzlz5VI3KO6ygcDiWgW_tPtQo2H1dt4bY7d-KYiwc2hZLrqQlstEFwhdmLVZUNwiO1YXUmACSPIkn5Fav8FommTK8qzwhhh5f2d/s1600/Bulgaria+Total+Loans.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="190" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhoBIIct0YjczBW8nZYvJoqGGav1FCEBP9oLwzlz5VI3KO6ygcDiWgW_tPtQo2H1dt4bY7d-KYiwc2hZLrqQlstEFwhdmLVZUNwiO1YXUmACSPIkn5Fav8FommTK8qzwhhh5f2d/s320/Bulgaria+Total+Loans.png" width="320" /></a></div>
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But the other part is surely the one Krugman identified in Japan, the growing shortage of Japanese (sorry, Bulgarians). It is hard to see how you can get serious retail sales growth in a population that is shrinking so rapidly. The end result is that the economy grew steadily into the global crisis, and subsequently has stagnated. This stagnation isn't simply conjunctural anymore, it has become structural, as the decline in domestic demand associated with ongoing deleveraging and population ageing and shrinkage precisely offsets the positive impact of all that export growth.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfJKxjv3bDVFd2YZije9QbCBBEFNq8thqtReLq3PYaLwpGiM99EEKslGhOBvTUQ8E9FrL1zow2aqsvW3Uc0Xd-aaWK_syvBiGWK2YpAxjn4oDbr5VkFKUi7Yc6VSNbqlrEnJ_O/s1600/Bulgaria+Constant+Price+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="189" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfJKxjv3bDVFd2YZije9QbCBBEFNq8thqtReLq3PYaLwpGiM99EEKslGhOBvTUQ8E9FrL1zow2aqsvW3Uc0Xd-aaWK_syvBiGWK2YpAxjn4oDbr5VkFKUi7Yc6VSNbqlrEnJ_O/s320/Bulgaria+Constant+Price+GDP.png" width="320" /></a></div>
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Not everyone is convinced, of course. The IMF expect the Bulgarian economy to return to a rate of growth of between 3% and 4% after 2014, but looking at the demographics and comparing it with what we are seeing elsewhere that seems pretty unrealistic. What is the expression Christine Lagarde would use? "Wishful thinking" perhaps?<br />
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In any event, in the short term the country looks set to significantly underperform any such rosy expectations. <a href="http://www.focus-economics.com/index.php">FocusEconomics</a> Consensus Forecast panellists expect the economy to expand 1.4% this year. In 2014, the panel expects economic growth to reach the impressive rate of 2.4%.<br />
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<span style="font-size: large;"><b>Growing Political Discontent </b></span><br />
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Since Bulgaria is a small country, and a poor one to boot, most of the above had been going on virtually unnoticed by the rest of the world. Then last week the Bulgarian government <a href="http://www.reuters.com/article/2013/02/20/bulgaria-government-idUSL6N0BK1FG20130220">suddenly resigned en bloc</a>. The immediate cause of the crisis which lead to the resignation was the continuing rise in energy costs, a rise which was largely blamed on the Czech provider CEZ. To appease the street protestors the government has now initiated<a href="http://www.bloomberg.com/news/2013-02-20/bulgaria-regulator-holds-hearing-on-cez-license-april-16.html"> a procedure to revoke the company's licence</a>, a move which has started to raise concerns about institutional protection in the country. <br />
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According to <a href="http://www.bloomberg.com/news/2013-02-20/bulgaria-regulator-holds-hearing-on-cez-license-april-16.html">the report in Bloomberg</a>:<br />
<blockquote class="tr_bq">
Bulgaria’s State Financial Inspection Agency started a probe into CEZ’s Bulgarian units last year and submitted a report on Feb. 8, saying that CEZ ‘‘evaded requirements of the Law for Public Tenders,” the Energy and Economy Ministry in Sofia said on Feb. 18.
The ministry asked the authority to conduct a similar investigation into the local units of Austria’s EVN AG and Prague-based Energo-Pro, it said.
Bulgaria sold seven power distributors in 2005 to EON SE, CEZ and EVN before joining the European Union. EON sold its Bulgarian companies to Energo-Pro in 2011.
</blockquote>
Czech Prime Minister Petr Necas <a href="http://www.bloomberg.com/news/2013-02-19/bulgarian-police-clash-with-sofia-anti-government-protesters-1-.html">was not slow to respond</a>:<br />
<blockquote class="tr_bq">
“I regard the statements by Bulgarian officials about CEZ and other foreign companies as very non-standard and see the whole issue as highly politicized because of the approaching parliamentary elections,” Necas said. “I expect Bulgaria, as a member of the European Union, to stick to its international obligations, European law and its own laws on protection of foreign investments.”
</blockquote>
Naturally energy prices are not the only issue. The population is tiring of austerity, and living standards that don't rise even as unemployment does.<br />
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One symptom of this is that Bulgaria's government <a href="http://www.reuters.com/article/2013/02/18/us-bulgaria-government-idUSBRE91H0KS20130218"> sacked Finance Minister Simeon Djankov</a> at the start of last week. Djankov was closely identified with austerity policies, and it isn't hard to read his departure as an attempt to curry favour with voters in elections which are due this summer.<br />
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Having said that, the country's government debt at under 14% of GDP is incredibly low, so there is room for flexibility, if it wasn't populist flexibility. The real issue is that simply spending more this year, or next, won't fix the underlying problem, and that problem is unlikely to be addressed until it is recognized as a problem by the institutions responsible for economic policy formulation. As someone once said, de-nile is not only a river in Egypt.<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>".<br />
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<span style="font-size: large;"><b>Postcript</b></span><br />
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<a href="http://en.wikipedia.org/wiki/There%27s_a_Hole_in_My_Bucket">According to wikipedia</a>: "There's a Hole in My Bucket" (or "...in the Bucket") is a children's song, along the same lines as "Found a Peanut". The song is based on a dialogue about a leaky bucket between two characters, called Henry and Liza. The song describes a deadlock situation: Henry has got a leaky bucket, and Liza tells him to repair it. But to fix the leaky bucket, he needs straw. To cut the straw, he needs a knife. To sharpen the knife, he needs to wet the sharpening stone. To wet the stone, he needs water. However, when Henry asks how to get the water, Liza's answer is "in a bucket". It is implied that only one bucket is available — the leaky one, which, if it could carry water, would not need repairing in the first place.<br />
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<br />
The origin of this song seems to go back, oddly enough, to the German collection of songs known as the Bergliederbüchlein. Ironically Henry's Q&A with Liza fits the quandry facing the countries on Europe's periphery and their lack of constructive dialogue with their core peers about the roots of their problems to a tee.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3950127.post-70911719515789204992013-02-24T17:03:00.002+01:002013-02-24T17:03:10.304+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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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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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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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.
</blockquote>
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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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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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-3950127.post-29707934623489458252012-11-25T16:51:00.002+01:002012-11-25T16:51:33.133+01:00After The Fat Lady SingsFinancial journalists across the globe were both surprised and puzzled recently <a href="http://www.telegraph.co.uk/finance/financialcrisis/9682247/Lagarde-Not-over-in-Greece-until-fat-lady-sings.html" target="_blank">when they heard Christine Lagarde using a strange expression</a>. "You know, it's not over until the fat lady sings, as the saying goes," she told bemused reporters at a press conference in Manilla. Which fat lady, and what does she sing must have been questions going through the heads of many of those present.
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Further investigation would have lead them to discover that far from this being some new piece of feminine wisdom that the IMF DG wanted to transmit, the phrase in fact comes from the rather male world of business deals and contact-sport-commentators and is generally used to describe closely contested matches, or deals which won’t be struck till the final offer is actually made.
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Ms Lagarde naturally had other things in mind. She was referring to the state of negotiations surrounding the latest Greek bailout review, prior to the handing over of that long awaited 31.5 billion euro tranche the country so badly needs to meet its ongoing commitments. The curious thing about the holdup in this case is that it isn’t the result of a stand-off between the Troika and the Greek government. Last week the Greek parliament passed the final set of budget decrees required by the international lenders to enable the transfer. <br />
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No, in this case the dispute is an “internal affair” between the rival parties which make up the Troika, and in particular between the German government and the IMF. The issue is how to leave Greek finances having at least the appearance of being on a stable and sustainable path, which in this case is defined as attaining a sovereign debt level of 120% of Greek GDP come 2020. Delaying the country’s fiscal objectives by 2 years effectively means putting back the theoretical attainment of that objective by the same amount of time - until 2022. Jean-Claude Juncker was willing, but the IMF is digging its heals in. Any new agreement, Ms Lagarde said as she left Manilla en route for Tuesday’s Brussels EU finance ministers meeting, should be "<a href="http://www.reuters.com/article/2012/11/17/us-imf-europe-idUSBRE8AG0C720121117" target="_blank">rooted in reality and not in wishful thinking</a>.” Tut tut, Mr Juncker.
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So whence this sudden hardening in the Funds position? Well, it may be just a coincidence, but the US elections are now over. Barack Obama need not now preoccupy himself with what a hypothetical exit by Greece from the Euro would do for his campaign. Non-European members of the Fund have long been chaffing at the bit over the extent of the “kid gloves” treatment so many apparently rich countries have been receiving, and have been arguing for a much more independent and tougher approach. Now with the US starting to shift its ground the balance of opinion has clearly changed.
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Greece’s debt is evidently on an unsustainable path however you look at it. Just getting through to 2020 isn’t enough, since the following decade is going to be very challenging demographically for the struggling country. Greece needs either a much more substantial reduction in its debt levels, or a negotiated exit from the Euro. <br />
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Realists are now pushing this view, but realists are also pragmatic people, they recognize that Angela Merkel has elections looming in the autumn of 2013, and that she can only go so far at this point. So it is simply the principle of the thing that needs to be established now. We can all get down to the real details once Greece fails another review, possibly towards the end of 2013. What Christine Lagarde did make clear in Manilla is that being “rooted in reality” means is that the best way countries in the Euro Area can send a strong and credible signal they remain committed to Greece’s continuing Euro membership is by agreeing in some way shape or form - the formula doesn't matter - to reduce the debt Athens owes them. <br />
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As Deutsche Bank analyst Mark Wall so tactfully put it in his latest report on the situation, "The objective of the current round of decisions will be to 'kick the Greek can' beyond the German elections in September 2013".<br />
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So it seems to me that later, after the German elections are over, the fuller implications of this initial signal of "realism" can be fleshed out. By that point Greece’s crisis-weary population will surely be ready for neither another year of substantial austerity cuts, nor for yet another year of recession, so a solution will need to be found. Unemployment will likely be over 27% at that point, and with people possibly being asked to grin and bear a seventh year of recession, we may well be rapidly closing in on a "just how much of this can you really stand" type situation. <br />
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If the debt pardoning cannot be great enough then Grexit will be on the table as a contemplatable solution. As Citi analyst Giada Giani puts it in the their latest report, "even if a return to a semblance of sustainability is agreed for the Greek debt and the next bailout tranche is released, we doubt this will be the deal that fixes Greece once and for all. We think a Grexit scenario still has a 60% probability of occurring in the next 12-18 months."
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<strong>Calm Before the Storm?</strong><br />
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So, the Euro Crisis is going to be effectively put on the back burner over the next nine months or so, or at least that is the hope in Berlin. Naturally there are no shortage of loose cannons that can come into play to make this hope just another example of what Lagarde calls “wishful thinking”, but even assuming everyone gets the time-out people are hoping for, just what is going to happen when the German election milestone is passed? To the external observer, it does look like fund managers from across the planet are being told one thing (that Germany will then take the bold steps which are so evidently needed to shore up the common currency) while German voters will be voting in the exact opposite belief, even to the extent perhaps of being lead to think that the OMT bond buying programme is merely temporary. So someone is going to be very badly disappointed, and not long from now market participants will have to start placing their bets on who they think that someone is going to be.
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<br />
But to return to where we started, just who was that fat lady, and what exactly did she sing? Well deeper investigation into the world of urban legends reveals that the woman in question is none other than Brünnhilde, shieldmaiden and valkyrie in Norse mythology, as well as heroine in Wagner's famed and fateful opera Götterdämmerung. As opera fans will remember, when the singing stops the world of Valhalla comes to an abrupt end, as Brünnhilde throws herself on a pre-prepared funeral pyre and in so doing initiates the final destruction the known world. Although the interpretation that this was some sort of "Freudian slip" for what the IMF boss actually fears could happen - namely the Greek Heracles might finally abandons his labours and descend into the nether world of Hades - is plausible and available, I prefer to think it was in fact a match of American football she had in mind. At least that way I sleep better.
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-3950127.post-27331966157773255662012-11-19T10:57:00.001+01:002012-11-19T10:57:31.638+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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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 />
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<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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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRC5E34W04Q8hIUTmfZgUdTf5_Zjn4_mPjgQzcXw2hQgxiyuL-43ssS4yfaxlc4JyO4ObXcxP8153ZEAyQFIT9oqYkYs8xNMqnRKFdpsZSVVSgUViQA4W_-rYRU2_D2DW6bbUK/s1600/Spain+services.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="185" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRC5E34W04Q8hIUTmfZgUdTf5_Zjn4_mPjgQzcXw2hQgxiyuL-43ssS4yfaxlc4JyO4ObXcxP8153ZEAyQFIT9oqYkYs8xNMqnRKFdpsZSVVSgUViQA4W_-rYRU2_D2DW6bbUK/s320/Spain+services.png" width="320" /></a></div>
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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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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiSJQe4ZYpbRVbIZce3oXyZ5weXzb5RyZQRzCWeODs4v_Uwsehr1pJqalKqduRG3FWm7a4_pUt0N_-reDCysM3YWBVdVa9UU9pK-8wuhnERlyPfrYQmBj7xMWmd-ib8qIqkfJee/s1600/Spain+Constant+Price+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="192" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiSJQe4ZYpbRVbIZce3oXyZ5weXzb5RyZQRzCWeODs4v_Uwsehr1pJqalKqduRG3FWm7a4_pUt0N_-reDCysM3YWBVdVa9UU9pK-8wuhnERlyPfrYQmBj7xMWmd-ib8qIqkfJee/s320/Spain+Constant+Price+GDP.png" width="320" /></a></div>
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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 />
<strong></strong><br />
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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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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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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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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Not only that the goods trade deficit is reducing:<br />
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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/AVvXsEgD9mwTclvDTW0RzbjJVZVaY3N8GsvqtPY2cHKDNAtmdUzxKpxrMR0mfKqfXIJaIiy7v6WPaK_doB-CPLsJ8LB5tpZnb6cd1Fz9H2dHe_vW_9LXx-3Je52yfwmBi5SJKhO9bKD3/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/AVvXsEgD9mwTclvDTW0RzbjJVZVaY3N8GsvqtPY2cHKDNAtmdUzxKpxrMR0mfKqfXIJaIiy7v6WPaK_doB-CPLsJ8LB5tpZnb6cd1Fz9H2dHe_vW_9LXx-3Je52yfwmBi5SJKhO9bKD3/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/AVvXsEgVwOdC1lmhKYGadkMlnm2vxJl6qzImFOpcBLskhJ-ZxM-5ipgeGnBAjnj-9Z0YiKdt1OpHghwZMgBJI7HKQRg_l5uRERcHkhHIwmenuj5acBLU-xs9NjYogWlXKhl-ajuz1MlE/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/AVvXsEgVwOdC1lmhKYGadkMlnm2vxJl6qzImFOpcBLskhJ-ZxM-5ipgeGnBAjnj-9Z0YiKdt1OpHghwZMgBJI7HKQRg_l5uRERcHkhHIwmenuj5acBLU-xs9NjYogWlXKhl-ajuz1MlE/s320/Spain+Machinery+and+Equipment+Investment.png" width="320" /></a></div>
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<br />
<strong>Where Is The End Game?</strong><br />
<br />
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/AVvXsEiw0r3R7vNlGtZV-51AGnvACtlrR5X7x4y7atI7vshL7aO_B2dCJmX7hFz7h_OJvwZlRr5rOnKF6UN5v78V7dBdBUVD0EJDmxznDsh8Y8hqd56YJr0Myq06nrvYzJHq-7QiPBCf/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/AVvXsEiw0r3R7vNlGtZV-51AGnvACtlrR5X7x4y7atI7vshL7aO_B2dCJmX7hFz7h_OJvwZlRr5rOnKF6UN5v78V7dBdBUVD0EJDmxznDsh8Y8hqd56YJr0Myq06nrvYzJHq-7QiPBCf/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/AVvXsEiAkT6X-PeBryYbRjjVoS_hTJtBz1F9oPVD_tcNtGHCtrm2jfwOcSK5AaJe7ExtFBfTQbt8LCPL824OsK_jflZXrc2R8nmWQNyqUZyMuLd1E2X2gpo4N-xoXqMVNQsfmdWPak0S/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/AVvXsEiAkT6X-PeBryYbRjjVoS_hTJtBz1F9oPVD_tcNtGHCtrm2jfwOcSK5AaJe7ExtFBfTQbt8LCPL824OsK_jflZXrc2R8nmWQNyqUZyMuLd1E2X2gpo4N-xoXqMVNQsfmdWPak0S/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-3950127.post-70355012568313491532012-10-22T17:07:00.000+02:002012-10-22T17:50:07.562+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 />
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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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
But is the argument symmetrical? That is, does it work the other way round?<br />
<br />
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 />
<br />
<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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<br />
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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<br />
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-3950127.post-61470720986144775872012-08-14T17:52:00.002+02:002012-08-14T18:11:38.580+02:00In Search Of Lost DemandSo here's the 5 trillion dollar trick question. In <a href="http://finance.yahoo.com/news/analysis-five-years-central-banks-172756291.html" target="_blank">an interesting article</a> on the limitations of central bank monetary policy in the current environment, Reuter's Alan Wheatly made the following statement which caught my attention. "Central banks are rummaging through their toolkits because, despite slashing interest rates and buying vast quantities of bonds, they have signally failed to revive a global economy hamstrung by heavy debts and weak banks". But thinking about it for a couple of minutes, you could ask yourself why is this so? <br />
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Why is the global economy hamstrung by heavy debts and weak banks? Or put another way, why doesn't deleveraging happen, and the weight of debt reduce, and why doesn't the economy expand so the weak banks can once more become robust and healthy ones?<br />
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Short answer, it's the demand side stupid! The longer version was offered by Paul Krugman when he asked the ironic question, "To which planet are we all going to export?" Basically the demand needs to come from somewhere - unless of course you believe that "supply creates its own demand". What makes this crisis different from many of its predecessors is the global extension of the problem. If we were just talking about a few countries (as in the Asian crisis of 1998, which is so often mentioned in this context) then the answer would not be that hard, reduce currency values and export like mad to the non-affected countries. But in the current crisis, almost all developed economies are affected to one degree or another. The to one degree or another part is interesting, but it doesn't form part of what I am driving at here.<br />
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There are countries which are not so heavily in debt, and which do have a large growth capacity and a huge quantity of so called "pent up" demand - the so called Emerging Economies. But the simple math fails us. If we look at the first chart below the non "advanced" economies have been growing much more rapidly than the advanced ones since around 2002, so the potential is there.<br />
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But if we look at the second chart, these economies are still only around 40% of global GDP, so it is demand in 40% which is having to pull the other 60% with it. The interesting part is that in the space of a decade these economies have surged from 20% to 40% of the total. If the same trend continues by 2020 they could easily constitute 60%. Then things could be different, since we could have 40% of the total living from exporting to the other, faster growing, 60%. But we aren't there yet, which is why I think this decade will be a transitional one, one during which the developed economies (on aggregate) will struggle to find growth.<br />
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Nonetheless, emerging markets are growing fast, aided from time to time by an injection of liquidity from the developed world central banks. The IMF still expects the world economy to grow by 3.5% this year. Two issues cast something of a shadow over the immediate outlook. The first is the visible slowdown in Chinese growth, and the other is ongoing concern about the ultimate endpoint of the Eurozone drama in innumerable acts. The key point to appreciate about the second issue is that with “risk off” due to the European Debt Crisis, even the Emerging Markets are unable to exploit their huge potential for growth. Capital is not flowing into these markets in the way it did following the various rounds of QE in the US and even the LTROs in Europe. These impacts can be seen in the JP Morgan Global Composite PMI chart below.<br />
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Both QE1 and QE2 were followed by large surges in global activity, and even last November's LTRO from the ECB produced an unexpected turnaround that some would argue has only been putting off the inevitable. Certainly, the force of the LTRO impact wrong footed many of us, since it produced a stabilization of global activity which lasted all through the first half of this year (see the latest German GDP results for additional evidence).<br />
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The China factor is also important. It was curious to watch a world which had just slumped following the collapse of an unsustainable debt orgy hoping to save itself by egging another country on to repeat the performance. Naturally, history isn't a mere repetition of the same, and the Chinese conundrum contains plot elements not seen elsewhere, including an ultra important export sector, but still it is hard to see how so many people could have remained silent in the face of what appears to have been a crazed investment boom. Still, China is a long way from having its back broken, even if the spinal column does need a lot of straightening out. The awkward part is that the "Chinese correction" comes just at the wrong time as far as global growth is concerned.<br />
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In any event, the BRIC concept was always far too general. It is just based on population size and the presence of underdevelopment. The key factor for growth dynamics, as I keep arguing, is age structure, and in this sense India and Brazil look very different from Russia and China. Economic growth is partly about favourable demographics, and partly about institutional quality. Some EMs have favourable demographics, and some of these also are increasingly moving towards growth enhancing institutions. Others with favourable demographics are an institutional nightmare - Argentina is a good example, and others (like Ukraine or Belarus) have neither favourable demography nor positively evolving institutions, indeed in the two aforementioned cases it is unlikely they ever will.<br />
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What follows is a summary of my July manufacturing PMI report. The complete version can be found on Slideshare (<a href="http://www.slideshare.net/Edwardhugh/july-manufacturing-pmi-13903225" target="_blank">here</a>).<br />
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<strong>Manufacturing Visibly Slowing Across The Planet</strong>
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We live in a globalised world. And what better illustration of this truism than the way in
which manufacturing activity is steadily slowing across the planet. In theory the
worsening conditions are a by-product of the Euro Debt Crisis, but in reality there
are a multitude of factors at work – the slowdown in China, exhaustion of a credit
boom in Brazil, a Japan which can’t export as much as it needs to due to the high
value of the Yen, a United States where the various rounds of quantitative easing
appear to have run out of steam.<br />
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But we also live in a world which is structurally in transition. The developed countries
are overly in debt (especially when we consider health and pension liabilities
looking forward) and ageing excessively. The emerging economies are
experiencing a massive demographic, cultural and economic transition. The so
called “Arab Spring” is just one example of this. Risk is being re evaluated, with
developed world risk rising, at the same time as risk perception of Emerging Economies improves.<br />
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So the paths are crossing. Recessions in the developed world will now be more
frequent and the recoveries shallower, while EMs will experience substantial catch
up growth, while the recessions will be much more modest than previously.<br />
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Having said this, it is still impressive to note the diversity even among the EMs. This month I was struck by the way manufacturing sectors in some countries (like Indonesia and Vietnam) are now evidently having a hard time of it, while in others (India, Turkey) they are managing to keep their heads just above water. But in all cases what is most notable in the report summaries that follow is the way in which exports are suffering, and export order books contracting, which suggests we have another six months or so of stagnation or worse staring us in the face.
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<span style="font-size: large;">Global manufacturing downturn gathers pace in July</span><br />
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The global manufacturing sector slid further into contraction territory at the start of the third quarter. At 48.4 in July, the JPMorgan Global Manufacturing PMI posted its lowest level since June 2009. The PMI remained below the neutral 50.0 mark for the second straight month, signalling back-to-back contractions for the first time since mid-2009.
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Europe remained the main source of weakness during July, while the performances of the US, Brazil and much of Asia were at best only sluggish. Manufacturing PMIs for the Eurozone and the UK sank to their lowest levels for over three years. Within the euro area, the big-four nations fell deeper into recession, while Greece continued to contract at a substantial pace. Eastern Europe fared little better, with downturns continuing in Poland and the Czech Republic.<br />
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The ISM US PMI posted a sub-50.0 reading for the second successive month in July. Rates of contraction accelerated in Japan, South Korea, Taiwan and Vietnam, but eased slightly in Brazil and China. Brighter spots were Canada, India, Indonesia, Ireland, Mexico, Russia and South Africa, which all signalled expansion during the latest survey period. Manufacturing production and new orders both fell for the second month running in July, with rates of contraction gathering pace. International trade volumes, meanwhile, declined to the greatest extent since April 2009. Job losses were reported for the first time November 2009. With demand still weak and a sharp drop in backlogs suggesting spare capacity is still available, staffing levels could fall further in coming months.
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Commenting on the PMI survey, David Hensley, Director of Global Economics Coordination at JPMorgan, said:
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<blockquote>
"Weak demand and the ongoing period of inventory adjustment pushed the global manufacturing sector into deeper contraction at the start of Q3 2012. Job losses were also recorded for the first time in over two-and-a-half years. Recent cost reductions are providing some respite, but this will be of little long-term benefit if underlying demand fails to pick up.”</blockquote>
<b><span style="font-size: large;">Asia</span></b><br />
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Viewed as a continent, it is very hard to make generalitzacions about Asia. Japan is
among the oldest countries on the planet. Domestic demand is congenitally weak, and
exports struggle against the weight of an overvalued yen. The important point to notice
is that all last years predictions about Tsunami reconstruction bring a new lease of life to the country have proven to be ill founded. All the associated damage has done is produce more debt. And still the economy struggles to grow. This issue will doubtless become worse after the government introduces the long promised increase in consumption tax. <br />
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China is suffering from a real estate adjustment which influences internal demand, while the global trade slowdown harms the export sector. In addition, the country’s potential growth rate, after hitting double digits at one point, is now slowing steadily as China steadily moves from emerging economy to mature economy status. India continues to advance at rates which are not seen in most Asian economies these days, but the country has an endemic inflation problem which remains unresolved, and growth is also hampered by poor infrastructure and widespread corruption. The semi developed economies like South Korea and Singapore still struggle to overcome weak export demand, and even new emergers like Vietnam and Indonesia remain challenged to find growth at this point.<br />
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<strong>Japan</strong>
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The Japanese economy slowed more sharply than expected in the April-June quarter as exports and consumer spending lost steam, raising the specter of further deceleration for the rest of this year.
Japan's economy grew strongly in the first quarter on increased government spending to aid in the rebuilding of areas battered by the March 2011 earthquake and incentives to boost sales of fuel-efficient vehicles. But fiscal policy appears no longer enough to offset the growing impact of the high yen coupled with Europe's persistent debt crisis and the resulting global slowdown on Japan's export-reliant economy.<br />
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July data from the Markit/JMMA manufacturing PMI survey confirmed the continuation of the April-June trend since it showed manufacturing output falling at the sharpest rate in 15 months, with both new orders and new export business decreasing at accelerated rates. <br />
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<blockquote>
Commenting on the Japanese Manufacturing PMI survey data, Alex Hamilton, economist at Markit and author of the report said:
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“Business conditions in Japan’s manufacturing sector took a turn for the worse in July, according to latest PMI survey findings. Factory output, new orders and exports all decreased at the fastest rates since April 2011, while input buying and backlogs also decreased markedly. These are worrying developments given the weakness of global demand at present.</blockquote>
<strong>China</strong><br />
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In China the HSBC Purchasing Managers’ Index posted 49.3 in July, up from 48.2 in June, signalling Chinese manufacturing sector operating conditions only deteriorated marginally. Indeed, the month-on-month increase in the index, though small, was the largest in 21 months.
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So while the Chinese economy is holding up far better than most of the hard landing people thought, the expectation was that it would be doing more than just holding up at this point in time. It was supposed to be both in the midst of a full-fledged recovery and driving the global demand chain. Chinese economic growth slowed to an annualised 7.6 per cent in the second quarter, its slowest pace since the height of the global financial crisis in 2009. And further data published last week indicated that it may need to do more to stop the rot which has now set in. Industrial production growth dipped to 9.2 per cent from 9.5 per cent in June, defying many analysts expectations for a rebound. Retail sales growth fell to 13.1 per cent from 13.7 per cent, while investment only managed to hold steady at a 20.4 per cent year-to-date pace. These are still large numbers, but for China, incredibly, they represent a slowdown. The fear is there may be worse to come.
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<blockquote>
Commenting on the China Manufacturing PMI™ survey, Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC said: <br />
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“Final manufacturing PMI confirmed only a modest improvement of manufacturing conditions thanks to the initial effect of the earlier easing measures. But this is far from inspiring, as China’s growth slowdown has not been reversed meaningfully and downside pressures persist with external markets continuing to deteriorate. We still expect Beijing to step up policy easing in the coming months to support growth and employment.”
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<strong>India</strong><br />
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In India the HSBC Purchasing Managers’ Index posted 52.9 in July, down from the reading of 55.0 recorded in June and pointing to a continuing slowdown in the manufacturing sector.
In fact Indian industrial production slid in June for the third time in four months, with output of capital goods plunging the most on record.
Production at factories, utilities and mines declined 1.8 percent from a year earlier, after a revised 2.5 percent rise in May. Capital goods output, an indication of investment in plants and machinery, fell 27.9 percent.
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Indian manufacturing has been struggling in recent months as inflation hovering above 7 percent has been eating into domestic demand and Europe’s debt crisis restricts exports. Price pressures from a drop in the rupee and the impact of a weak monsoon on crops forced the central bank to leave interest rates unchanged in July, breaking a trend towards reduced borrowing costs which extends from China to Brazil to Europe. The rupee has now slumped about 18 percent against the dollar in the past 12 month.<br />
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Headline inflation, which was 7.25 percent in June (the fastest pace among the world’s largest emerging markets) fell unexpectedly to the slowest pace in nearly three years in July following a sharp drop in fuel prices, but risks of a revival in price pressures may still discourage the central bank from lowering interest rates to spur economic growth.
The wholesale price index rose 6.87% in July from a year earlier. <br />
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Indian GDP rose 5.3 percent in the first quarter from a year earlier, the slowest pace since 2003, and both Standard & Poor’s and Fitch Ratings have warned they may strip the country of its investment- grade credit rating, citing risks including fiscal and current- account deficits.
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<blockquote>
Commenting on the India Manufacturing PMI™ survey, Leif Eskesen, Chief Economist for India & ASEAN at HSBC said: <br />
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"Manufacturing activity grew at a slower clip in July on the back of power outages and a moderation in new order inflows, with the weak global economic conditions dragging down export orders. Moreover, orders decelerated faster than inventory accumulation suggesting that the more moderate expansion in output will continue in the months ahead. The slowdown in order growth allowed manufacturers to reduce backlogs of work. Moreover, input and output prices decelerated, but inflation remains above historical averages."</blockquote>
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<span style="font-size: large;">Europe Heads Into Its Next Recession</span><br />
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The eurozone economy shrank in the second quarter, having flatlined in the first, despite continued German growth which looks increasingly fragile with every passing day out. Bailed-out Portugal saw its recession deepening with GDP diving by 1.2 percent on the quarter and 3.3% on the year, meaning that the threat of missing its deficit target this year is becoming increasingly real.<br />
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Figures released earlier had already showed deficit-cutting measures helped to shrink Greece's economy 6.2 percent year-on-year in the second quarter.
Italian data last week showed the economy contracted 0.7 percent quarter-on-quarter, compounding the difficulties for Mario Monti's technocrat government as it tries to avoid a bailout.
Spain's economy shrank 0.4 percent over the same period, pushing it deeper into recession.
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As a result the currency bloc contracted by a quarterly 0.2 percent despite Germany eking out 0.3 percent growth. The storm cloud don't cease to gather, though, and just today the forward-looking ZEW sentiment index slid for a fourth month running. All the leading indicators for Germany now suggest looming contraction.<br />
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Thus, even as Europe’s leaders continue to fiddle around with the debt crisis, the economies of the Euro Area sink deeper into the mire. The latest round of PMIs suggest that the recession will become official in the third quarter, and at the present time there is no let up in sight. <br />
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Certainly progress is being made in terms of the liquidity and capital needs of Euro Area banks, and further moves to ease sovereign financing difficulties seem to be at hand, But competitiveness issues are still a long way from finding solution. There is no evidence to back the idea of a surge in German inflation, while VAT hikes in country’s like Spain continue to damage their relative cost position. <br />
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The ECB has raised market expectations considerably in recent days. In the short run such expectations have foundered on disappointment. In the longer run, however, the ECB is likely to have few unbreachable limits to its freedom of action. Movement by the EU and the ECB will require formal requests for aid and involve conditionality. When this happens the most likely policy move with be SMP reactivation by the ECB in the secondary market and EFSF purchases in the primary one. Finally a reminder: it is important to remember the Greek problem has not gone away, it is simply in limbo. The Troika have gone home for now, but they did leave a message, courtesy of the Ramones, “see you in September”.
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<strong>Eurozone manufacturing recession deepens at start of third quarter</strong>
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The final Markit Eurozone Manufacturing PMI fell to a 37-month low of 44.0, down from 45.1 in June. The PMI has now signalled contraction for 12 consecutive months. Widespread weakness was seen across the region, with almost all of the national PMIs at sub-50.0 levels. Only Ireland bucked the trend, seeing improved business conditions as its PMI hit a 15-month high. Rates of decline in Germany, France and Spain were either at or close to the steepest since mid-2009. Italy recorded the worst overall performance in three months, while Austria slipped back into contraction and business conditions in the Netherlands continued to deteriorate. Greece stayed rooted to the bottom of the PMI league table.
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Casting a long shadow over the future, total new orders contracted for the fourteenth straight month, with the rate of decline the third-fastest for over three years. Greece and Spain recorded the steepest falls, while the big-three of Germany, France and Italy all posted sharp contractions. Declines in the Netherlands and Austria were much weaker in comparison, while Ireland saw new order growth hit a 15-month high. New export orders fell at the fastest pace for eight months, with intra-Eurozone trade particularly subdued. Only Ireland and the Netherlands reported increases in new exports. The German export machine remained firmly in reverse during July, recording the steepest drop in new orders of all countries and the fastest rate of decline since May 2009.
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Chris Williamson, Chief Economist at Markit said:
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<blockquote>
“The Eurozone manufacturing sector’s woes intensified again in July. Output fell at the fastest rate since mid-2009, consistent with the official measure of production falling at a quarterly rate in excess of 1%. Manufacturing therefore looks to be on course to act as a major drag on economic growth in the third quarter, as the Eurozone faces a deepening slide back into recession.</blockquote>
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<strong>Germany</strong><br />
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The performance of the German manufacturing sector took another turn for the worse in July, with output and new orders both declining at the sharpest rates since April 2009. This led to a further drop in the Markit/BME Germany Purchasing Managers’ Index from 45.0 to 43.0 in July, its lowest level since June 2009.
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<br />
July data also saw the thirteenth successive monthly contraction of incoming new business in the German manufacturing sector. This is the longest continuous period of falling new orders since the survey began in April 1996. Survey respondents frequently reorted an unwillingness among clients to commit to new spending, largely in response to the uncertain global economic outlook. New export work continued to decline at a steeper pace than total new business receipts in July. Manufacturers noted shrinking sales in Western Europe, alongside softer demand in Asia and the US. The overall decline in new export work was the steepest since May 2009.
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<br />
<blockquote>
Commenting on the final Markit/BME Germany Manufacturing PMI® survey data, Tim Moore, senior economist at Markit and author of the report said:<br />
<br />
The German manufacturing PMI number slipped to bronze position in the ranking of the ‘big four’ eurozone economies during July, its lowest position for three years and indicative of a sharp deterioration in business conditions over the month. Manufacturers linked the latest setback to shrinking export sales and a general shortage of new work to replace completed projects. Output dropped at the steepest pace for over three years and job shedding was the most marked since the start of 2010.</blockquote>
<br />
<br />
<strong>Italy</strong><br />
<br />
Manufacturers in Italy continued to face a challenging operating environment at the start of the third quarter. A further contraction in demand led to lower output levels and the sharpest reduction in employment for 33 months, with a sharp and accelerated decrease in backlogs of work underlining the degree of excess capacity in the sector.
<br />
<br />
The Markit/ADACI Purchasing Managers’ Index dipped to a three month low of 44.3 in July, down from June’s reading of 44.6. The headline index has posted below the neutral mark of 50.0 throughout the past year, and was below the average recorded over the second quarter as a whole giving the impression that the recession may even be deepening.<br />
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<br />
<blockquote>
Phil Smith, economist at Markit and author of the Italian Manufacturing PMI said: <br />
<br />
“July saw the recession in the Italian manufacturing sector extend to a year. Moreover, the downturn was shown to have deepened as the PMI sank to its lowest level in three months, primarily reflecting a sharper reduction in staffing levels. A solid and accelerated decrease in stocks of purchases also dragged the headline index lower, and suggested that firms had grown more concerned about cash flow and were not anticipating a rise in production requirements in the near term. </blockquote>
<br />
<span style="font-size: large;">Central and Eastern Europe</span><br />
<br />
<strong>Czech manufacturing business conditions deteriorate further</strong><br />
<br />
The latest HSBC PMI report confirmed the ongoing weak downturn in the Czech manufacturing economy at the start of the third quarter. New orders and purchases of inputs by manufacturers both fell for the fourth successive month, while output remained stagnant. This is all in line with the fact that Czech GDP has now been falling for three successive quarters. The PMI remained below the no-change mark of 50.0 in July, continuing the pattern seen since April. The deterioration in overall business conditions signalled by the headline figure remained modest, however, as the PMI was little-changed at 49.5 from June’s 49.4.
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<br />
<blockquote>
Commenting on the Czech Republic Manufacturing PMI survey, Agata Urbanska, Economist, Central & Eastern Europe at HSBC, said:<br />
“The PMI index changed little in July compared to June and still points to a slight deterioration of business conditions in the manufacturing sector. Among the index components, the suppliers’ delivery times improved (lengthened), offsetting worsening output, new orders and employment indices. We assess this combination as negative and remain cautious of downside risks. This is particularly the case in face of weaker than expected leading indicators in July like IFO and PMI in Germany. The PMI’s input and output prices indices show a further decline of inflationary pressures, and leave room for the central bank to cut its policy rate to a new record low later this year.”</blockquote>
<strong>Contraction of Polish manufacturing sector slows in July</strong>
<br />
<br />
HSBC survey data compiled by Markit indicated a near-stabilisation of business conditions facing Polish manufacturers in July. New orders declined at the weakest rate since March, while output fell only marginally since June and firms raised headcounts at the fastest rate since February 2011. The PMI recovered from June’s 35-month low of 48.0, posting 49.7 in July. That signalled a fourth successive overall deterioration in the business climate, but at only a marginal pace that was the weakest in that sequence.
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<br />
<br />
Commenting on the Poland Manufacturing PMI® survey, Agata Urbanska, Economist, Central & Eastern Europe at HSBC, said: “The recovery of the PMI index, despite the fact that it still remains in contraction territory, is a positive following a month of activity data releases all surprising on the downside. The PMI still points to a marginal deterioration in business conditions in the manufacturing sector, but the pace of deterioration has slowed compared to previous months.
<br />
<br />
<strong>Turkish manufacturing output falls for first time in four months</strong>
<br />
<br />
The seasonally adjusted HSBC Turkey Manufacturing PMI dropped below the 50.0 no-change mark in July, posting 49.4. This followed a reading of 51.4 in June and signalled the first deterioration in business conditions since March. That said, the decline was only marginal. Both output and new orders decreased in July. New business fell for the fourth month in 2012 so far, following stagnation in June.
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<br />
<br />
<blockquote>
Commenting on the Turkey Manufacturing PMI® survey, Melis Metiner, Economist at HSBC, said:<br />
<br />
“Turkish manufacturing conditions deteriorated in July, falling into contraction territory for the first time since March. Both output and new orders fell, while new export orders recovered after a sharp decline in June. The pace of improvement was marginal, however.</blockquote>
<span style="font-size: large;">United States</span><br />
<br />
<strong>US PMI indicates slowest manufacturing expansion for nearly three years</strong>
<br />
<br />
Growth of the U.S. manufacturing sector slowed to its weakest pace in nearly three years in July, according to the Markit U.S. Manufacturing Purchasing Managers’ Index. At 51.4, down from the flash estimate of 51.8 and below June’s reading of 52.5, the PMI hit a 34-month low and signalled only a modest expansion during the month.<br />
<br />
The volume of new orders received by manufacturers increased in July. The increase in total new work largely came from the domestic market, however, as new export orders fell for the second consecutive month, partly reflecting the ongoing economic crisis in Europe. Overall, new orders (both domestic and exports) rose only modestly, with the rate of increase weaker than the earlier flash estimate and the second-slowest since orders began rising almost three years ago.
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<br />
<blockquote>
Commenting on the final PMI data, Chris Williamson, Chief Economist at Markit said:
“The final reading of Markit’s U.S. Manufacturing PMI was even weaker than the flash estimate, indicating that manufacturers are currently reporting the weakest growth since September 2009.
</blockquote>
<blockquote>
“Producers are being hit by the ongoing euro zone crisis, slower global economic growth and increasing unease about demand in the home market as elections loom closer and uncertainty hangs over fiscal and monetary policies.“With order books barely growing in July as export orders fell for the second month in a row, the survey signals a real risk of manufacturing production falling in the third quarter unless demand picks up soon.</blockquote>
<br />
<strong><span style="font-size: large;">Brazil</span></strong><br />
<br />
<strong>Further declines in both output and new orders in Brazilian Manufacturing in July</strong>
<br />
<br />
July data signalled a further deterioration in manufacturing business conditions in Brazil, with survey respondents largely citing weak client demand. Both output and new orders fell for the fourth month running, albeit at slightly weaker rates than those registered in June, and firms reduced their workforces to the greatest extent in three years.
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<br />
<blockquote>
Commenting on the Brazil Manufacturing PM survey, Andre Loes, Chief Economist, Brazil at HSBC said:<br />
<br />
“The HSBC Manufacturing PMI stabilized in July, rising from 48.5 last month to 48.7. On the whole, the headline index and its key components remained below the 50 threshold, suggesting that the industrial sector in Brazil continued to contract in July. But at least this decline in economic activity appears to be losing momentum, with the very modest rise in the headline PMI index being led by improvements in both the output and new orders indices.”
</blockquote>
<br />
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-3950127.post-83896721623070357072012-08-12T20:50:00.001+02:002012-08-12T20:50:01.743+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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<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
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 />
<br />
"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".
<br />
G.W.F. Hegel, Preface to the Philosophy of Right<br />
<br />
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-3950127.post-20684136020442937942012-08-11T08:03:00.002+02:002012-08-11T08:03:44.938+02:00Is The Italian Elephant About To Break Loose Again?Market nervousness about Italy has been growing in recent weeks, with the <a href="http://online.wsj.com/article/BT-CO-20120713-704619.html"> Moody's credit downgrade</a> of the country being only one of the reasons. A bailout is clearly in the offing, with the only real questions being how and when. While the situation inside his country appears to be deteriorating, Mario Monti has been doing the rounds of European capitals in an attempt to drum up support. While in Helsinki he raised an eyebrow or two when he warned that without a serious plan to bring down interest rates <a href="http://online.wsj.com/article/BT-CO-20120802-704424.html">disaffection with the euro in his country could easily grow to dangerous proportions</a>. Crying wolf, or a piece of insider information? Probably a bit of both.<br />
<br />
Italy <a href="http://www.timesofmalta.com/articles/view/20120809/business-international/Italy-s-recession-pain-stretches-to-a-year.432184">is in a deepening recession</a> which has now lasted for over a year. Monti himself <a href="http://www.businessweek.com/news/2012-07-10/monti-says-he-wont-serve-beyond-end-of-term-next-year">has ruled out the possibility</a> that he could continue in office after next spring's general elections, while at the same time <a href="http://www.ft.com/intl/cms/s/0/24d08f80-cd04-11e1-b78b-00144feabdc0.html#axzz20hJrJVYB">Silvio Berlusconi is constantly hinting</a> that he would not be averse to accepting prime ministerial office again, should his country need him. All of which makes me ask myself just over a year after my "<a href="http://www.economonitor.com/edwardhugh/2011/05/22/is-italy-not-spain-the-real-elephant-in-the-euro-room/">Is Italy, Not Spain, the Real Elephant in the Euro Room?</a>" post, whether in fact the currently chained beast is not about to break its tethers and go for a crockery breaking rumble round the Euro living room.<br />
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What follows is a summary of a revised version of a presentation I gave in Cortona last autumn. I have put the presentation <a href="http://www.slideshare.net/Edwardhugh/whats-wrong-with-italy-a-review-of-the-countrys-economic-and-demographic-challenges">online here</a>.<br />
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<strong><span style="font-size: large;">Low Growth And High Debt, A Highly Combustible Cocktail</span></strong><br />
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Just as I highlighted <a href="http://www.economonitor.com/edwardhugh/">in the case of Portugal in my recent post</a>, Italy's problem is long term growth. This is not a passing phenomenon, but one which has been getting steadily worse over decades. Italy has lost growth at a pace of about one percent a year over the last four decades. If the pattern continues Italy GDP will drop over this decade and continue to do so for as far ahead as the eye can see.<br />
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To give us an idea of what this means, Italian GDP at the end of June was at the same level it first reached in the second quarter of 2003. If the current recession continues as forecast by the Italian government during this year, by December we will be below the GDP level of December 2000, which is another way of saying that it will be below the level first attained some 12 years earlier. If the recession is slightly deeper that the current government forecast, and continues throughout 2013 (certainly not an excluded scenario) we might even arrive at levels first seen in the late 1990s. In the meantime the country's population will have risen from 57 million to 61 million, hence GDP per capita will have fallen substantially. This is not a situation either to be taken lightly, or one which it will be easy to turn around.<br />
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There are a variety of reasons for this sharp drop in growth momentum. Some of the reasons are undoubtedly, as I will argue demographic. Others are associated with the loss of international competitiveness experienced by the Italian economy since entering the European monetary union.<br />
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Once clear indication of the extent to which the deteriorating growth outlook is associated with cometitiveness loss is to be seen in the correlation between worsening growth performance and the deteriorating current account balance.<br />
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<span style="font-size: large;">Double Dip Recession</span><br />
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Italy first fell into recession at the end of 2007 – some months before the other Euro Area countries - and didn’t come out of it again till the start of 2010 , so the economy contracted for two full years. GDP fell by 1.2% in 2008, and by 5.5% in 2009.
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<br />
After an 18 month recovery, the economy
again fell into a second “double dip”
recession around the middle of 2011, after a
surge in borrowing costs forced the
government to apply stringent austerity
cuts in an attempt to recover investor
confidence.
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In the three months up to June GDP contracted for a fourth straight quarter, falling by 0.7 percent over the previous quarter. We don't have the detailed breakdown from the statistics office yet, but it seems clear the contraction was again led by sharp falls in consumption and investment as concerns about the fiscal outlook and the euro area crisis depressed confidence and tightened credit conditions.<br />
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It is quite possible that Italy will experience a deeper recession this year and next than most forecasters predict (IMF current 2012 -1.9%), reflecting headwinds from the sovereign debt crisis compounded by Italy’s large planned fiscal adjustment. The government will likely miss its deficit targets and even in the absence of any major shocks to yields, the country’s debt to GDP ratio is surely going to increase significantly over the next few years.<br />
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Part of the problem is that Italy's fiscal spending has assumed the importance it has in the country's economy due to the loss of international competitiveness. Reducing the government contribution to GDP in this context only makes the economy fold in on itself. More urgent competitiveness raising issues are needed, ones which will bring quicker results than the ongoing programme of long term structural reforms.<br />
<br />
<span style="font-size: large;">So Just What Do We Mean By International Competitiveness?</span><br />
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The issue of international competitiveness is the one which has perhaps caused most theoretical controversy during the current Euro Area crisis, with one side arguing vehemently that some sort of devaluation is essential, while the other argues equally vehemently that it isn't. In the follwoing slides I propose a slightly new definition of international competitiveness, which is to do with having an export sector which is appropriately large given the median population age of the country concerned.<br />
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You can enlarge the slides for easier reading by clicking on them, or <a href="http://www.slideshare.net/Edwardhugh/whats-wrong-with-italy-a-review-of-the-countrys-economic-and-demographic-challenges">alternately you can view them via my slideshare version</a>.<br />
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<strong>Bottom line</strong>:<br />
• Median population age is an important economic indicator
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• Populations with high median ages tend to be export dependent
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• Export dependency gives a better, more precise measure of international
competitiveness.
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• An export dependent country is internationally competitive
when it has a large enough export sector to drive economic growth.
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<strong>Italy and The Eurozone Debt Crisis</strong>
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Total Italian debt is not excessive in comparison with some other countries in the Eurozone, but public debt is the second highest.
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Despite having normally run positive primary balances
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Italy has run general budget deficits since the 1980s
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The problem here is the weight of the debt, the burden of interest payments
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<strong>Italy Is Now Poised On A Knife Edge</strong><br />
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Italian gross government debt to GDP is currently perched just under 123% of GDP. The key factors which will influence the future trajectory are GDP growth, inflation and interest rates. With GDP falling, inflation low and interest rates rising the outlook seems quite problematic.
Hence The Problem Of Market Pressure, and concerns about interest rates. Italy is currently paying around 6% for 10 year debt issues, and <a href="http://www.bloomberg.com/news/2012-08-08/ecb-s-rescue-worsens-spain-italy-maturity-crunch-euro-credit.html">the average maturity of Italy’s debt is 6.7 years</a>, the lowest level since 2005. <br />
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The IMF currently predicts that Gross Government Debt To GDP will peak at 124% in 2013. Any significant slippage on this and debt restructuring becomes inevitable. Investors are worried with good reason. Market responses are not just simple speculation. ECB support is critical, but so are radical measures to increase the growth rate.
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<strong><span style="font-size: large;">Too Big To Rescue?</span></strong><br />
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As stated above, Italy shrank further into recession in the second quarter with a 2.5 per cent annual decline. The 0.7 per cent quarterly fall in gross domestic product, only slightly better than the first quarter’s 0.8 per cent decline, means the economy has now been contracting for over a year, and there is at least another year of the same or worse to come as spending cuts steadily bite and the Euro debt crisis rocks its way forward. The recession will weaken tax revenues and hit jobs and consumer spending, a vicious circle which makes it harder for Mario Monti, who is aiming to cut the budget deficit to 0.1 per cent of GDP in 2014, to meet his public finance goals.
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Consumer Confidence and PMI indicators suggest that the Italian government’s GDP growth estimates (of a contraction of 1.2% for 2012 and an expansion of 0.5% for 2013) are way too optimistic . The consumer confidence reading was only just up in July from June's 14 year low, and for the first time since the launch of the PMI services survey in January 1998 firms generally expected output to be lower in a year’s time than current levels.<br />
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The employers group Confindustria now forecast a contraction in GDP of 2.4% in 2012. A further fall of 2.0% is not unlikely in 2013 as the European debt crisis worsens. Compared to the other forecasters I would be more negative on the outlook for both private consumption and investment activity. In addition, with a more negative outlook for the euro area economy – destination for 43% of Italian exports — these are unlikely to put in an unexpected stellar performance in 2013.
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<strong>Unemployment Rising Sharply</strong>
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Italy's unemployment rate hit a record 10.8 percent in June, up from 10.6 percent in May. There were 2.79 million people looking for work in June, according to seasonally adjusted figures -- a rise of 37.5 percent compared to a year earlier. Youth unemployment dropped from 35.3 percent in May to 34.3 percent. These are not yet anything like Spanish numbers, but they are not to be sneezed at either.
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The number of people living in absolute poverty in Italy rose to 3.4 million in 2011, or 5.7 percent of the population, up from 5.2 percent in 2010.Those living in relative poverty for Italian standards were roughly stable at 8.2 million, or 13.6 percent. But among families with no workers and no pensioners, the relative poverty rate rose to 51 percent from 40 percent.
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<strong>Fiscal Targets Look Increasingly Out Of Reach</strong>
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The implementation of austerity measures in Italy is likely to have a substantial negative impact on the economy in the coming years. Given its lack of competitiveness, the economy lived off constant demand stimulus from the government. Without this the growth problem is likely to become worse. <br />
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There have now been five fiscal packages introduced by Italian governments since July 2011, with the objective of a cumulative fiscal consolidation of some 5.2% of annual GDP (€85.8bn) between 2011 and 2014. With the majority of the measures concentrated in 2012, there will inevitably be a large negative impact on the economy throughout this year. <br />
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Given the deep recession the country will be in over the next couple of years and poor potential growth prospects over the medium- and longer-term, Italy’s public sector balance sheet problems are likely to mount. Although the 2011 fiscal deficit of 3.9% was not particularly high in comparison with many Euro Area countries the governments projection of a close-to-balanced budget in 2014 looks hugely optimistic. A more realistic expectation would be for the deficit to be under the EU 3% level at that stage, but the danger is this could well mean gross debt to GDP will be over 130%. Above the danger mark.
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The ECB's role in the crisis both helps and doesn't help, depending on how you look at it. They have been very tardy in acting, and normally when they have done so it is been via half measures which have not got to the heart of the problem. The LTROs are a good example. Italian banks have borrowed more than 283 billion euros from the ECB via the 3
year LTROs and other liquidity operations, but this liquidity is by and large used to either purchase government bonds or buy up their own expiring debt. Buying government bonds is attractive since they pay
yields which are far above the ECB lending rates. This difference - the so called "carry" - helps bank profitability and enables them to recapitalise,
but it also means that interest rates charged to small business clients rises as they need to compete with the government for funds. Despite the fact that such practices make the banks more "joined at the hip" than ever with their sovereigns, and that their exposure to losses should the Italian sovereign eventually have to restructure rises, they remain attractive because the risk weighting and hence "capital consumption" of public sector lending under the Basle rules remains absurdly low. This is where the real private sector “crowding
out” comes.<br />
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Banks increased their holdings of the country’s bonds by about 78 billion euros in
the first six months of 2011. This forms part of the “nationalisation” of Europe’s
sovereign debt markets. Foreign investors cut their holdings of Italian government
securities by 18 percent in March from a year earlier, according to the Bank of Italy.
In the same month Italian banks boosted them by 39 percent.
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Meanwhile, as we can see in the chart above, the rate of new lending to the private sector has been falling steadily, to both households and corporates. As I say part of the problem is that as the recession deepens the credit risk perception of Italian households and companies deteriorates,as the ECB pointed out in their latest monthly report.<br />
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The report immediately produced <a href="http://www.ft.com/intl/cms/s/0/cc277fb2-e205-11e1-b3ff-00144feab49a.html#axzz22m9DwM9e">criticism from the Italian consumers’ association Codacons</a>, who complained that the ECB itself had not found a solution to this situation. “If companies are insolvent it’s because banks are strangling them, denying them credit,” Codacons said. Coldiretti, the Italian agricultural association, also estimates that 60 per cent of companies in the sector risk being starved of credit as they face interest rates that are 30 per cent higher than the average of other sectors.<br />
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This problem is more complex than it seems. It is not so much a question of credit being strangled, but of demand being strangled as austerity bites. Companies who cannot sell profitably are a high credit risk. There is demand globally, but as I am saying Italy is insufficiently competitive to take advantage of it. Bottom line, the high cost of financing Italian government bonds is pushing up longer term interest rates, and discouraging investment, and this is an issue the ECB could address, by directly buying commercial paper, for example.
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<strong>Easing In The Bailout</strong>
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The possible Italian bailout is fast becoming a tricky political issue. The technocratic government of Mario Monti <a href="http://www.bloomberg.com/news/2012-08-09/monti-s-cabinet-discussed-possible-bond-buying-request.html">would like to get an MoU agreed before handing the country back to the politicians</a>. <br />
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The request for bond buying would involve ECB secondary market purchases as well as primary market purchases by the EFSF.
It would also involve a Memorandum of Understanding which would undoubtedly contain strict conditions and an implementation supervision mechanism. The ECB would surely also have a say in those conditions if bank bond purchases were to form part of the package. Indeed, the ECB has only this week in its August bulletin <a href="http://www.ft.com/intl/cms/s/0/cc277fb2-e205-11e1-b3ff-00144feab49a.html#axzz22m9DwM9e">made clear what it thinks is required</a>. The Bank suggests countries with high unemployment
need to “abolish wage indexation, relax job protection and cut minimum wages”. The bank is not impressed with the Italian labour
reform, which is too little too late, and thinks direct wage cuts are now the only workable remedy.
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Unsurprisingly, many Italian politicians are highly reticent about being seen to hand over their country’s future to an institution with such views, which if implemented would be massively unpopular in the country, so pressure is mounting for Monti not to ask for help. That having been said, the country really has no alternative if it wants to stay in the Euro.
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<strong>Is Italy Facing A period of Growing Political Instability?</strong>
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But this is just it, exactly how committed is the Italian political class to staying in the Euro? Certainly it is the one country on Europe's periphery where you can hear speeches from politicians with serious followings questioning whether there are not alternatives. Indeed Mario Monti warned on <a href="http://www.economonitor.com/edwardhugh/2012/08/10/is-the-italian-elephant-about-to-break-loose-again/" target="_blank">just this point during his recent Helsinki visit</a>. "I can assure you that if the (bond yield) spread in Italy remains at these levels for some time then you are going to see a non euro-oriented, non fiscal-discipline-orientated government taking power in Italy," he said.
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He was, of course, referring to the ambivalence of Silvio Berlusconi on the Euro issue, and the outright hostility to the common currency displayed by the rising (5) star of Italian politics, Beppe Grillio. “After me the populists”, as Monti once said.
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A lot of these statements can be read as brinksmanship, but as BofA Merrill Lynch foreign exchange strategists<a href="http://www.bloomberg.com/news/2012-07-12/italy-exits-before-greece-in-bofa-game-theory-cutting-research.html"> David Woo and Athanasios Vamvakidis warned in a July 10 report</a>, investors “may be underpricing the possibility of voluntary exit of one or more countries” from the currency bloc. And these countries may not be the ones most widely talk about, like Greece or Spain. It was Italy, the euro area’s third-largest economy, which they found would enjoy a higher chance of achieving an orderly exit than others and would stand to benefit from improvements in competitiveness, economic growth and balance sheets.<br />
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Woo and Vamvakidis employed a variant of game theory and found that while Germany could “bribe” Italy to remain in the bloc and avoid the fallout from an exit, its ability to do so is limited. That’s because Italy has more reasons than Greece to leave so any compensation could become too expensive for Germany and Italians may be even more reluctant than the Greeks to accept the conditions for staying.
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Interestingly enough in this connection Nomura's Jens Nordvig and Nick Firoozye (whose excellent work on Euro break up dynamics unfortunately did not win them the Wolfson Prize) argue in their afterthought essay (Wolfson: What we learned about the future of Europe, Nine specific lessons from the Wolfson Economics Prize competition) that one of the things they learnt from doing the spadework was the following.
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<blockquote>
"We have constructed a data base of the relevant liabilities for each Eurozone country, and our calculations show large relevant external liabilities in Greece, Portugal, Ireland and Spain. This analysis highlights that currency depreciation following exit from the Eurozone would substantially increase the external debt burden of these countries...."<br />
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"Meanwhile, we note that estimated balance sheet effects following exit in the case of Italy and France, are substantially smaller than in other peripheral countries, mainly as a function of the prevalence of local law obligations (which can be redenominated) within external liabilities. It follows that policy makers and investors should pay close attention to the size of balance sheet effect (not only to standard competitiveness and the trade effects) when thinking about the macro impact of specific exit scenarios".</blockquote>
So, summing up briefly, while the Monti Government’s structural reforms are obviously a step in the right direction it is unlikely they will go either far enough or fast enough to significantly lift the country’s potential growth rate from its present lamentable level. Further, as the April 2013 election approaches the growing popularity of new political movements like Beppe Grillo's Five Star one could easily lead to the kind of political fragmentation already seen in Greece - Italy has hardly been a model example of the two party system - making the traditional political forces which back the Monti Government even more reluctant to accelerate the adoption of far-reaching reform.<br />
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And going beyond April, the political arithmetic of a post Monti government looks complicated, making the kind of stability needed to advance what the population may well see as "harsh" reforms unlikely. In other words, as Monti says, when I go watch out for the populists!
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<br />
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-3950127.post-13007751669025819892012-07-30T12:37:00.001+02:002012-07-30T12:38:43.785+02:00What’s Up Doc?According to Wikipedia, <a href="http://en.wikipedia.org/wiki/Kabuki" target="_blank">Kabuki</a> is a classical Japanese dance-drama known for the stylization of its plot and for the elaborate make-up worn by the key performers. This definition also seems to fit the drama in an unknown number of acts currently being acted out on the European stage by some of the continent’s leading central bank players perfectly. <br />
It all started last Thursday when, as surely everyone but my blind and deaf uncle must now know, Mario Draghi made what is widely though to have been an important speech. We will do whatever it takes, as long as it is in the mandate, <a href="http://www.cbc.ca/news/business/story/2012/07/26/drghi-ecb-bond-buying.html" target="_blank">he is reported as saying</a>. And since stopping anything which could be life-threatening to the Euro dead in its tracks forms part of the bank's mandate under any conceivable interpretation, the ECB now have the widest possible brief within which to circumscribe its actions. The only limitation is that it should be enough, just enough, and no more. As Mario Draghi said, “believe me, it will be enough”. <br />
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But then on Friday the Bundesbank dark clouds started to loom on the horizon as the Bundesbank appeared to wade into the fray, making a statement which on first reading seems to have been intended to say “now just hold on a minute there!” As the Irish Independent put it in a headline “<a href="http://www.independent.ie/business/european/bundesbank-pushes-against-ecbs-draghi-pledge-to-save-the-eurozone-3181832.html" target="_blank">The Bundesbank Pushes Against ECB’s Draghi Attempt To Save The Eurozone</a>". <br />
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Yikes! That sounds dangerous. Someone wants to save the Euro, and with it the entire planet, and someone else wants to stop him. Assuming we are not in James Bond territory here, how can that be? <br />
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Well, that’s why I say "seem", since digging into the situation a bit, I found it very hard to identify an original source for the statements that were being attributed to that most venerable of German institutions. Certainly there was no trace of anything on the central bank website. If this was a real counter offensive, you would at least expect to see some evidence for it hanging from the bank battelements. <br />
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Well, as Ludwig Wittgenstein used to say, when you seem to hit bedrock, and even if the blade is a bit bent, don’t let your spade be turned. Just keep on digging. So I did.<br />
<br />
What I found was a Reuters correspondent who claimed to have been told by a bank spokesman that "The Bundesbank regards central bank purchases of sovereign debt as monetary financing of governments, from which the ECB is prohibited by European law”. "The mechanism of bond purchases is problematic”, the spokesman apparently said, “because it sets the wrong incentives." On the other hand the possibility of the EFSF bailout buying government bonds was viewed as "as less problematic".<br />
<br />
But then I moved on to <a href="http://stream.wsj.com/story/markets/SS-2-5/SS-2-37007/" target="_blank">Dow Jones News Wires</a>, where I got the weird feeling their journalist had had exactly the same conversation. "Germany’s central bank remains opposed to further government bond purchases by the European Central Bank, but isn’t against using the euro-zone’s temporary rescue fund doing so to drive down soaring sovereign borrowing costs”, a Bundesbank spokesman was said to have told their reporter. Odd, I though that two separate journalists had rung up the bank independently only to have had exactly the same conversation. <br />
<br />
In order to try and clarify matters – remember markets next week have to decide what the next chapter in the Euro Debt Crisis is going to be, so it isn’t simply pedantic to want to get this one right - I did what every well trained economist does in cases of an emergency - I went back to <a href="http://www.ft.com/intl/cms/s/0/0cfab5c4-d7cd-11e1-80a8-00144feabdc0.html#axzz221GtX9A8" target="_blank">the original story that caught my eye in the Financial Times</a>, where to my horror I was unable to find any mention of any conversation - imaginary or real - with a bank spokesman. The FT simply informed the world that "The Bundesbank says....." an assertion that was followed by a wording not that different to the ones to be found in Reuters and Dow Jones Newswires. Then I went to <a href="http://www.telegraph.co.uk/finance/financialcrisis/9431975/Bundesbank-opposes-ECB-bond-buying.html" target="_blank">the Daily Telegraph</a>, and found they followed the FT in simply asserting that "the Bundesbank says bla bla bla....."<br />
<br />
But where does it say it, and who is saying it? If it is a statement of bank policy why is it not on the website, and if it is the personal opinion of say Jens Weidmann or another top official why is this not made plain?<br />
<br />
Why does this matter? Well, maybe this IS being pedantic, but I don’t think we should start accepting that the Bundesbank (or anyone else) thinks something or other simply because the FT says they do, much as I love the paper and its charming corps of staff. Even if we are told “an anonymous source from the Bundesbank who under no circumstances wanted to be identified publically” said x, this can help us evaluate the significance of x. If we are told nothing, then frankly I for one don’t know where to start. <br />
<br />
This is a moment when what is needed is absolute clarity about how the Euro Area is going to make the institutional changes that are so badly needed to save the common currency, and this is just what we aren't getting. And I am not the only one who was having diddiculty understanding just what the Bundesbank "intervention" was about. As Martin Essex put it in the WSJ blog:"<a href="http://blogs.wsj.com/eurocrisis/2012/07/27/did-draghi-not-check-with-the-bundesbank/">Did Draghi Not Check With the Bundesbank?</a> "
<br />
<blockquote>
Could it really be that before European Central Bank president Mario Draghi raised hopes of determined ECB action to lower Spanish and Italian bond yields he failed to check with the Bundesbank? Or do they simply agree to disagree?
It wasn’t Mr Draghi’s pledge in a speech on Thursday to do “whatever it takes” that was important. That’s been said before. It was his comment that high Spanish and Italian borrowing costs “hamper the functioning of the monetary policy transmission channel” and therefore come within the ECB’s mandate that boosted the markets, leading to predictions that the ECB will reactivate its Securities Markets Program of bond buying next week.</blockquote>
Thankfully, Bloomberg finally came to my rescue. They owned up to what had actually happened:
<br />
<blockquote>
"A spokesman for the Frankfurt-based central bank said in a statement read over the phone earlier today that there haven’t been any changes in its position on bond purchases”.</blockquote>
So there we have it, a case of sex (or rather policymaking) over the phone. What journalists were presenting us with was an official Bundesbank statement. In that sense the FT were right, even if they didn't explain why they were right.<br />
<br />
Having understood that (which was the hard part) I then spent the rest of the weekend wondering what it might mean. Could the ECB and the Bundesbank really regard it as desireable at this delicate moment to have such a public disagreement? Noting the impact Mario Draghi's statement was having on market confidence, would they really have wanted to undermine his authority. Or was there something more subtle going on?<br />
<br />
Looking through the evidence I have come to the conclusion that it was a case of the latter. But it was a close call, and there's no ruling out the possibility that tomorrow we will be given new, additional information which forces me to change my mind.<br />
<br />
My reading of the Bundesbank statement (crickey, this is almost becoming theological, or better put "Kremlinological", isn't it?) is that it constitutes a delineation of what can, and what can't happen next. In this sense it could even be read as being helpful to Mario Draghi. One solution which is actively being anticipated by the markets - giving a banking licence to the ESM - is described as "prohibited" the Reuters quotes, and is thus ruled out.
<br />
<blockquote>
"A banking licence for the bailout fund would factually mean state financing via the printing press and would be a fatal route, which therefore is prohibited by the EU treaty," a Bundesbank spokesman said, narrowing the ECB's policy options.</blockquote>
Buying bonds in the secondary market, on the other hand, although not actively welcomed by the Bundesbank is simply termed "problematic" and "not the most sensible way" while using the EFSF to buy in the primary markets is very straightforwardly "unproblematic". Now, since the Bundesbank understands very well that Mr Draghi needs to do something, this looks very much like a road map to me - a dose of probematic, but not prohibited, SMP in secondary markets and backing full use of EFSF firepower (such as it is) in the primary ones.<br />
<br />
Adding to the scenification <a href="http://www.telegraph.co.uk/finance/financialcrisis/9434768/ECB-president-Mario-Draghi-to-meet-Bundesbank-head-Jens-Weidmann.html" target="_blank">we have a visit by Mario Draghi to Frankfurt this morning</a>, in an attempt to "convince" Bundesbank representatives of the need for action on the part of the central bank. Kabuki theatre in its purest form.<br />
<br />
Which brings us to that <a href="http://www.irishtimes.com/newspaper/breaking/2012/0727/breaking29.html" target="_blank">Le Monde story</a> that was going the rounds last Friday. The newspaper, again citing unnamed - although not evidently Bundesbank - sources, said the ECB was willing to take part in a combined action, but on condition that governments agreed to tap the bailout funds, the European Financial Stability Facility and the European Stability Mechanism.<br />
<br />
So here's the key - the countries involved (Spain and Italy) have to request help, and this means conditionality. It wouldn't be a full bailout, the countries wouldn't be taken completely out of the market (commercial banks in Spain and Italy would still be able to go on earning "carry" to help them recapitalise), and the IMF (at this point) wouldn't be involved, but there would be strings attached, and this is important not only for the Bundesbank, but for the entire ECB governing council.<br />
<br />
So there we have it. Now it's over to you Mariano. You have to ask for help. And just in case you aren't in any hurry, there are always those kindly market participant types just waiting round outside the gate to act as herdsmen, and cajole you into the corral.
But in this case the blows which will rein down upon your financial system will be all too real, and not the stylised replica of them to be found in that Japanese dance drama. <br />
<br />
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-3950127.post-40217141349173532042012-07-14T19:33:00.003+02:002012-07-15T15:02:26.496+02:00Portugal - Please Switch The Lights Off When You Leave!The <a href="http://online.wsj.com/article/BT-CO-20120202-714171.html" target="_blank">recent decision by the Portuguese constitutional court</a> to unwind public sector salary cuts included by the government in its austerity measures has once more given rise to speculation the country may not meet it's 4.5% deficit target for 2012. The court - which ruled the non-payment of the two traditional Christmas and Summer salary payments for the years 2012 through 2014 was unconstitutional - took the view that since the measure did not also apply to the private sector, it was discriminatory. Whatever view we may take on how the Portuguese Constitution defines "discrimination" the important detail to note is that the decision will not apply to 2012, and will hence only have the impact of forcing the government to find additional adjustments for 2013 and 2014, or at least a new formulation which allows them to constitutionally cut public sector pay.<br />
<br />
Nonetheless, despite the fact it will not affect this years fiscal effort the coincidence of the timing of the court decision with the appearance of a report from the parliamentary commission responsible for monitoring the execution of this years budget only served to heighten nervousness about the possibility that, with unemployment rising more sharply than anticipated and the economic recession still accelerating, <a href="http://online.wsj.com/article/BT-CO-20120705-708671.html" target="_blank">this years deficit numbers may not add up as planned</a>. <br />
<br />
The country is facing a deep ongoing recession with a contraction of the order of 3.5% expected this year, and the outlook for the second half of the year is no shaping up as though it may well be tougher than the first half. In addition, with the European sovereign debt crisis threatening to cast its long shadow right across next year, it looks increasingly unlikely that the country will be able to go back to the bond markets in September 2013 as planned. So September may well be a good month to make some needed revisions to the existing IMF programme.<br />
<br />
Portugal is making progress in reducing its fiscal deficit, even if it may fail to precisely meet this years target. But it is not making sufficient progress in reducing external imbalances, and in achieving international competitiveness. As a result sustainable economic growth and stable job creation still seem some years away. In the meantime young educated Portuguese are increasingly upping and leaving the country in the search for a better life elsewhere. This negative dynamic needs to be broken, and Troika representatives instead of repeating the same old policy errors need to take a fresh look, and with an open mind, at the situation.<br />
<br />
Otherwise Portugal may find itself in the invidious position of complying with most of its immediate programme objectives while leaving the road to sustainable debt and growth levels may fraught - as the IMF itself notes <a href="http://www.imf.org/external/pubs/cat/longres.aspx?sk=25826.0" target="_blank">in its April programme review</a> - with almost insurmountable difficulty, thus putting the long term future of the country in doubt. This post - which is a revised and expanded is version of a presentation I recently gave in Brussels - will examine the challenges - both demographic and economic - the country faces in the longer term. You can find <a href="http://www.slideshare.net/Edwardhugh/social-dimensions-of-portugals-crisis" target="_blank">the original presentation on Slide Share</a>.<br />
<br />
<span style="font-size: large;"><strong>So Here’s The Problem</strong></span>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgP3adx47qpUeW6t5xPjkfwxBlnz1ElsETvf59qolCnzTZteaLFAAH9AgMD8uhD2pgw1b2NY-MWACRRNcK_g7mFk5b2Rj_Zocs3X6XURXqxb29B0rgU-BiBUFUlr0avsUD9bYpF3w/s1600/Portugal+long+term+growth.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="189" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgP3adx47qpUeW6t5xPjkfwxBlnz1ElsETvf59qolCnzTZteaLFAAH9AgMD8uhD2pgw1b2NY-MWACRRNcK_g7mFk5b2Rj_Zocs3X6XURXqxb29B0rgU-BiBUFUlr0avsUD9bYpF3w/s320/Portugal+long+term+growth.png" width="320" /></a></div>
<br />
Over the past ten years the Portuguese economy has been virtually
stationery. The problem is not, note, simply a Euro one, since the decline
started in the mid 1990s, and has never been reversed. Here’s another way of looking at the same issue. Portuguese GDP rose rapidly
in the 1990s, and then much more slowly in the first decade of the 21st
century.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLWeolo3-7I8FFmYQZlNJjqgXqnCk4hq4UGGdWJY-BeETEqpx7X7Xnf3kYRuRHdgz-GZm2zlAomfFmFDzONmTxU0FAbmVcpKdeyxOif55bMNfD6Bc7Wm7iQ5VcFmhok5YbyPJ2DQ/s1600/Portugal+Constant+Price+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="242" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLWeolo3-7I8FFmYQZlNJjqgXqnCk4hq4UGGdWJY-BeETEqpx7X7Xnf3kYRuRHdgz-GZm2zlAomfFmFDzONmTxU0FAbmVcpKdeyxOif55bMNfD6Bc7Wm7iQ5VcFmhok5YbyPJ2DQ/s400/Portugal+Constant+Price+GDP.png" width="400" /></a></div>
<br />
So now we know that the issue is not hard to define, the only difficulty facing policy makers is finding the way to do something about it. Under standard economic theory, once a country falls into recession the "hidden hand" adjustment mechanisms will, one day sooner or one day later, serve to drag the country back out of it again (unless, naturally, the economy is caught in one of those darned liquidity traps). But for the countries inside the Euro the normal automatic adjustment mechanisms aren't operative, since one of the links in the chain - the devaluation one - has been (intentionally) broken. So as we can see, countries can get "stuck", and aspects of the situation can become "self perpetuating" - and this is the danger that Portugal faces.<br />
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<span style="font-size: large;"><strong>Ageing Society With Growing Debt</strong></span><br />
<br />
Portugal's problem is as much about debt as it is about growth. During the Euro years the levels of both the public and the private sector debt grew substantially - which means it has the worst of all worlds.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJ-go2bhj6JEgjO5h-fbAMWD95MGgkymXNnVvIuAIPYw3rRb8gXtGZVrkmLxtHRyidMjeV3e8bWOeFkOpzD_T_mptmrQilo_aMoUDk3g2TKm8PJQOLVfWk3CMU4wWrNxJMacNl9A/s1600/portgual+gross+debt+to+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="177" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJ-go2bhj6JEgjO5h-fbAMWD95MGgkymXNnVvIuAIPYw3rRb8gXtGZVrkmLxtHRyidMjeV3e8bWOeFkOpzD_T_mptmrQilo_aMoUDk3g2TKm8PJQOLVfWk3CMU4wWrNxJMacNl9A/s320/portgual+gross+debt+to+GDP.png" width="320" /></a></div>
<br />
In addition, the country had private sector debt (including securities as well as bank lending) to the tune of 249% of GDP at the end of 2011 according to Eurostat data. Add this to the 106% of gross government debt and you get a total debt to GDP ratio of around 355%. Without growth this is clearly not sustainable. In fact what is incredible is how the country was able to accumulate so much debt without the accompanying economic growth. The bang per buck was, frankly, terrible. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRzRu6d2QVd20GnNZ2jspzgmbz8VoYXIMnOzr_IdKqMnQTTUsWSR3pTraIie4n51fHX8HiyIZgJMl_umotcZmX_RsI4pcmfq1Yly5SNumYr6nKykMPzRztuc1K-qqk9U_0dPh75w/s1600/Portugal+Total+Private+sector+Debt.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="173" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRzRu6d2QVd20GnNZ2jspzgmbz8VoYXIMnOzr_IdKqMnQTTUsWSR3pTraIie4n51fHX8HiyIZgJMl_umotcZmX_RsI4pcmfq1Yly5SNumYr6nKykMPzRztuc1K-qqk9U_0dPh75w/s320/Portugal+Total+Private+sector+Debt.png" width="320" /></a></div>
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And it isn't just any old debt. A lot of it has been financed through the European interbank market, meaning a massive external debt has been run up, and used to finance all those imports and current account deficits. Portugal's net international investment position showed a debt of over 100% of GDP at the end of 2011.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhuw1FeDV1bgVd-SCoRGwnJcnbipnCTp1BjXs2FKhEPFoBUadPXR8x42KF-tOc70kKCjkJz8bhPzc-xxF9TBndF3EOlWlK2InKhdNdK9CA3rNsPnNlLL8muLyv6p__4ED_LtLYuNg/s1600/Portugal+IIP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="172" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhuw1FeDV1bgVd-SCoRGwnJcnbipnCTp1BjXs2FKhEPFoBUadPXR8x42KF-tOc70kKCjkJz8bhPzc-xxF9TBndF3EOlWlK2InKhdNdK9CA3rNsPnNlLL8muLyv6p__4ED_LtLYuNg/s320/Portugal+IIP.png" width="320" /></a></div>
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Now of course the moment of truth has come, and it is time to start paying it all back. Which means that living standards which were being maintained by borrowing to buy imports will fall since the borrowing stops, but they will also fall due to the need to now pay the borrowed sums steadily back. <br />
<br />
So, far from Euro membership being an unmitigated success for Portugal, the country
has seen a serious lack of growth in living standards and even a loss of relative position
in the “Euro league” If we look at the graph below - which shows per capita GDP in both Portugal and Slovenia as a percentage of the EU average - we can see that while living standards in Slovenia rose steadily during the first decade of this century, in Portugal they were more or less stationary (in relative terms). Yet as we know, Portugal is a comparatively poor country in EU terms, and should have benefited much, much more. Now Portugal's relative position is even likely to fall.<br />
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The thing I often say about the monetary union is that it is a structure which offered every facility to a country which wants to get into trouble (cheap borrowing, enhanced credit rating, very low sovereign debt spreads) but which makes it much more difficult to correct the problems once they have built up. Portugal's tragedy is that it got into trouble just before it joined, and the Euro only added to the countries problems rather than offering a framework which made it possible to sort them out. How ironic that the one country unable to advance unaided the reform and growth programme that became know as the Lisbon Agenda should be Portugal. The real "Lisbon" agenda was evidently something else entirely.<br />
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<strong><span style="font-size: large;">Some Unique Portuguese Features</span></strong><br />
<br />
The curious thing about Portugal is how its trajectory towards first full EU and later EMU membership shows more resemblance to the path which was later trod by a number of East European societies than it does to that of its South European peers.<br />
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<br />
In what was to be a harbinger of events elsewhere a decade or so later, the country systematically lost population during the EU “coupling” years, as workers left in droves in search of higher wages elsewhere. The phenomenon has left a lasting scar on both the economy and the society. Little surprise that the country which was once a prototypical "emigration society" should so rapidly have become one again under the impact of the current crisis.<br />
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<br />
Naturally Portugal, like all European societies, is ageing quite rapidly, a process which won't be helped any by the significant numbers of young people who are now leaving.
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<br />
And the main reason for this societal ageing process is, of course, long term very low fertility. I've said it before, and I'll say it again, it makes absolutely no economic sense for a society with long term fertility well below replacement rate to become a net exporter of labour. In the long run the economy of such a country cannot be sustainable, and I'm surprised the IMF haven't noticed this yet.<br />
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<br />
<strong><span style="font-size: large;">Under The Tutelage of the Troika</span></strong><br />
<br />
Portugal was the third Euro Area country to succumb to the pressures of the financial markets, and bolt for safe harbour in the form of an EU/IMF rescue programme. As a result the country has now received an initial 78 billion euro bailout in return for which it is implementing a strict deficit correction programme. Even if one might want to quibble about some of the details, the country has implemented most of what was asked of it.<br />
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And as a result the Troika has consistently given Portugal what can only be called "glowing reports" - which compared to the ones Greece receives they certainly are.<br />
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And along with the deficit even the bond yields are coming down. Yields hit a spike back in February as markets worried about the second Greek bailout, with its debt restructuring component, and asked themselves the question - will Portugal be next?<br />
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<strong><span style="font-size: large;">So Where Are The Problems?</span></strong>
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<br />
Well, so much for the good news. Despite the high level of programme performance, the country still faces severe "challenges" since implementing reforms and austerity is one thing and achieving growth and reducing debt quite another. Not unsurprisingly, the economy is now in deep recession. The IMF expect the economy to contract by 3.3% in 2012, and return to timid growth in 2013 (0.3%). But as the fund themselves recognise, there are strong downside risks to the 2013 forecast, and it is not improbable the economy will once more contract.
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Equally worryingly, unemployment has now started rising sharply, raising questions about a "Greek turn" in events. Apart from the social distress caused this surge in unemployment is having two consequences. The original deficit targets will not now be met, even with this years public sector pay cut, and the young and educated are leaving the national ship in increasing numbers.<br />
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As the IMF says in its <a href="http://www.imf.org/external/pubs/cat/longres.aspx?sk=25826.0" target="_blank">April programme review</a> the country is conducting a large macro economic adjustment with only a "constrained toolbox" available (a euphemism I presume for the inability to devalue).<br />
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The IMF report was, incidentally, quite frank and realistic about the problems the country faces, unusually so, and far more explicit about the issues than <a href="http://romaniaeconomywatch.blogspot.com.es/2012/07/whom-gods-would-destroy.html">the Romania one I reviewed last week</a>.
On the one hand they state "competitiveness indicators are showing some signs of improvement with wages declining in some sectors and a sizeable improvement in the current account deficit in 2011".... yet...."Despite this progress,formidable challenges remain...the simultaneous pursuit of fiscal austerity, structural reforms, and the deleveraging
of the economy—objectives that can work at cross purposes—increases the risk that the
program’s objective of rapidly reducing macroeconomic imbalances remains out of reach in the near term".
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What macroeconomic are we talking about here? Well, in the first place, despite the above-mentioned improvements the country still runs a goods trade deficit.<br />
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And while the current account deficit has been substantially reduced, the IMF are still forecasting a 4% of GDP one for 2012. More tellingly, they see the country as being unable to reduce the deficit below 3% of GDP before 2018. To really start to get sustainable export-driven growth and ongoing debt reduction (what the IMF call "external stability") we will need to see, remember, the current account move into surplus, and stay there. So are we facing a case of the low hanging fruit now having been picked? In any event, and taking the IMF warnings to heart, it doesn't seem unrealistic to suppose that Portugal will need some sort of support for its correction throughout the rest of this decade. That is what having a "constrained toolbox" means.<br />
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Portugal's post 2009 export recovery has been strong.<br />
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But as with most other economies on the periphery the slowdown in European and Emerging Market growth is making this improvement in export performance hard to sustain. Indeed the rate of export growth has been slowing, and has now fallen into negative territory on an interannual basis.<br />
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Obviously Portuguese exports will pick up again once global growth starts to recover, but by just how much can they pick-up without a much larger change in relative prices? As part of its third programme review the IMF carried out a competitiveness study as a result of which the Fund estimated the competitiveness gap at some "13–14 percent as of 2010", noting in passing that "the gap has to date only narrowed marginally (by about 1 percentage points)". <br />
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Using an external stability approach 8one which focuses on reducing the net International Investment Position - IIP) they also found that "to halve Portugal’s highly negative IIP (to about -52 percent of GDP), a real exchange rate depreciation of about
13 percent would be needed".
Both ways of looking at the issue seem to give a similar result - that around a 13% improvement in competitiveness is needed - and given that they also found that "since peaking in 2009, the adjustment in unit labor costs has been fairly limited. In particular, as of Q3 2011, ULC-based real effective exchange rates are only 2–3 percent below their 2009 peaks" it is clear there is still a very, very long way to go.
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<strong><span style="font-size: large;">Banking and Financial Sector</span></strong><br />
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Portugals banks continue to be dependent on the ECB for liquidity. Borrowing hit a new record of 60.5 billion Euros in June, up 3% from May.<br />
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At the same time the flow of credit to the private sector remains constrained. Bank lending to the private sector was down about 4.5% from a year earlier in May according to Bank of Portugal data.<br />
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Also bad loans are rising, and especially in the construction sector. Bad debt owed by Portuguese households and companies rose a further eight percent in April to reach almost €14 billion according to bank of Portugal data. This was an increase of €2 billion since the start of the year.
The majority of this, around €9 billion, is corporate debt, but there has surely been a good deal of "evergreening" going on, and the total exposure of Portuguese banks to souring loans - in particular builder and developer ones - is undoubtedly much larger.<br />
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<span style="font-size: large;"><strong>Construction Slump Threatens Bank Balance Sheets and Employment</strong></span><br />
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Portugal did not have a housing boom like Spain or Ireland, nonetheless with a strong tourist industry construction has played an important role in the economy in recent years, constitution something like 18% of total GDP in turnover terms. <a href="http://www.reuters.com/article/2012/06/28/us-portugal-construction-debt-idUSBRE85R18T20120628">According to Manuel Reis Campos</a>, head of the Portuguese Construction and Real Estate Confederation, the sector, which is the country's largest employer, faces rampant unemployment and bankruptcies that threaten the repayment of 38 billion euros in debt to the banking sector as the credit crunch and austerity bite.<br />
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"The (construction) sector owes 38 billion euros to the banks, bad loans have gone up sharply, much more than expected, along with bankruptcies. We expect 13,000 companies to go bust this year and the sector to lose 140,000 jobs," Reis told foreign correspondents at a briefing. "The sector has no work, the banks don't finance us and the state does not pay. It is a disaster," Reis said.
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Reis predicts the country will follow Greece and Spain into the 20% plus unemployment bracket by the end of this year if things don't change - government forecasts have unemployment rising to 15.5% this year from last year's 14% and to 16% in 2013. Unemployment was at a seasonally adjusted 15.2% in May according to the latest Eurostat data. Construction and real estate employed 670,000 workers in Portugal in 2011, compared with 830,000 in 2008.
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According to the Royal Institute of Chartered Surveyors European Housing Review 2012 Portugal has seen a drop of 71% in annual housing starts since the initiation of the crisis.<br />
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As they say, this puts the country just behind Spain, Ireland and Greece in the construction slump league.<br />
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House price increases were modest, as have been the more recent declines:<br />
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But the slump in construction activity has been dramatic.<br />
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<br />
<strong><span style="font-size: large;">Conclusions - What Happens Next?</span></strong><br />
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<strong>The First Consequence - A Second Bailout Looks Very Likely</strong><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSa-rjLFP7Zde62VTIyFI4oaNpjWk5lJ0DPZhQn8MooSiFO0FiX9w1LyrJXdV4WY7lYY2ix4eu3uXZyEobAEyNOZxZPi_ZCv5jcz7MKzASI8YgsOTEBUfGSl_jhZZDc_ItbQu4mw/s1600/2012-06-25_170440.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="152" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSa-rjLFP7Zde62VTIyFI4oaNpjWk5lJ0DPZhQn8MooSiFO0FiX9w1LyrJXdV4WY7lYY2ix4eu3uXZyEobAEyNOZxZPi_ZCv5jcz7MKzASI8YgsOTEBUfGSl_jhZZDc_ItbQu4mw/s320/2012-06-25_170440.png" width="320" /></a></div>
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Portugal is scheduled to return to the bond markets next year. Given the outlook for the sovereign debt crisis this seems unlikely to be possible. In addition <a href="http://www.businessweek.com/news/2012-01-15/portugal-s-credit-rating-is-cut-to-junk-by-s-p-on-euro-crisis.html">January's Standard and Poor's decision to downgrade the country</a> (from BBB- to BB), means that its debt is now rated sub-investment grade (aka "junk" status) by all three main credit rating agencies. In practical terms downgrade led to a reduction in the country's potential investor base, since many investment and money market funds are now unable to hold Portuguese debt, while resident financial institutions can't possibly assume responsibility alone.<br />
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On the other hand markets have pulled back from their aggresive stance of earlier this year, and bond yields have fallen substantially. One conclusion which could reasonably be drawn here is that they are now not pricing in Private Sector Involvement (PSI) in any kind of debt restructuring in any forthcoming programme revision during the foreseeable future. And this seems perfectly realistic since Portuguese PSI is most unlikely at this point. What is more probable is a restructuring of the size and term (and possibly interest cost) of the current official sector loans, together with some relaxation in deficit targets in tune with the EU's new "modified austerity" stance.<br />
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Estimates of the size of the second bailout vary. More than likely we are talking about something in the region of 50 billion euros 24.2 billion for financing in 2013/14, plus another 26.9 billion euros for 2015. And then something to allow for the worsening economic scenario and the
relaxed deficit conditions.<br />
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But whatever happens in September, in the longer run the future of Portuguese debt looks very precarious, since it is delicately balanced on a knife edge, and could easily veer sharply upwards under an unfavourable scenario. So PSI in the longer term is far from ruled out.
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As the IMF says in its third programme review, "if growth disappoints, interest rates are higher, or the fiscal effort less than envisaged under the program, the debt dynamics would be less forgiving—leading to a debt-GDP ratio that would remain well above 100 percent for the foreseeable future. And the adverse combination of low growth, higher interest rate and a lower primary balance would place debt on an unsustainable trajectory".
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They also stress the danger that private sector debt may need - Spanish style - to be bailed out: "The scenarios also show that there would be little scope to accommodate the migration of private sector liabilities to the public sector balance sheet".
Think of Mr Campos mentioned above, of Portuguese builders and developers, and of what may be happening to bank balance sheets even as I write.<br />
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Or think of the significant number of effectively state owned enterprises that are still officially classified as private sector. According to IMF estimates, explicit guarantees to SOEs (including those outside general government accounts) represented between 10% and 15% of GDP in mid-2011.
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According to the Troika’s central case scenario, Portuguese debt will increase from 107.2% of GDP in 2011 to 116.3 % of GDP in 2012 and peak at 118.1% in 2013. Debt sustainability is expected to be confirmed from 2014, when the debt-to GDP ratio is expected to decline to 115.8%. The Troika assumes that Portuguese GDP falls by 3.0% in 2012 followed by a mild recovery (0.7%) in 2013 and a pick-up in growth to 2.4% in 2014. Thereafter, the Troika assumes real GDP growth of 2.0% per year and nominal GDP growth of 4%. As the Troika expects that Portugal will return to market funding in 2013, it estimates the average interest rate for new debt of around 4.8% for the period up to and including 2015.
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Back in February a team of Citi researchers lead by Jürgen Michels examined a number of scenarios for GDP growth spanning the 2012-16 period around the Troika’s baseline (see chart above). To give an idea of just how sensitive the Portuguese debt path is to the economic growth parameter, they found that in the event of GDP growth undershooting the baseline forecast by between 1 percentage point and 3 percentage points the debt-to-GDP ratio would be on an unsustainable path, rising to 134% and 202% of GDP, respectively,by 2020.
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Naturally, having higher than expected interest costs, or significant debt transfer from the private sector would have similar negative effects.<br />
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<strong><span style="font-size: large;">In Addition Young Educated People Are Increasingly Leaving</span></strong><br />
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According to Peter Wise, <a href="http://www.ft.com/intl/cms/s/0/67d4921a-beb6-11e1-b24b-00144feabdc0.html#axzz2047kJd53">writing in the Financial Times</a>, "Portugal’s prime minister has been free with his advice to the legions of young and unemployed in his country. They should “show more effort” and “leave their comfort zone” by looking for work abroad. Teachers unable to find a job at home should think about emigrating to Angola or Brazil".
The background to this controversy is, as Peter points out, the sudden emergence of Portugal as an origin country for emigration.
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<blockquote>
"In the decade after Portugal met the criteria to join the euro in 1999, emigration, which had served as an economic “escape valve” for 200 years, virtually came to a standstill. For the first time in its history, Portugal was a net importer of migrants. But with an estimated 120,000-150,000 people leaving a country of 10m last year, emigration has now surged back to the peak levels of the 1960s and 1970s, when waves of impoverished workers departed for northern Europe and the Americas."</blockquote>
And as he emphasises, the difference between this and earlier population outflows is that, unlike the largely uneducated workforce that left in previous haemorages, many of today’s migrants are young graduates with university degrees.
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The net loss of human capital is evident. The impact on population ageing is less so, but soon becomes clear when you think about what happens to the population pyramid. But what about economic growth, what does this do to the long term growth rate? Isn't a country with long term below replacement fertility effectively commiting suicide if it exports its working age population?<br />
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Economic growth attracts migrants as the labour market expands, this increases the working age population and with it the long term growth rate. On the other hand, a country which has a lasting economic contraction can loose population as unemployment rises (this is what is happening now along Europe's periphery), with the loss of population the potential growth rate falls, and with it future employment. If you aren't careful this encourages more people to leave, and the situation becomes circular (arguably<a href="http://www.slideshare.net/Edwardhugh/latvias-demographic-future" target="_blank"> this has already happened in Latvia</a>) with low growth/recession feeding on itself. If the median age of the people leaving is lower than the median age of the workforce, or if the educational level of those leaving is above the average of the workforce, then the quality of your labour force, and with it potential productivity, falls. At the same time the debt problem becomes greater, since there are less people left to share the debt. <br />
<br />It gets worse, because less young people means less household formation (think of those builders with their empty houses), less new families, less children, and more health and pension unsustainability in the long term. All of this is so obvious that the only thing which surprises me is that I have found NO EVALUATION WHATEVER of this phenomenon in any of the Troika literature. <br />
<br />Some will say that these movements are good, since what Europe needs is more labour market flexibility. To which I would say yep, you are right, the only difficulty is we still have nation states who are expected to be self sustaining, so pension contributions are paid in one place, while the old people waiting to receive are in another. The statement by Pedro Passos Coelho reminds me of an earlier one by <a href="http://workinglife.org/blogs/view_post.php?content_id=6871">Mexican President Vicente Fox that he would create six million jobs</a>. "Yeah," one witty observer said later, "what he didn't tell us was that they would all be in California."
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<blockquote>
"During President Vicente Fox's six years in office his goal was to create six million jobs across all sectors of the economy. Mr. Fox fell far short of that goal. Between 2000 and 2006, the period when he was in office, Mexico created only 1.4 million jobs. Though accurate figures are difficult to arrive at, the Government Accountability Office estimates that during each year of Mr. Fox's presidency between 400,000 and 700,000 illegal immigrants arrived in the U.S. from Mexico. The number of illegal immigrants from Mexico was roughly equal to the number of jobs Mr. Fox did not create."</blockquote>
Naturally, if the Euro Area was one single nation state like the United States is none of this would be a problem - but it isn't!
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<br />
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-3950127.post-24882597356683667212012-07-08T13:23:00.000+02:002012-07-08T14:09:51.589+02:00Neither Grexit, Nor Spexit, It's Fixit or Fexit<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The aftermath to last weeks EU summit has certainly proved to be a damn sight more perplexing than the actual summit itself. Contrary to earlier experiences, this time round the more the details have been "clarified" the more confused we have become.</span><br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Just what exactly was approved? Will Spain's banks really obtain capital directly from the ESM, and if so, how and when? Is Spain about to get a full bailout? Is Italy? Is there a commitment to bringing down sovereign borrowing costs. And just to top it all of what about Greece, what is the next move, is there any kind of plan?</span><br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Little wonder then that Spain's 10 year bond yields <a href="http://money.cnn.com/2012/07/06/investing/spanish-bond-yield/" target="_blank">were once more back over 7% on Friday</a>. Markets had taken the view that while agreement on the details of an ESM bond buying formula and full banking union would obviously take time, surely the ECB would be prepared to do something - another LTRO, reopen the Security Markets Programme - in the meantime. But no, Mario (Draghi this time) was not for turning, and <a href="http://in.reuters.com/article/2012/07/05/markets-bonds-euro-idINL6E8I5A7U20120705" target="_blank">sent the ball straight back into the politicians court</a>.</span><br />
<br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Really I think the markets have gotten a bit ahead of themselves here in expecting instant action, since European decision making works according to its own timeless laws. To reach my conclusions before I draw them, I think it is plain that Spain's bank recapitalisation will be, kicking and screaming, an all Euro Group affair. That is to say the debt sharing the Finnish Finance Minister so desparately fears will take place, even if we take a while to get there. And Spanish and Italian bonds will be bought, even if we need to take a quick look down into the abyss just one more time first. But these measures alone won't save the Euro, only getting the periphery back to growth can do that, and at the moment the suggestion box seems to be empty on that count. Structural reforms alone will work neither far enough nor fast enough. </span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><br />
<strong><span style="font-size: large;">Root Of The Problem</span></strong><br />
<br />But if the markets have gotten ahead of themselves in their enthusiasm there are reasons for this. So first a bit of background.<br />
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The root of the problem here goes back to the G20 summit in Los Cabos, Mexico, where an outnumbered Angela Merkel came under general pressure to accept <a href="http://www.reuters.com/article/2012/06/19/us-g20-europe-bonds-idUSBRE85I1F620120619" target="_blank">an idea from the other Mario (Monti)</a> to let the bailout funds (ESM, EFSF) buy Spanish and Italian government bonds to bring down borrowing costs. After the meeting the impression was given that Germany had acceded to the pressure and commited itself to the idea of "driving down borrowing costs across the single currency area", indeed the <a href="http://www.blogger.com/goog_535191169">FTs </a><a href="http://www.ft.com/intl/cms/s/0/44c211c0-ba34-11e1-84dc-00144feabdc0.html#axzz1zminryh5" target="_blank">Chris Giles and George Parker even asserted</a> this phrasing to have been in the communiqué:
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"></span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"></span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><blockquote>
"Eurozone members of the group of G20 leading economies have committed to driving down borrowing costs across the single currency area, according to the communiqué from the summit in Mexico".</blockquote>
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Reading through<a href="http://www.telegraph.co.uk/finance/g20-summit/9343250/G20-Summit-communique-full-text.html" target="_blank"> the text</a> though, it rather looks as if they had been "had". There is no such mention, and the key reference sentence simply states, <br />
<blockquote>
"Euro Area members of the G20 will take all necessary measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks".</blockquote>
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More anodyne unimaginable. To add insult to injury, further down the body of the text it says:
<blockquote>
"The adoption of the Fiscal Compact and its ongoing implementation, together with growth-enhancing policies and structural reform and financial stability measures, are important steps towards greater fiscal and economic integration that lead to sustainable borrowing costs"</blockquote>
Which is more or less pure Merkelese. So we shouldn't say we weren't warned.<br />
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<strong><span style="font-size: large;">Once Bitten Twice Shy?</span></strong><br />
<br />
Obviously, given the way leaked commitments suddenly disappeared in the concluding statement, we should have been prepared for the possibility that decisions which appear in a concluding statement may later disappear in the mists of clarification. We weren't, even though we should have been more on our guard the second time around. <br />
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Now according to the official version of what happened in Brussels a coalition of "Latin" states, lead by Mario Monti and Mariano Rajoy steamrollered the Angela Merkel into accepting policy measures which they had been pressing for. Der Spiegel <a href="http://www.spiegel.de/international/europe/monti-and-rajoy-get-direct-bank-aid-and-bond-support-from-merkel-a-841632.html" target="_blank">put it thus</a>:<br />
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"Italy and Spain were able to secure immediate measures to lower their borrowing costs at the European Union summit in Brussels on Thursday night. The agreement allows direct EU bailout aid to struggling banks, which Chancellor Angela Merkel had opposed".<br />
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Further, <a href="http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131359.pdf" target="_blank">according to the statement</a> issued after the summit, the meeting agreed that the ESM would be able to recapitalise Spain's banks directly.<br />
<blockquote class="tr_bq">
We affirm that it is imperative to break the vicious circle between banks and sovereigns. …. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly.</blockquote>
The measure was seen as an important one, with implications for other member states, as witnessed by the reference to Ireland that was included.<br />
<blockquote>
"The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment
programme. Similar cases will be treated equally".</blockquote>
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So the clear implication was that Spains banks would be recapitalised directly, and that this would be done in such a way as to break the link between banks and sovereigns, and that while it was recognised there would need to be some kind of bridging measure - the statement affirms that "the financial assistance will be provided by the EFSF until the ESM becomes available, and that it will then be transferred to the ESM, without gaining seniority status" - it was assumed that the money would then be retroactively assigned to the banks themselves, by-passing the sovereign. The explicit reference to Ireland allows no other reading.
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<br />
Yet on Friday the earth under our feet started to move, and with it the financial market assessment of Spanish sovereign risk. <a href="http://blogs.wsj.com/marketbeat/2012/07/06/will-europe-really-break-the-spanish-sovereign-banking-loop/" target="_blank">Matina Stevis reported on Dow Jones Newswires</a> a conversation with a senior(but anonymous) EU official who stressed the following point:<br />
<blockquote class="tr_bq">
“I need to make clear what the ESM can do: the ESM is able–if one were to decide ever on such an instrument–to take an equity share in a bank. But only against full guarantee by the sovereign concerned,” the official said. “What you have is that it cuts out the effect of that loan on the debt-to-GDP ratio of the sovereign. Does it still remain the risk of the sovereign or [does it go to] the ESM? It remains the risk of the sovereign.”</blockquote>
Charles Forelle sums the situation up quite aptly <a href="http://blogs.wsj.com/marketbeat/2012/07/06/will-europe-really-break-the-spanish-sovereign-banking-loop/">on the WSJ blog</a>, what we have here is much less of a bold step forward and rather more of a neat exercise in accounting footwork.
<blockquote>
Many in financial markets have assumed the ESM would recapitalize banks on its own–by giving them cash or high-quality bonds in return for equity stakes (or some sort of hybrid instrument, like contingent-convertible notes) in the banks. That way, the whole of the euro zone, and not just Spain, would bear the risk of the banks’ rescue.
Yes, structuring the aid as a direct recapitalization does avoid the need for Spain to incur an actual liability to the bailout fund (and pay interest on its borrowing), but requiring that Spain indemnify the fund against losses just saddles the country with a contingent liability instead of an actual one.</blockquote>
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What matters to investors trying to assess the viability of investing in Spanish government bonds isn't what it says on the official Eurostat EDP accounting docket, but rather the actual path of total Spanish debt (including contingent liabilities, and their probability of becoming actual ones) and the sustainability of that path. Sustainability issues may arise either because the total debt becomes too high, or because growth is too low, and in the Spanish case there are concerns on both counts, and especially if the Euro Group will not share losses in the Spanish banking system.<br />
<br />
On the other issue, that of bonds purchases, the situation is less clearcut. True the statement did hold out the possibility of purchases:<br />
<blockquote class="tr_bq">
We affirm our strong commitment to do what is necessary to ensure the financial stability of the euro area, in particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets for Member States respecting their Country Specific Recommendations.</blockquote>
<br />
But in fact this possibility still exists, since the statement also affirms that any such use would be contingent on a prior memorandum of understanding, and a precondition for the drafting of one of these is that someone apply, and to date neither Spain nor Italy have made any such application. <br />
<br />
So, in fact <a href="http://www.spiegel.de/international/europe/monti-and-rajoy-get-direct-bank-aid-and-bond-support-from-merkel-a-841632.html" target="_blank">Der Spiegel</a> was not actually being faithful to the letter of the statement when it argued the following:
<blockquote>
The key to getting your way in tough negotiations, of course, is to find your opponents Achilles' heel. Italian Prime Minister Mario Monti and Spanish Prime Minister Mariano Rajoy did that on Thursday night and early Friday morning in Brussels. And the result is a euro-zone agreement to allow the common currency bailout funds to give direct help to ailing banks and to become active on sovereign bond markets to provide relief on the financial markets -- free of conditions for the countries in need of such aid.</blockquote>
Further down the article, the authors qualify the point:
<blockquote>
In addition, emergency aid funds will in the future be made available to stabilize the bond markets without requiring countries, providing they are complying with EU budget rules, to adopt additional austerity measures.</blockquote>
This is the so called "virtuous countries" clause. <br />
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<br />
Something somewhere deep inside me chokes on the idea of considering Spain and Italy "virtuous" countries (in the economic sense, of course), since Spain's is surely not going to be able to reach this years deficit target of 5.3% of GDP (just as it failed to reach last years target of 6%), while Italy's gross debt looks all set to surge onwards and upwards as the country sinks deep into a recession of unknown duration. The phrase both claims too much for both of them, and too little for the other three who have already received bailouts (the non-virtuous countries, or sinners, I suppose). <br />
<br />
Instead of being sanctimonious about this, what not be straight and up-front: Spain and Italy are large countries, with far more political clout than the others, and both Mr Monti and Mr Rajoy would be hard pressed to sell a bailout at home, in just the same way that the Euro Group would be hard pressed to fund one. <br />
<br />
<strong><span style="font-size: large;">Where Do We Go From Here?</span></strong><br />
<br />
As we can see from yesterday's movement in Spanish yields, market participants have been left busily scratching their heads. Is the delay in bond purchases only temporary, or is there a more substantive problem looming? Certainly the threat by the Bavaria based CSU, sister party to Merkel's own CDU, to unseat the government, if necessary, is not reassuring. <a href="http://www.cnbc.com/id/48067997" target="_blank">The FT reports</a> they are far from happy with the terms of the "agreement".
<blockquote>
"Horst Seehofer, leader of the Bavarian sister-party of Ms Merkel’s conservative Christian Democrats, warned that softening the conditions for funds would “at some point lead to the situation” in which his Christian Social Union could no longer support eurozone aid".</blockquote>
In addition the Finnish finance minister has now gone further, and suggested that her country <a href="http://online.wsj.com/article/SB10001424052702303962304577510232449188446.html" target="_blank">might feel forced to leave the Eurozone</a> should debt sharing - implicit in the direct bank recapitalisation - be agreed to.
<blockquote>
"Finland is committed to being a member of the euro zone, and we think that the euro is useful for Finland," Urpilainen told financial daily Kauppalehti, adding though that "Finland will not hang itself to the euro at any cost and we are prepared for all scenarios. Collective responsibility for other countries' debt, economics and risks; this is not what we should be prepared for," she added.</blockquote>
Well, Roger Bootle should be pleased, <a href="http://www.thisismoney.co.uk/money/news/article-2169214/Roger-Bootle-wins-250k-Wolfson-prize-guide-euro-break-up.html?ito=feeds-newsxml" target="_blank">he can take his shining new Wolfson trophy</a> up there and see if he can recruit a client. In fact Finland must be one of the few cases where leaving the Euro Area might not be traumatic in its consequences, although I'm not sure how the decision would go down in neigbouring Estonia.
<blockquote>
Our suggested exit path from the euro involves the overnight introduction of a national currency, with monetary amounts converted at 1 for 1, while the currency is allowed to fall well below this on the exchanges"</blockquote>
Whoops, the Finnish case wasn't contemplated - since their currency would doubtless rise, not fall - but still, it's all in a days work. Anyway, those sufficiently interested can find a simple set of rules for exit outlined <a href="http://www.youtube.com/watch?v=tNfGyIW7aHM" target="_blank">in the following video</a>.<br />
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<br />
<strong><span style="font-size: large;">Gamechanger or Gameover?</span></strong><br />
<br />
Yet no matter how positively or cynically we perceive what just happened, the
fact of the matter is that this latest summit did produce results which, while
possibly not being complete game changers, would in fact constitute a significant
advance in the debt crisis if they were implemented, in particular since they do constitute steps towards that long promised banking and fiscal union. And basically, as I say at the start, even if it takes a bit of kicking and screaming first I do think they will be implemented.<br />
<br />
Far and away the most important of these decisions was allowing the ESM to in principle fund Spain's bank recapitalisation. If followed through the decision will possibly come to be seen as a landmark one. My feeling is that the nervy events of the last week will not be the end of the matter, and that eventually a plan and timescale for setting up a banking union will be agreed on, since the costs of not doing so would obviously be far higher than those involved in so doing.<br />
<br />
From now on at least a part of the costs of the Euro experiment's first decade will be shared by all those participating. The issue also serves to underline the fact that this crisis is not only about irresponsible fiscal policy. It is also about inadequate monetary policy and its after effects. Paying the costs of faulty decisions which were taken collectively should not only fall on the shoulders of a few - in this sense the Finns (true or otherwise) are wrong, this is not paying for others debts, it is about paying for joint and severally acquired ones. This is something I have been arguing for
since 2007, so I can hardly not be pleased by this step.<br />
<br />
The consequence is that with a "clean" implementation of the decision the entire Euro Area will now stand behind Spain'sbanks, as will Germany as part of the Euro Area, and indeed all countries in the monetary union would become become part-owners of at least some of Spain's banks. As Angela Merkel said last week, Germany can only thrive if her neighbours do, and now the German's will become stakeholders in the financial institutions of one of those very neighbours.<br />
<br />
Markets would also be reassured by this outcome, since from that point it wouldn't really matter if the recent Oliver Wyman and Roland Berger reports gave
a full and adequate reflection of the full mid-term recapitalisation needs of
Spain's banks - if more money is needed there would be a mechanism in place whereby more money could be found. This is very different from having a Spanish sovereign which is teetering on the brink of being unable to finance itself having to try and guarantee a banking system which contains an unknown number of black holes. In this
context it is not unreasonable to think that the Euro Area partners could
eventually end up with a majority equity stake in the entire Spanish banking
system, we will see. The good news is that whatever the final damage, there is
now enough cement available to fill the hole, and we can stop playing around
with polyfiller.<o:p></o:p></span><br />
<br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Beyond Spain - as the summit statement recognises - the decision will also have implications for Ireland, and possibly - <a href="http://www.economonitor.com/edwardhugh/2012/07/05/and-then-there-were-six-is-slovenia-next/" target="_blank">as I argued last week</a> - Slovenia (which also needs a bank recap and is starting to experience difficulty in financing itself). And in Ireland Deputy Prime Minister Eamon Gilmore is surely right, it will be a gamechanger, since Ireland's huge burden of sovereign debt would be
significantly reduced as the equity holding is tranferred to the ESM.<br />
<br />
From the Spanish point of view the counterparty here is that the government will now need to accept permanent European supervision of Spain's banks. The Bank of Spain is effectively about to become a local office of a European bank regulation system. Having seen what we have seen since 2006 this outcome can only be welcomed.<br />
<br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><strong><span style="font-size: large;">Virtuous Circle?</span></strong></span></span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><strong><span style="font-size: large;"></span></strong><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The second chapter included in last week's Brussels pact is much more complicated. The moral hazard problem here is going to be considerable. especially if the ESM does finally directly recapitalise Spain's banks. Once the threat of having a large sum loaded onto Spain's national debt from its troubled financial sector, Spain actually is left with a gross debt to GDP level which is below the EU average, even after all those unpaid bills have been paid. So <a href="http://www.bloomberg.com/news/2012-07-07/rajoy-calls-on-eu-to-deliver-debt-purchases-as-spain-yields-rise.html" target="_blank">Mr Rajoy could easily argue</a> "where's the rush in reducing my deficit, I'm no worse than France or Germany" - German debt will, of course, have gone up due to its participation in the Spanish bank bailout. Complicated times.</span><br />
<br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">So this is surely why Mario Draghi was not willing to initiate another intervention in the bond markets, and why the EFSF isn't yet buying Spanish bonds - Spain needs to reach agreement with Brussels on the measures to go in the Memorandum of Understanding, and now Mr Rajoy is suddenly in less of a hurry than he was a week ago. <a href="http://uk.reuters.com/article/2012/07/04/uk-spain-economy-idUKBRE8630CS20120704" target="_blank">Press reports suggest</a> that Spain may need to undertake a further 30 billion euros in spending/revenue measures in exchange for an extension of the 3% budget target to 2014. This will almost certainly result in a stronger than anticipated economic contraction this year, and virtually guarantee a further sizeable one next year too. </span><br />
<br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p>Italy appears to be struggling with this years targets too. Despite the fact that <a href="http://online.wsj.com/article/SB10001424052702304141204577510072562464162.html?mod=googlenews_wsj" target="_blank">Mario Monti has just passed another 4.5 billion Euros in fiscal measures</a> for this year (and a total of 26 billion Euros between now and 2014) doubts still exist the country will be able to meet its targets, largely due to the scale of the recession it has brought down on itself. Making what seem to me to be pretty reasonable assumptions, a team of Citi analysts lead by Jürgen Michels reach the conclusion that far from bringing the budget close to balance by 2014, the deficit in that year is likely to be around 3%, bringing gross government debt to GDP to the perilously high level of 137% of GDP. The IMF have it at 123% for the same year, and between these two numbers lies a chasm which if crossed will be hard for the country to work its way back across.</o:p></span></span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;"></span></span><br />
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<br />
In addition Itay's political dynamics are now becoming particularly problematic, with elections looming next year, and <a href="http://www.ft.com/intl/cms/s/0/1f118ffc-c07c-11e1-982d-00144feabdc0.html#axzz1zminryh5" target="_blank">many of the political parties now positioning themselves in anticipation</a>. <br />
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<br />
So again, as in the Spanish case, the moral hazard issue looms large, as does the entire credibility of the programmes put in place so far. It's hard to make a strong claim they are actually working.<br />
<br />
And even were the will to bail out both Spain and Italy there, it still isn't clear what the way is. <br />
<br />
Allowing the ESM intervene by buying bonds raises the obvious issue that its notional €500 billion firepower would be quickly used up. In addition calls on the fund are only likely to grow in coming months. Following the lead of Cyprus last week, Slovenia is now more than likely waiting in the wings (<a href="http://www.economonitor.com/edwardhugh/2012/07/05/and-then-there-were-six-is-slovenia-next/" target="_blank">see here</a>). And before the year is out, a second programme for Portugal and a primary market support facility for Ireland are also likely to be necessary. <br />
<br />
Portugal risks missing this years deficit targets, partly due to <a href="http://www.reuters.com/article/2012/07/05/eurozone-portugal-budget-idUSL6E8I58US20120705" target="_blank">a fall in revenue</a>, and partly due to increased spending as a result of <a href="http://www.reuters.com/article/2012/06/05/us-portugal-economy-unemployment-idUSBRE8540KW20120605" target="_blank">a strong surge in unemployment</a>.<br />
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And as if all this wasn't enough, <a href="http://online.wsj.com/article/SB10001424052702303962304577510321047271412.html?mod=googlenews_wsj" target="_blank">Portugal's constitutional court ruled last Thursday</a> that the a government decision to withdraw public-sector workers' traditional additional two months salary payents between 2012-14 was unconstitutional, thus piling on the pressure on Prime Minister Pedro Passos Coelho to seek looser conditions for its bailout program.
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The likely date for the second Portuguese bailout is September, following the rationale for the Greek one, since Portugal is programmed to return to the markets to finance bonds in September 2013 (an outcome which is extremely improbable), and the IMF has a “financing guaranteed 12 months ahead” rule. More than likely the country will need something over 50 billion euros - 24.2 billion for
bond financing in 2013/14, plus another 26.9 billion euros for 2015. Then there will need to be something to allow for the worsening economic scenario and the
relaxed deficit conditions.
<br />
<br />
The Irish case is rather different, since the country has been promised a review of its programme in the light of the decision to give direct aid to Spain's banks. Bank recapitalisation has so far cost Ireland a total of €62.8 billion, or 40.7% of annual GDP, according to IMF data. Ireland's was the seventh most expensive bank recapitalization (as a share of GDP) on record and by the far the most expensive in recent history among the EU15 countries (with Finland’s early 1990s one coming second, at 12.8% of annual GDP).
It is not clear at this point what kind of flexibility will now be shown to Ireland. A "low cost" option would be to allow the ESM to replace the 30.6 billion euros in promissory notes issued to recap the IBRC. Doing this would cut Ireland’s government debt/GDP ratio (which was 108.2% in 2011) by about 20% of GDP, and also cut future deficits by about 1% of GDP. The "business class" option would be to take all of Ireland’s bank recapitalization costs onto the ESM, which would cut Ireland’s government debt/GDP ratio by about 40% (and, of course, at the same time reduce the future deficit path). The most likely outcome is the low cost one, but still the impact on Ireland's debt sustainability would be important. The Irish government has said it is seeking a decision by end-October, to have more certainty over future funding needs as the existing bailout nears its planned completion at end-2013.
<br />
<br />
<br />
Which brings us to Greece. Ah, Greece! Well the government has admitted that the country is no longer "on track" to meet its programme' fiscal objectives.<br />
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<br />
The country has also stated publicly that it does not want to renegotiate the Memorandum of Understanding. <br />
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<br />
<br />
<br />
And the "men in black" from the Troika are now back in town.<br />
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<br />
So we look all set for a new set of deficit targets to be agreed, along with a hefty injection of European structural funds and EIDB money. As I suggested here, everyone now will have done their sums, and seen just how expensive it would be for Greece to leave (not to mention the contagion risks) so the current priority must be to find ways of keeping the country in.<br />
<br />
Naturally stretching the austerity targets for Greece will also require fresh cash, but it is not impossible that a bit of creative accounting and juggling with numbers here and there could whisk this safely away and out of sight.<br />
<br />
Looking through all this we can safely draw three conclusions.<br />
<br />
1) September looks set to be a key month, as all the loose ends will need to be drawn together around that point.<br />
2) None of the programmes put in place to date have worked as planned<br />
3) The ESM will not have sufficient resources to meet all the forseeable calls on its funds.<br />
<br />
<br />
The last of these issues has a simple and prgamatic solution. Unlike the ECB, which can create the money it uses for secondary market intervention, the ESM first needs to raise the funds it lends. Granting the ESM a banking licence which would give access to ECB funding and greatly ease the problem. The downside is that there is no public political will for this at present, and indeed Mario Draghi explicitly rejected the idea at last weeks press conference.
Still, one thing we have all learnt in the two and a half years of this crisis is never say never.<br />
<br />
So...........<br />
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<br />
<strong><span style="font-size: large;">What Can Be Done?</span></strong>
<br />
<br />
a) Shotgun Wedding
<br />
b) Full Banking Union
<br />
c) Common Fiscal Treasury
<br />
d) Central Bank able to act like the BoJ, the BoE and the US Federal Reserve
<br />
e) Less austerity and common finance to support the various economies while
much needed structural reforms are undertaken.
<br />
<br />
This is just not doable say the critics. Well then, think about the alternatives for
just 5 minutes and maybe you will change your minds.
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<br />
<strong><span style="font-size: large;">
No Easy Answers At This Point</span></strong>
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<br />
Effectively I am suggesting turning the Euro Area into a second Japan. But Japan’s public debt path is not long term sustainable. There isn't any possibility Japan couldn’t exit the Yen, is there? I mean the country manifestly needs a much cheaper currency, yet despite issuing its own banknotes and being able to print somehow or other it doesn't seem able to achieve this (actually Joseph Stiglitz did suggest at one point the creation of a non convertable government issued second money to finance public spending, just as some have suggested for Greece). At present there are no capital controls in Japan, due to the presence of that famous "home bias" phenomenon whereby investors accept miserable rates of returns on their investments rather than sending their money abroad, but who knows, one day............<br />
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<br />
Basically we are faced with a complex set of problems which were never foreseen in economic theory. We don’t live in a perfect world. Angela merkel is wrong on austerity, but is right that in the longer run debt needs to be sustainable and our economies stable, even if that means accepting low, or even slightly negative, growth. Our intuitions are right, there are no free lunches. Stimulus can be good, depending on what else goes with it, but permanently living on borrowed time and running on “funny money” will inevitably end in tears.
<br />
<br /><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">As Paul Krugman <a href="http://krugman.blogs.nytimes.com/2012/07/05/ecb-death-wish/" target="_blank">put it recently</a>, the Euro crisis has three layers - troubled banks, overlaid on troubled sovereign debt, overlaid on a deep problem of competitiveness created by runaway capital flows between 2000 and 2007 which lead to a huge problem of external indebtedness. The lastest summit decisions (when implemented) will help Spain address the first and second of these. But the big outsanding issue is still growth, a topic which was almost relegated to the sidelines given the extent of the other decisions. Economies in both Spain and Italy are sinking deeper and deeper into recession, and the 120 billion euro all Europe programme will hardly be sufficient to turn this situation around. Indeed in the case of all the rescued countries the same issues remains - where is the growth to come from? So while the summit outcome is certainly an example of yet another significant step forward, it is also a case of "oh so many rivers still left to cross".</span><br />
<br />
<strong>Postscript</strong><br />
<br />
And of course time <strong>is</strong> pressing, and it shows. The last summit statement <a href="http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131359.pdf">concluded with the following words</a>, "We task the Eurogroup to implement these decisions by 9 July 2012."
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<br />
Having started this post with a piece the issue of press reporting of off the record remarks, maybe it would be appropriate to finnish (no pun) with one. A representative of Finland's Finance Minister Jutta Urpilainen (Matti Hirvola) has complained that the Minister never said “Finland would consider leaving the eurozone rather than paying the debts of other countries in the currency bloc" in her interview (as reported by AFP). What seems to be at issue here are comments which are made on and off the record, and then how newspapers report the off the record part. After all, if you aren't prepared for debt sharing, the obvious question is what are you going to do if it comes (and it will). The natural response is "we are prepared for all scenarios", which is what they claim she said.<br />
<br />
Curiously <a href="http://yle.fi/uutiset/urpilainen_misquotes_on_euro_spread_like_wildfire/6209783" target="_blank">the report from the Finnish newsagency YLE which covers the story</a> itself contains a good example of this kind of issue:<br />
<blockquote>
On Friday afternoon, the French news agency AFP cited an interview with Urpilainen published by the Finnish business paper Kauppalehti that morning. The wire service reported that “Finland would consider leaving the eurozone rather than paying the debts of other countries in the currency bloc, Finnish Finance Minister Jutta Urpilainen said".
</blockquote>
<blockquote>
In fact, Urpilainen said nothing of the kind in the interview. Rather she stressed that Finland is committed to euro membership and that “this is the message we must continue to convey”.</blockquote>
If you read the second paragraph again, the impression is given that it is YLE who are saying "nothing of this kind" was said in the interview, when actually it must be Matti Hirvola being quoted, since the YLE reporter was presumeably not present at the interview.</span></span>Since YLE themselves point to the Wall Street Journal's <a href="http://online.wsj.com/article/SB10001424052702303962304577510232449188446.html" target="_blank">corrected version of the story</a>, I think we can put the issue to rest with them:
<br />
<blockquote>
Finland would rather leave the euro zone than pay down the debt of other countries in the currency bloc, Finnish Finance Minister Jutta Urpilainen said in a newspaper interview Friday.<br />
<br />
"Finland is committed to being a member of the euro zone, and we think that the euro is useful for Finland," Urpilainen told financial daily Kauppalehti, adding though that "Finland will not hang itself to the euro at any cost and we are prepared for all scenarios."<br />
<br />
"Collective responsibility for other countries' debt, economics and risks; this is not what we should be prepared for," she added.<br />
<br />
Urpilainen's spokesman Matti Hirvola stressed to AFP that the minister's comments did not mean Finland was planning to exit the euro zone.<br />
<br />
"All claims that Finland would leave the euro are simply false," he said.<br />
<br />
In her interview with Kauppalehti, the finance minister meanwhile insisted that Finland, one of only a few EU countries to still enjoy a triple-A credit rating, would not agree to an integration model in which countries are collectively responsible for member states' debts and risks. </blockquote>
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-3950127.post-15320442721758171712012-07-05T17:59:00.000+02:002012-07-06T17:28:14.828+02:00And Then There Were Six - Is Slovenia Next?Slovenia is in the news. According <a href="http://www.bloomberg.com/news/2012-07-02/slovenia-heads-for-sixth-euro-area-bailout-request-to-aid-banks.html" target="_blank">to press reports</a> (and <a href="http://www.reuters.com/article/2012/06/19/ecb-kranjec-idUSF9E8CC04220120619" target="_blank">here</a>) solving the problems which have accumulated in the country's banking system may well mean the country is next in line for some sort of EU bailout assistance. Speculation was fueled last week when ECB Governing Council member and Bank of Slovenia Governor Marco Kranjec said that the country may well eventually need assistance, even if for the moment it will not be necessary. Sounds a lot like the other denials we have heard just before the "happy event".<br />
<br />
"We do not exclude anything ... but for now this is an entirely hypothetical question," he told his conference audience,"Conditions (in the Slovenian banking sector) are going in the bad direction, but for now I do not see a reason that Slovenia would need to ask for (international) help." He also made the point that "Yields on our (Slovenian) debt are very high but poor availability of (financial) resources is even more worrying,"
<br />
<br />
If the bailout materialises (and it seems to me likely it will) this will put the country in the same group as Spain and Ireland, who are to receive EU assistance for their banking sectors (even if <a href="http://www.ft.com/intl/cms/s/0/706a3b92-c45f-11e1-9c1e-00144feabdc0.html#axzz1zOThFjqc" target="_blank">Ireland's share is still to be negotiated</a>) as a result of having credit driven construction booms which were incentivised by excessively lax monetary policy at the ECB.<br />
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<br />
In fact during the years prior to 2009 Slovenia consistently ran an inflation rate which was higher than the Euro Area average. <a href="http://www.ecb.int/press/key/date/2007/html/sp070907_2.en.html" target="_blank">At the time we were told</a> these inflation differentials were relatively benign, since they were in part a product of the Balassa-Samuelson effect. Nowadays EU leaders are more willing to accept that these inflation differentials represent a problem, but the sad truth is that the damage is now done.<br />
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What makes Slovenia interesting despite the fact it is a small country (population circa 2 million) is that it is a relatively new entrant to the euro (2007) and was the first of the Eastern European countries to join the common currency, so there could be important lessons here for others who would like to join in the future. For some years it seemed that the country was one of the Euro project's shining beneficiaries, as living standards shot up, and the country even overtook older members like Portugal. Now it looks as if all that prosperity was at least partially founded on sand, and as the storm clouds gather all that new found wealth seems to slip away and out of sight.<br />
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<br />
<strong><span style="font-size: large;">Credit And Construction Boom</span></strong><br />
<br />
According to last years IMF Article IV report, "Slovenia’s economy is gradually recovering following one of the sharpest
GDP declines in the euro area during the crisis. Real GDP declined over
10 percent from peak to trough owing to: a sharp decline in external
demand; a significant tightening in external credit conditions forcing
banks to curtail domestic credit supply; and an abrupt end of a
construction and housing price boom". <br />
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The sharp slump part is certainly valid:<br />
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<br />
But the steady recovery bit, alas, is no longer so, since GDP decined in <strong>each of the four quarters in 2011</strong>, bringing in a small negative result for the year. The IMF now forecast an additional 1% fall this year, and next year we will see.<br />
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The issue is that something has gone wrong, badly wrong, in much the same way as it did in Ireland and Spain, even if, thankfully, the scale of the problem is smaller. As the IMF point out the root of the problem was an overheating in domestic demand from the time of the run-in to Euro membership, an overheating which was produced by an inflow of funds from the current account surplus countries.<br />
<br />
<br />
House Prices in Slovenia surged between 2004 and 2008 and then fell back sharply before making a timid recovery in the second half of 2009 (see chart). Since the start of 2011 house prices have again been falling, and the price of new built flats fell sharply (by 8%) in the first quarter of 2012, <a href="http://www.stat.si/eng/novica_prikazi.aspx?id=4725" target="_blank">according to the latest data from the Slovenian statistics office</a>. <br />
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Construction activity has also fallen considerably.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw8syuj4p4wQtGBkP3K7JALdqRB9ixGqp145rSCwqswZxxDQ-IoeRF-Qc-m1LvGnDMHb8-sm6BjaEULLhMFLRK9Ool37S5FUhx6V-INkZ8ZkEL0sJGFXRAeWWSND6l25aCWmssng/s1600/Slovenia+Construction+Index.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="179" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw8syuj4p4wQtGBkP3K7JALdqRB9ixGqp145rSCwqswZxxDQ-IoeRF-Qc-m1LvGnDMHb8-sm6BjaEULLhMFLRK9Ool37S5FUhx6V-INkZ8ZkEL0sJGFXRAeWWSND6l25aCWmssng/s320/Slovenia+Construction+Index.png" width="320" /></a></div>
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And as a result retail sales and domestic demand generally have stagnated.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkxvNADv85rpWXgB3XBKrvcdBXRcMlP9LLLOMs4LOwSajehCdc_TIGKFUMlhSVOnzgroH-s_kZwJrdRkYQ9TU7T_R3jTxMf1p_1UlKXG7BE3Ur1Mu1Qz2mDHS6Kwav8lbrmOKApA/s1600/Slovenia+Retail+Sales+Index.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="179" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkxvNADv85rpWXgB3XBKrvcdBXRcMlP9LLLOMs4LOwSajehCdc_TIGKFUMlhSVOnzgroH-s_kZwJrdRkYQ9TU7T_R3jTxMf1p_1UlKXG7BE3Ur1Mu1Qz2mDHS6Kwav8lbrmOKApA/s320/Slovenia+Retail+Sales+Index.png" width="320" /></a></div>
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While unemployment has continued to rise.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDeAepw2_n5ToQycXzvrOhFA9D3Of9Wy98z42AAZMlpAPlaqL67FWl_c2h00Ydrf1wUklvH5w8Xpdd4NaWa8JfYRonSk3KVo3x5gsu9hquPra595ZgJ44YzZTgNkGEyiez-_kkvw/s1600/slovenia+unemployment.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="195" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDeAepw2_n5ToQycXzvrOhFA9D3Of9Wy98z42AAZMlpAPlaqL67FWl_c2h00Ydrf1wUklvH5w8Xpdd4NaWa8JfYRonSk3KVo3x5gsu9hquPra595ZgJ44YzZTgNkGEyiez-_kkvw/s320/slovenia+unemployment.png" width="320" /></a></div>
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<strong><span style="font-size: large;">Time to regain competitiveness?</span></strong><br />
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Slovenia's economy lost competitiveness significantly during the high inflation boom years. As a result, despite the fact that exports have done well since the global recession, they have not done well enough (since the sector is not big enough) to pull the economy out of the ditch into which it has fallen. This is a familiar picture for anyone who has been closely watching events on Europe's periphery. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpmSH7NTbvn1KMy6Cam1NlJctfQ9YR5ULV9-ayip-PWo_OfxWtDVK1i5p2lGz-YifhfW4DRWwBQU7NC4P5rS-JL4i28_uyYdKztDQrCTA_-yXhyphenhyphenLJR9S0Wm3Kty0EbdeBeLupLWA/s1600/Slovenia+Constant+Price+Exports.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="175" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpmSH7NTbvn1KMy6Cam1NlJctfQ9YR5ULV9-ayip-PWo_OfxWtDVK1i5p2lGz-YifhfW4DRWwBQU7NC4P5rS-JL4i28_uyYdKztDQrCTA_-yXhyphenhyphenLJR9S0Wm3Kty0EbdeBeLupLWA/s320/Slovenia+Constant+Price+Exports.png" width="320" /></a></div>
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In addition with the external environment deteriorating as the Euro Debt Crisis worsens exports have now fallen back again, and are consistently below the level of one year earlier.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhniowguwpUvGd1FtyXs2uf8OKu7JVDwBo2z7LgHqh0s-bm06fP83scLqzoB7SnuCkIU1mt85IyBEucQwdy9dWw-PMFn1Bv8-uBPxnGY0_RdjbOl-jszPvt86r5Wq5BjO8f856y1Q/s1600/Slovenia+exports+YoY.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="174" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhniowguwpUvGd1FtyXs2uf8OKu7JVDwBo2z7LgHqh0s-bm06fP83scLqzoB7SnuCkIU1mt85IyBEucQwdy9dWw-PMFn1Bv8-uBPxnGY0_RdjbOl-jszPvt86r5Wq5BjO8f856y1Q/s320/Slovenia+exports+YoY.png" width="320" /></a></div>
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Slovenia enjoys significant income from tourism, but the goods trade balance remains in deficit.</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKdmk3KwidUsVqooaSvOeweG9022CDZkv59fzxY7HVsgAHVQrlcUMcUxu7qLK7lA7GVDBHo3rr_Lf-VUjunCTe_UnddTFJzx6cDkcZribpSNw6cQMbUxtzsT_-q_-ukm1wQkFDTg/s1600/Slovenia+Goods+Trade+Deficit.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="181" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKdmk3KwidUsVqooaSvOeweG9022CDZkv59fzxY7HVsgAHVQrlcUMcUxu7qLK7lA7GVDBHo3rr_Lf-VUjunCTe_UnddTFJzx6cDkcZribpSNw6cQMbUxtzsT_-q_-ukm1wQkFDTg/s320/Slovenia+Goods+Trade+Deficit.png" width="320" /></a></div>
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In another of the tell tale signs of Europe preiphery membership, the country has moved from a small current account surplus in the early years of the century to a consistent deficit today. The deficits in 2007 and 2008 were noteworthy for their size.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijh-rKbMsbs1bAcB1ViwEfuBXlI7tK6MHWPYJXv8Wff3RAO1UbMHd3-Ul_NtaPmbA37j4U6iYOhmd7dUQlg1ld5NtZ82jlXuti7t67qvG3tMPTyuVXetGiwpmo9L2hV_e7jav_nw/s1600/Slovenia+current+account+annual.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="198" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijh-rKbMsbs1bAcB1ViwEfuBXlI7tK6MHWPYJXv8Wff3RAO1UbMHd3-Ul_NtaPmbA37j4U6iYOhmd7dUQlg1ld5NtZ82jlXuti7t67qvG3tMPTyuVXetGiwpmo9L2hV_e7jav_nw/s320/Slovenia+current+account+annual.png" width="320" /></a></div>
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<strong><span style="font-size: large;">No Demographic Dividend</span></strong><br />
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What sets East Europe apart from other developing economies is their unusual demography, in the sense that under the earlier communist regimes they went through their demographic transition without getting any real growth bonus. Now they have been having rapid catch-up growth and rising elderly dependency ratios at one and the same time. <br />
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Slovenia, like most of the rest of Eastern Europe has had long term below replacement fertility.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEireanLZDE-6RthC7fayoZJN9wbYKC2AwOJQO9Z3xtGVOAdm9TkN2GmIUi1fn8iIs7Tp8vuhFc0U2_NSAcW0mHyqYEmGSdV1QeJpgS-FZthZyiwto-B9GuvS0NTmcsKFl06TLxG7w/s1600/slovenia+TFR.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="206" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEireanLZDE-6RthC7fayoZJN9wbYKC2AwOJQO9Z3xtGVOAdm9TkN2GmIUi1fn8iIs7Tp8vuhFc0U2_NSAcW0mHyqYEmGSdV1QeJpgS-FZthZyiwto-B9GuvS0NTmcsKFl06TLxG7w/s320/slovenia+TFR.png" width="320" /></a></div>
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The country has high male life expectancy for the region (over 75) and as such has one of the oldest populations by median age in Eastern Europe.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_aMSkAxsKW328V2Mq7PFiwhyphenhyphennxoo3Z_BQwXoh3GLHomNytNhT0O9Ao07p51b-2Elt8erS2YPSoMJ84G3WOZhu7h4kt1_BtBJXZbeVoqxtvU2D7ptzAwTV6RIxxEH1dMe1LZ_8KA/s1600/Slovenia+Median+Age.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="177" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_aMSkAxsKW328V2Mq7PFiwhyphenhyphennxoo3Z_BQwXoh3GLHomNytNhT0O9Ao07p51b-2Elt8erS2YPSoMJ84G3WOZhu7h4kt1_BtBJXZbeVoqxtvU2D7ptzAwTV6RIxxEH1dMe1LZ_8KA/s320/Slovenia+Median+Age.png" width="320" /></a></div>
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One plus feature about Slovenia is that the population has not been falling like that of many countries in the region, and indeed has risen steadily over the last decade, help by a constant flow of immigration. From an economic point of view it is important to find solutions to the current economic crisis, since otherwise the migration flows could invert, following a now familiar pattern elsewhere.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjg8Q5ogitTq-gNXt_FstwtetRlP5GLUBCVvfxhQuR7JRBHYiudZMN0GvOvDYTQLLaPcqyy8hgfYM4uxJHTzDwVEHllUxX2MFZ55qlkqFSyKmNDoBo6VKroS_U7rzVhI3-BFlYn1Q/s1600/slovenia+population.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="208" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjg8Q5ogitTq-gNXt_FstwtetRlP5GLUBCVvfxhQuR7JRBHYiudZMN0GvOvDYTQLLaPcqyy8hgfYM4uxJHTzDwVEHllUxX2MFZ55qlkqFSyKmNDoBo6VKroS_U7rzVhI3-BFlYn1Q/s320/slovenia+population.png" width="320" /></a></div>
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<strong><span style="font-size: large;">Debt And Deficit Problems</span></strong><br />
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Like most countries on the EU's Eastern European flank Slovenia does not have a large accumuated sovereign debt issue. But since the deep recession of 2008/2009 deficits have been high (5.7% in 2011, and 4.7% forecast by the IMF for 2012. <br />
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As a result sovereign debt has been creeping upwards, and reached 47% of GDP in 2011. The IMF forecasts it will reach 52.5% of GDP in 2012, and pass the permitted 60% in 2015. This may seem low by Southern and Western European standards, but we should remember the rapid ageing in Eastern Europe, and the comparative absence of accumulated savings as a heritage of the communist era. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfYijxeIDF0XHhJdkBH5iQwYtmD6EBTFAmh3JhRcQR9yVQgRd4JUUhksMnsF8bfea_PBEFvaV1yFOWI874QzzImeF2p-I5-jMudQmPVpyOVmD0FwYtMali9Mts-XWhLLTQOA8Aaw/s1600/Slovenia+Government+Debt.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="206" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfYijxeIDF0XHhJdkBH5iQwYtmD6EBTFAmh3JhRcQR9yVQgRd4JUUhksMnsF8bfea_PBEFvaV1yFOWI874QzzImeF2p-I5-jMudQmPVpyOVmD0FwYtMali9Mts-XWhLLTQOA8Aaw/s320/Slovenia+Government+Debt.png" width="320" /></a></div>
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Hence the concerns about Slovenia's debt. In a now familiar patternon Europe's periphery, the Slovenian economy is broken, the old construction and consumption model now won't work, yet the economy is not internationally competitive enough to attract the investment it needs to move to sustainable export driven growth, so politicians under pressure to raise living standards run deficits. <br />
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In an attempt to break the cycle, Slovenia's government recently introduced the EU fiscal stability law, much to the chagrin of the country's opposition parties. Indeed Prime Minister Janez Jansa <a href="http://www.bloomberg.com/news/2012-06-27/slovenia-may-ask-for-bailout-in-july-prime-minister-jansa-says.html" target="_blank">even threatened the opposition with a bailout</a> if they didn't vote for the law. “If we continue to get more and more debt", he told them, "we will see a Greek scenario here and the next generation will have to pay dearly for the stupidity of those that have delayed decisions". It is noteworthy that Mr Jansa has subsequently backed away from his earlier declarations, and <a href="http://www.bloomberg.com/news/2012-07-04/slovenia-won-t-seek-international-bailout-premier-jansa.html" target="_blank">now argues the threat has subsided</a>. “Such a danger was eliminated when we adopted and enacted
the legislation to balance public finances," he told
the Slovenia-based Radio City. Obviously a bailout is something you mention when it is unlikely and call improbable when it may really happen.<br />
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<strong><span style="font-size: large;">Credit Crunch Needs Solving</span></strong><br />
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While Prime Minister Jansa argued a full bailout would not be necessary, he did admit was that the banks might need help in the same way their Spanish counterparts did. A thorough evaluation of the souring loans problem at Slovenian lenders has yet to be completed, he told the radio, but whatever the outcome the decision taken by European Union leaders at the recent summit to enable countries to receive bank aid without the debt directly impinging on the sovereign would mean there would be no direct sovereign debt implications. Slovenia would apply for such aid “if the situation demanded it,” he said.
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The <a href="http://www.google.com/url?url=http://www.bloomberg.com/news/2012-07-02/kbc-won-t-contribute-to-381-million-euro-nlb-capital-boost-1-.html&rct=j&sa=X&ei=1K71T8uVIsezhAelyKyRCg&ved=0CDEQ-AsoATAA&q=Nova+Ljubljanska+Banka&usg=AFQjCNF6Tofg4gwvANRoR__CKnK1zthvzw" target="_blank">European Commission approved last week</a> an additional capital injection of €382.9 million for Nova Ljubljanska Banka Group (NLB) to enable it to meet the minimum 9% capital requirements required by the European Banking Authority. NLB is the largest Slovenian bank by assets and holds about one third of total assets in the Slovenian banking sector. The majority shareholder is the Republic of Slovenia while the Belgian bank KBC has a significant minority stake.
In order to recapitalise NLB issued contingent convertible - or coco - bonds, that were subscribed by the government (thus sticking to the letter of a government promise that no new government money would be put into the bank, since technically the it is a loan, until, of course, it is finally converted into equity). In addition 62 million Euros of new stock was subscribed by government owned funds (KAD and SOD), since KBC backed out of the whole deal at the last minute, alleging EU rules had prevented them from participating (KBC is itself in receipt of EU approved state aid which involves eventually selling its holding in NLB).
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The country's second and third largest banks, state owned Nova KBM and privately owned Abanka Vipa also need fresh capital this year to meet tougher capital requirements. The Bank of Slovenia suggest the entire sector will end 2012 with an aggregate loss for the third consecutive year due to the mounting pile of non performing loans, lead by those in the real estate sector. Provisions for non-performing loans were up by 27 percent in the first five months of 2012 while the country's banking sector had an aggregate pre-tax loss of 45.7 million euros over the period.
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Just like Spain, problems in the financial sector are inflicting a severe credit crunch on the whole economy. In May this lending to the non-banking sector of the economy shrank an annual 4.8 percent on declining loans to both companies and households.
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Slovenian banks, which now heavily rely on loans from the European Central Bank, are restricting credit to the economy due to lack of access to wholesale funding and because they are setting aside record reserves to cover bad loans. Non-performing loans in Slovenia rose to 11.8 percent of all outstanding bank loans in March and totalled some 6 billion euros.
Bad loans rose by 300 million euros on the month, the biggest monthly increase to date, mainly because of non-performing loans to construction companies and to financial services and insurance firms. In fact, at <span id="articleText"><span class="focusParagraph">Nova Ljubljanska
Banka NPLs are higher, and currently represent about 20 percent of the loan portfolio (or around 3 billion euros), <a href="http://in.reuters.com/article/2012/07/06/novaljubljanskabanka-badloans-report-idINL6E8I64XZ20120706" target="_blank">according to chiefexecutive Bozo Jasovic</a>.</span></span><br />
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Slovenia is still hoping <a href="http://www.reuters.com/article/2012/07/04/slovenia-bond-idUSL6E8I437O20120704" target="_blank">to go to the bond markets in the coming months</a>, even though an earlier attempt in April was pulled <a href="http://www.reuters.com/article/2012/06/13/slovenia-banks-idUSL5E8HD3W120120613" target="_blank">after yields reached 5%</a> <span id="articleText"> following a Fitch statement that the country had one of the weakest
banking markets in Central and Eastern Europe due to rising
non-performing loans.</span> Yields on their 10 year benchmark, <a href="http://blogs.ft.com/beyond-brics/2011/11/11/slovenias-bond-yields-hit-7-per-cent/" target="_blank">which broke 7% last November</a> before falling back have once more started to rise. They<a href="http://www.bloomberg.com/news/2012-06-19/slovenia-s-benchmark-bond-yield-rises-on-europe-domestic-woes.html" target="_blank"> passed 6% again in mid June</a> and today hit 6.51% in morning trading today (Thursday 5 July), up 0.13 percentage points from the open, and fast approaching the 6.55% yield currently available on
Spanish ten-year bonds. <br />
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Thus while it is not true to say that the country is shut out of the markets, it is now a very close thing. My bet is we will see some sort of rescue in the near future, but as we have seen in Spain moving from rescue to getting credit flowing and getting back to sustainable growth looks set to be a very hard road.
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<br />
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-3950127.post-63316158468511837592012-06-17T16:02:00.000+02:002012-06-18T08:30:27.983+02:00On The Brink Of What?This weekend I have been thinking quite a lot about what the world is gonna look like on Monday, and have come to the conclusion that it won't be that different from the way it was last Friday. The big news surprise of the weekend was in fact Greece related - since the national football team qualified for the quarter finals of the Eurocopa, beating the Russia by a resounding 1-0.<br />
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Oh yes, they also had elections in Greece, didn't they?<br />
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The most likely outcome, as far as I can see at the time of writing, is a neck and neck finish between the far left Syriza and the centre right New Democracy, with the key to the resolution of the outcome lying in the fact that whichever party comes first gets a bonus of an additional 50 seats. This will mean that if New Democracy do win, as it seems they have, they will probably be able to negotiate a deal with the other smaller parties (PASOK, for example) around some sort of face saving formula which will enable a government to be formed and a deal struck with Berlin. <br />
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On the other hand, if Syriza were to finally win no one has a clue what will happen. The party doesn't want to leave the Euro, but does want to reject the memorandum. The only problem is that the only parties Syriza could form a government with would most likely want out of the Euro too. So Syriza winning by a short head would seem to imply more elections, or... or.... some sort of pact. I vote for the latter. <br />
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I say this since I think even if Syriza were by some quirk now to win some sort of government or other would still be formed, even if it needs the military to rustle sabres in the background just to get everyone to concentrate on the issues in hand. In the game of brinksmanship which will now be played, Syriza can blackmail Berlin with the threat of instability and disorderly exit (even in opposition), while Berlin can dangle money, lot's of it I imagine, before their eyes, if only they agree to help form a government. The track record says that politicians normally, when faced with a serious punch up or going for the money will normally go for the money.<br />
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Naturally, the money I am talking here about involves EU funds, not men in black suits carrying suitcases, although if the <a href="http://rt.com/business/news/siemens-greece-bribery-payment-596/">recent 270 million fine accepted by Siemens</a> for bribing Greek officials to obtain lucrative telecommunication contracts is anything to go by, we shouldn't rule the other possibility out entirely.<br />
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Actually Angela Merkel has already hinted at this sort of solution. "This is why it is so important that, in the Greek election tomorrow ... a result emerges in which those who form a government in future tell us, yes, we want to keep to the agreements," <a href="http://www.dw.de/dw/article/0,,16031437,00.html">she told a meeting of party faithful in Darmstadt</a> this weekend, "This is the basis on which Europe can prosper."<br />
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What the forthcoming Greek government needs to do, then, is say loudly and clearly in public that it will stick to the memorandum. Say in public mind you, not necessarily follow the statement through in practice. The phrase being asked for certainly isn't an <a href="http://en.wikipedia.org/wiki/J._L._Austin">Austinian performative</a>, equivalent to saying "I do" in a wedding. In this case uttering the phrase does not constitute implementation. Another example of something which also does not constitute what the British philosopher JL Austin would have termed a performative would be the expression “I promise to pay the bearer on demand the sum of …” which appears on the back of UK bank notes, and is evidently not a promise, or even a lick. It is simply just another way of spilling ink.<br />
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So then, with the protocols safely out of the way, the real deal can be done. Francois Hollande is already talking about <a href="http://www.bloomberg.com/news/2012-06-15/eu-leaders-to-call-for-further-urgent-measures-to-aid-growth.html">an EU growth programme</a> of <a href="http://www.reuters.com/article/2012/06/17/eurozone-france-idUSL5E8HG5QU20120617">around 120 billion Euros</a>. And <a href="http://www.ft.com/intl/cms/s/0/18512fda-b643-11e1-a14a-00144feabdc0.html#axzz1xVjDHNDv">the Financial Times has revealed this weekend</a> that, "European officials are preparing to dangle a package of incentives in front of a new Greek government to convince it to stick to the country’s current bailout deal after Sunday’s high-stakes elections. The package would include further reductions in interest rates and extended repayment periods for bailout loans, as well as EU money to spur investments in Greek public works programmes through the European Investment Bank".<br />
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Naturally, and even in the best of cases, the future government of Greece will be weak, and the economic situation dire. So the agreement to be reached will only be a band aid, one which one hopes will hold until the bigger issues are faced up to over the summer. All that has been avoided this weekend is a disorderly rupture in Greece's relations with the EU and the IMF, <a href="http://www.foreignpolicy.com/articles/2012/05/31/grexit_spexit_let_s_call_the_whole_thing_off" target="_blank">and as I argued here</a>, this outcome was never really very likely. <br />
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So Greece in the short term will be staying in the Euro, although I am not sure whether a majority of observers will necessarily regard this as good news, since clearly it only postpones some sort of day of reckoning or other.<br />
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<strong><span style="font-size: large;">Sigh Of Relief In Berlin</span></strong><br />
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One venue where people will be unequivocally happy with the outcome is - although some may find this surprising - inside policy circles in Berlin. The reason for this is evident. Germany itself is at greater risk of fall out from the Greek election than even Greece itself is. Personally I think the upward trickle in German Bund yields we have been seeing over the last week or so is pretty significant. It is almost as if the market is beginning to prepare for a two stage scenario. The first stage would be Greek non exit. Then in a second stage, the EU would not be moving ahead of the curve fast enough, and the common curreny could disintegrate. Germany, as the creditor country who would not be paid, would be one of the biggest losers. <br />
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More interesting perhaps than 10 year Spanish yields hovering around 7% is <a href="http://www.ft.com/intl/cms/s/0/26aabbcc-b49b-11e1-bb2e-00144feabdc0.html#axzz1xVjDHNDv">the fact that German yields have also started rising</a>, as have German CDS and <a href="http://soberlook.com/2012/06/latest-on-sovereign-cds-activity.html">the volume of German CDS being traded</a>.<br />
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My interpretation of this is as follows. This situation can end in either of two ways. The Euro can disintegrate, or full political union can be put in place. In either case Germany's debt burden will increase. In addition the country is export dependent, and will be negatively effected by any event which damages the other Euro economies. Robin Wrigglesworth <a href="http://www.ft.com/intl/cms/s/0/26aabbcc-b49b-11e1-bb2e-00144feabdc0.html#axzz1xVjDHNDv">put it like this in the Financial Times</a>.<br />
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<blockquote class="tr_bq">
<em>Analysts said this was a worrying development, which indicated investors could be starting to prepare for two “tail-risks” – a break-up of the common currency bloc or moves towards fiscal union.“If we see a trend of periphery bonds, Bunds and the euro start to sell off simultaneously we’d move from concern to alarm,” said David Lloyd, head of institutional portfolio management at M&G Investments.</em></blockquote>
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Estimates of just how much the Troika are on the hook for should Greece default vary, but a common number is <a href="http://www.reuters.com/article/2012/05/17/us-ecb-greece-idUSBRE84G0DA20120517" target="_blank">somewhere in the 200 billion euro range</a>. Of course, some of this would eventually be recoverable, one day, and assuming Greece were able to pay, but in the meantime (given the super senior status of the IMF participation) it is highly likely that governments and taxpayers in the other Euro Area countries would need to cover the shortfall, and this, to put it mildly, is unlikely to be popular with voters. Yet another reason for "fudge and muddle through". <br />
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There are three main sources of Troika exposure to Greece, bailout loans, sovereign bonds owned by the ECB, and liquidity provided to the Greek central bank thorugh the Eurosystem via what is known as Target2. According to estimates by Commerzbank analyst Christoph Weil, between loans and bond purchases Greece owes a total of €194bn, which breaks down into €22bn owed to the IMF, €53bn to Euro Area countries, €74bn to the EFSF and €45bn to the ECB. On top of this there are Target2 liabilities of the Greek central bank vis-à-vis the ECB - and indirectly to the German banks - to the tune of €104bn. <br />
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<strong><span style="font-size: large;">As long as the music is playing, you’ve got to get up and dance</span></strong><br />
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It was in fact former Citigroup chief Charles Prince <a href="http://blogs.reuters.com/great-debate/2009/11/17/while-the-music-plays-funds-gotta-dance/">who used this expression</a> to characterise why, in a highly leveraged bailout (sorry, buyout) market fund managers continued to play the game, but it could equally well describe the "in for a penny in for every shilling I've got" situation German policymakers now find themselves in.<br />
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One of the silliest ideas introduced into the present Euro debate is the idea that Germany has always been a reluctant party to the common currency, and that the monetary union has acted to the country's disadvantage. <a href="http://citywire.co.uk/money/why-germans-and-dutch-will-exit-suicide-pact-eurozone/a559322">Lombard’s Chief Economist Alexander Dumas tells us</a>, for example, that ‘what you’re actually dealing with here... is a German population which has had a rotten deal – and that’s why they’re all so angry’.<br />
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Dumas's view is interesting since it highlights two popular misconceptions. The first of these is that Germany has been a long suffering victim of the spendthrift policy of its Euro Area partners, and the second is that German household consumption is so weak due to a domestic policy of wage compression. Now if we take the former argument, in fact the German economy entered the common currency in very poor shape, on the back of mid 1990s credit and construction boom, and was forced to make a substantial transition at the end from being a consumer-credit- driven economy running a small current account deficit to being an export driven one, pushed forward on the back of a large current account surplus.<br />
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If you look at the above chart, it would seem hard to argue that Germany has had a really hard time of it after joining the Euro. Just think about it. Who was buying all those German exports which are reflected in those massive current account surpluses.<br />
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This point seems so obvious it is hard to believe some people are still capable of ignoring it. It is not as if there wasn't a lot of material around pointing to this pretty evident truth. A good example of this work are the two recent and highly stimulating essays by Citi economists, Nathan Sheets and Robert Sockin, who convincingly argue that German trade performance since the start of monetary union has been significantly boosted by having a currency which was valued significantly below the valuation it would have been subjected to had the country still been using the Deutsche Mark. As a result of this systematic undervaluation Germany’s external surpluses widened significantly, led by rapid export growth. <br />
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Sheets and Sockin use a simple econometric procedure to estimate that that European monetary union, coupled with the country’s extraordinary wage restraint, has resulted in a real effective exchange rate for Germany that is currently 15 to 20 percent lower than the one which would have prevailed if Germany had had its own floating currency. And naturally the weaker real exchange rate has provided a significant windfall for Germany’s export sector. They thus find that the lower German real exchange rate has lifted the country’s nominal trade surplus by roughly 4 percent of GDP (or €100 billion) annually and the real trade surplus by about 3 percent of GDP annually. In addition, since the outbreak of the Greek crisis, Euro weakness has meant that German exports have been in an almost uniquely privileged position to benefit from strengthening global demand in the emerging market economies.<br />
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The comparison with Japan is significant in this case, since as of December 2011, Japanese exports were still running at 8% below their pre-crisis high point, while German exports were about 7% above their pre-crisis high. Since the global financial crisis German exports to China have risen most strongly, while Japanese exports to China have virtually stagnated. What could be the explanation for this strange phenomenon, since evidently Japan has efficiently produced technologically-advanced products to sell? Well, the relative values of the two currencies the countries use might offer us some part of the explanation. From the start of 2007 to mid 2008, the Japanese yen was trading in the range of 0.06 – 0.065 to the Euro. At the start of 2012 it was trading at all time record levels of just over 0.1 to the Euro – that is the yen rose versus the Euro by over 60% in just three and a half years. What German policy makers might with good reason worry is that should their country go back to the Deutsche Mark a similar fate might well await them.<br />
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Naturally in June 2008 Japan’s currency was significantly under-valued, due to its habitual use as the “carry” funding currency of preference, while Germany’s currency is currently significantly under-valued (due to the impact of the sovereign debt crisis). In July 2008 Japan’s currency valuation spiked dramatically – rising by around 30% in 3 months – as the global financial crisis took its toll and the carry trade unwound. Since that time Japan’s currency has risen steadily (as has, for example the Swiss Franc) due to the country’s safe haven status. Naturally such a state of affairs only serves to exacerbate the country’s long running deflation problem.<br />
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Taking everything into account, surely it would not be unreasonable to suggest that a Euro unwind would lead any new German currency to surge dramatically in the aftermath just as the Japanese one did in 2008, and then continue its upward path for safe haven reasons. The key point is that in the age of the global financial accelerator currency movements have a strong non-linear component.<br />
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<strong>Gazing Into The Tea Leaves</strong><br />
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I suspect events will pan out as follows. The Greek elections will give markets a mildly positive surprise, since the country will not immediately exit the Euro, nor will European money be cut off (the IMF is another matter). In fact, as I suggest above, more money may be sent to Greece than expected via EU structural funds, or the EU investment bank.<br />
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In the meantime measures will be put in place in the direction of a European banking system and closer fiscal union. But the pace will be slow, painfully slow, and much slower than markets need to see to be convinced that real changes are coming.<br />
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So German bond yields and CDS can continue to rise, and this will produce political strains in Germany. It is these tensions inside Germany that can become the undoing of the Euro, since if political pressures cause leaders to put a break on the integration process market pressures could become too great to withstand.<br />
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Thus the reason for this sudden rush to keep the Greeks happy is evident. Germany has done its sums, and found that it is at even greater risk of getting hit by fall-out from the Greek election than Greece itself is. The thing is the Germans have now cunningly boxed themselves into a corner, and whichever way things go their position can only become worse. <br />
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I think German policy from this point on will be increasingly dictated by a belated attempt to avoid just this sort of outcome, and that we will see evidence of this over the next couple of weeks. Far from being a threat, Francoise Hollande might even help get Merkel off the hook. On the other hand, Fernando Santos, the Portuguese coach who trains Greek national side, <a href="http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_17/06/2012_447445">reportedly told the press</a> his players' victory was more inspired by Greek history than by Angela Merkel. Well if I remember my Thucydides aright, most Greek cities fell to their opponents not in pitched battle, but via "informal negotiations" held somewhere close to an unguarded side gate. Talks to form a new government will start tomorrow. <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-3950127.post-79596540832088397752012-06-16T19:04:00.001+02:002012-06-22T12:05:37.476+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 />
<blockquote class="tr_bq">
<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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<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-3950127.post-46109523200450867222012-06-03T17:53:00.000+02:002012-06-03T18:21:05.824+02:00Global Manufacturing Growth Shudders Towards A HaltThis months manufacturing PMI data only confirm what several months of prior surveys (and now <a href="http://www.marketwatch.com/story/us-outlook-cloudier-after-weak-jobs-data-2012-06-03" target="_blank">the latest US jobs report</a>) have been telling us, namely that growth in the developed economies is getting scarcer and scarcer, and harder and harder to come by. Following a brief brief period of stabilisation, which lasted roughly from November last year to this January, conditions have been steadily deteriorating in manufacturing sectors across the planet, with the deterioration being lead by an ongoing decline in new export orders. Roped in together through the various trade channels, the worlds industrial base is now, even in the best of cases, barely ekeing out growth, as can be seen in the fact that the JP Morgan global index registered a mere 50.6 in May, only marginally above the 50 no change level. <br />
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As the Global report puts it, the main drag on global industry remains Europe, where the Eurozone and UK PMIs fell to three-year lows. PMIs for Germany, France, Italy, Spain, the Netherlands and Greece all signalled contractions. Ireland saw a modest expansion, while Austria edged closer to stagnation. But beyond this activity in Eastern Europe weakened, as it did in Asia and the Americas.</div>
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New business continued to contract, with the rate of contraction especially marked, according to the report, in the case of export orders. Manufacturers in Europe, China and Japan all reported reduced levels of new export business, while growth in new exports slowed sharply in the US.</div>
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With the world nervously waiting to see how the Greek election process pans out, and where the Spanish government will find the money to recapitalise the country's banks, the slowdown in China is turning out to be a wild card, which simply punds negative feedback into an already difficult situation.</div>
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<strong><span style="font-size: large;">Western Europe</span></strong></div>
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Most eyes at the present time are, however, firmly fixed on Europe, and in particular the Euro Area, where the seasonally adjusted Markit Eurozone Manufacturing PMI fell to a near three-year low of 45.1, down from 45.9 in April and little-changed from the earlier flash estimate of 45.0. The Euro Area PMI has now signalled contraction in each of the past ten months.</div>
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Ireland was the only nation to register accelerating, albeit modestl, expansion, while in Austria - the other country in the Area where manufacturing conditions still improve - the PMI slipped back and closer to stagnation. All the other Euro nations covered by the survey saw contractions.PMIs for Germany, France and Spain all fell to their lowest levels since mid-2009, while the downturn in the Netherlands accelerated to its fastest in five months. In a pretty symbolic gesture, Greece moved off the bottom of the euro PMI league table for the first time since January 2010 to be replaced by Spain.</div>
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New export orders fell to the greatest extent since November last year, reflecting both slower global economic growth and lower levels of intra-Eurozone trade. Germany, Spain and Greece all reported especially marked reductions in new export orders.</div>
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The renewed decline in German activity is particularly significant, given the importance of the German economy in the Euro Area and its dependence on industry. As Tim Moore, senior economist at Markit put it in his report.</div>
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“Germany’s manufacturing output continued to lurch downwards in May, with the resilience of the first quarter now giving way to the steepest drop in production levels for almost three years. Weaker global economic conditions resulted in shrinking order inflows, especially from export markets. The latest drop in new work from abroad was the fastest for six months, which manufacturers linked to softer demand within Europe and signs of a slowdown in Asia".</div>
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Naturally the situation in Spain is a point of particular concern, with everyone keeping their fingers crossed that the achievement of pole contraction position over Greece does not augur a wider development wherein the country is driven hurtling off along the same path. Summing up the situation in Spain, Andrew Harker, economist at Markit and author of the report, said:</div>
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“Things went from bad to worse in the Spanish manufacturing sector during May. Rates of decline in output and new orders are now faster than at any time in the past three years. The ongoing lack of demand in the sector is mainly reflective of domestic problems, but the weakness in the rest of the eurozone was also reported to have weighed on demand in May. All of this provided a further squeeze on the labour market as the rate of job shedding remained marked.”</div>
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Apart from the rather erratic readings we keep seeing on the Hungarian PMI (perhaps there is some problem with the seasonal adjustment process), the rest of the CEE countries surveyed (Poland, the Czech Republic and Turkey) all showed conditions deteriorating.</div>
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The Czech Republic is already in recession, and its all important export sector is heavily dependent on Germany, which is itself slowing. Commenting on the Czech Republic survey, Agata Urbanska, Economist, Central & Eastern Europe at HSBC, said:</div>
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“It is hard to beat the bad news conveyed by much deeper than expected GDP contraction in the first quarter of this year and in this sense the weakening PMI comes as no surprise. But the PMI index still points to downside risks in the coming quarters. The outlook for growth keeps getting worse. Higher than expected German GDP growth in 1Q12 failed to support the Czech economy while, most recently, the leading indicators, ZEW and Ifo, have deteriorated and caught-up with the weakening PMI trend. Indeed the Czech May PMI collapsed to a 33-month low driven by the new orders and the new export orders. Exports growth was stable in the first quarter of 2012 but would have likely slowed in the second quarter adding to downside pressure on growth. The outlook for the manufacturing sector has deteriorated sharply in the last couple of months following Nov-11 to Mar-12 recovery".</div>
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Manufacturing activity in Turkey also fell back to near the 50 no change level, which is again worrying, becuase one of the growth areas we should be looking for is in emerging markets. </div>
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Commenting on the Turkey survey, Dr. Murat Ulgen, Chief Economist, Central & Eastern Europe and sub-Saharan Africa at HSBC, said:</div>
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“Manufacturing sector growth almost stalled in May, after a notable improvement in April due to a very subdued rise in output volumes and a minor contraction in new orders. New export orders, on the other hand, showed a slight improvement, suggesting that the slowdown in economic activity is driven more by moderating domestic demand, while Turkish exporters continue to successfully diversify geographies for trade".</div>
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Even Asia is not the momentum powerhouse it was six months ago. In what has now become a familiar pattern, Chinese activity weakened yet again. The rate of incoming new business has now contracted for seven consecutive months.The HSBC Purchasing Managers’ Index registered 48.4 in May, down slightly from 49.3 in April, signalling a seventh successive month-on-month worsening of Chinese manufacturing sector operating conditions. Neither export demand, nor internal consumption, nor even strong loan stimulus seem able to sustain the staggering giant at the moment. </div>
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Japanese industry continues to move sideways, with an ongoing decline in export activity being offset by domestic demand which is fuelled by the continuous stimulus and reconstruction spending by the government. The order book is a good indicator in this sense.</div>
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As the report says:<br />
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"The latest rise in new orders was the fifth in as many months. Companies mainly attributed new order growth to better demand from domestic sources. Although only slight, the overall increase in new orders contrasted with a further decline in new work received from overseas clients. Goods producers commented on muted demand from China and Europe".</div>
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Activity in India simply held steady. </div>
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Leif Eskesen, Chief Economist for India & ASEAN at HSBC said:</div>
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“Activity in the Indian manufacturing sector kept up the pace in May with output, quantity of purchases and employment expanding at a faster pace. New orders decelerated slightly led by domestic orders and stock levels rose, suggesting a slight moderation in output growth going ahead".</div>
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<strong><span style="font-size: large;">The Americas</span></strong></div>
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At 54.0, down from 56.0 in April, the final Markit U.S. Manufacturing Purchasing Managers’ Index came in a tad higher than the earlier flash estimate of 53.9 but nevertheless still signalled the weakest improvement in business conditions since February.New orders, in contrast, showed a slightly smaller rise than indicated by the flash estimate, taking growth sharply lower than seen in both April and March. The weaker growth of total new orders reflected to a large extent a near-stagnation of new export orders for the second successive month, which contrasted with more robust growth rates seen earlier in the year. The marginal rise in new export orders was also even smaller than the flash estimate.<br />
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Commenting on the final PMI data, Chris Williamson, Chief Economist at Markit said:</div>
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“The final PMI data confirm the earlier flash reading showing growth in the U.S. manufacturing sector to have slowed in May. The sector nevertheless continued to expand at a reasonable pace, growing at an annualised rate of around 3%, and should contribute to sustaining steady though unspectacular economic growth in the second quarter".</div>
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Further South, May data signalled a second monthly decline in both output and new orders at Brazilian manufacturers. Nevertheless, at 49.3, unchanged from April, the PMI was only slightly below the neutral threshold suggesting only a modest deterioration in Brazilian manufacturing business conditions.Firms working in Brazil’s manufacturing sector generally linked the deterioration in operating conditions to weak client demand. The volume of new orders received by companies fell for the second consecutive month in May, albeit the decline was only modest and to a lesser extent than in April. Meanwhile, new export orders also fell during May, with the rate of decline solid and the strongest in 2012 to date.</div>
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Commenting on the Brazil survey, Andre Loes, Chief Economist, Brazil at HSBC said: </div>
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“The HSBC Manufacturing PMI index remained unchanged at 49.3 in May. This is the second consecutive month where the manufacturing PMI has been below 50 (after above-50 readings in the first quarter), and reinforces the perception that Brazil’s manufacturing sector is going through a particularly difficult time, squeezed between rising costs on one side, and competition from imports on the other.</blockquote>
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<b>One Easy Reading</b> <br />
<br />There is one simple, easy and unequivocal message to be garnered from all this - the Euro crisis needs to be settled and resolved in the shortest time possible. This won't be easy, but it has to be done. What was once a small localised crisis with its epicentre in Greece, having spread to the entire Euro Area is now extending beyond the frontier of the monetary union, and threating the entire recovery on a global basis, as investors loose their appetite for risk fearing the arrival of another Lehman moment. Naturally, the problem isn't only the Euro, most developed economies are overleveraged and struggling under the weight of legacy debt.<br />
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Meanwhile China offers another warning. Simply pumping up demand in unsustainable quantities in areas like construction may bring short term export advantage for the West, but in the longer term the problems produced make the process hardly worth the effort, a point which could well be borne in mind when thinking about policy towards the Indias, Turkeys and Brazils of this world, where short term capital flows have pumped up consumer credit in undesireable ways. Since these countries have started increasing credit from a very low base, the threat is hardly dire at this point, but warnings should be heeded. With domestic mortgages at something like 5% of GDP Brazil is somewhere near where Spain was in 1992. No big deal, but imagine the process is allowed to continue unchecked, and then look where Spain is now, or rather was when the bubble burst in 2007, a mere 15 years later.
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<br />
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-3950127.post-75648003704225240212012-05-20T12:34:00.001+02:002012-05-20T22:03:13.645+02:00Can This Really Be Europe We Are Talking About?In recent days I have been think a lot, and reading a lot, about the implications of Greece's recent election results. <br />
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At the end of the day the only difference this whole process makes to the ultimate outcome may turn out to be one of timing. If Alexis Tsipras of the anti bailout, anti Troika, party Syriza won and started to form a government then the second bailout money would undoubtedly be immediately stopped. On the other hand if the centre right New Democracy wins and is able to form a government, <a href="http://www.google.com/url?sa=t&rct=j&q=greece+polls&source=newssearch&cd=1&ved=0CC8QqQIwAA&url=http%3A%2F%2Fwww.independent.co.uk%2Fnews%2Fworld%2Feurope%2Fgreece-poll-boosts-austerity-politicians-7767043.html&ei=ULu3T8jmHdKDhQfj0LTsCA&usg=AFQjCNEvzqUzi8rbSEKzVSP73KFYUJjRMw">as the latest polls tend to suggest</a>, then the country would quite possibly try to conform to the bailout conditions, but in trying it would almost certainly fail, and <strong>then</strong> the money would be stopped. Before the last election results, it will be remembered, this was the main scenario prevailing. <br />
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Indeed <a href="http://www.reuters.com/article/2012/05/17/greece-troika-idUSL5E8GGH9420120517">reports coming out of Greece</a> suggest that the end point may be reached more quickly than even previously thought, since the main impact of recent events is that the reform process in the country has been put on hold, meaning that slippage on implementation by the time we get to June will be even greater than it otherwise would have been. <br />
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"The only thing we are doing is waiting," said a government official who declined to be named. Another Greek official close to bailout negotiations said ministers in the outgoing cabinet have not been authorised to negotiate with Greece's lenders since the May 6 election. A senior party official said the caretaker government would not publish any decrees and all tender procedures were suspended. <br />
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<span id="articleText">Even before the May 6 election, many reforms were put on the backburner to avoid antagonising voters, officials involved in bailout talks say. These include a plan to slash spending by over 11.5 billion euros in 2013-2014, which Greece must agree by late June to meet a key bailout target.</span><br />
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Other measures Greece should have taken by the end of June include a plan to improve tax collection by 1.5 percent of GDP in 2013-2014, a review of social spending to identify 1 percent of GDP in savings, and a pay cut for some public sector jobs by an average of 12 percent.<br />
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One key measure is the budget deficit. Athens was broadly on track in the first quarter with a primary surplus on a cash basis of 2.3 billion euros excluding interest payments on debt, versus a 0.5 billion primary surplus in the same period in 2011.<br />
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But low value added tax collection and increased transfers to the social security system to offset weak business and employee contributions continue to be soft spots.<br />
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Another problem - which the EU and IMF will check before giving any green light on the accounts - is government arrears. Unpaid debts to third parties for over 90 days stood at 6.3 billion euros at end-March or 3.1 percent of projected GDP this year, according to economists at EFG Eurobank.<br />
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<span id="articleText">EU and IMF policymakers, exasperated by repeated delays on all reform areas over the two years of a first, 110-billion euro bailout, have warned they will not deliver any more aid under the new bailout if Athens veers off the reform track yet again.</span></blockquote>
Looking at the above list, it is hard not to come to the conclusion that it might be in the interests of all concerned for Syriza to win the elections and force the issue. Putting together another weak government that can't implement will only lead to more fudging, and put us back where we are now in three or six months time. <br />
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<strong><span style="font-size: large;">Grexit Ahoy?</span></strong><br />
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Either way, it is what happens next that leads to all the speculation. The international press has been full all though the last week of statements from one European leader after another suggesting that Greece may need to exit the Euro. The latest to add his name <a href="http://www.blogger.com/goog_176961312">has been the Slovenian Finance Minister </a><span id="articleText"><a href="http://www.reuters.com/article/2012/05/19/us-greece-exit-slovenia-idUSBRE84I08I20120519">Janez Sustersic</a>, but before him there has been a long list of leading personalities including EU<span id="articleText"> Trade Commissioner Karel De Gucht who told the press that the European Commission and the European Central Bank were working on scenarios in case the country had to leave. European Central Bank President Mario Draghi even entered what are unchartered waters for the institution he leads <a href="http://www.bloomberg.com/news/2012-05-16/draghi-signals-ecb-won-t-keep-greece-in-euro-area-at-any-cost.html">and acknowledged that Greece could end up leaving the euro area</a>, although if it did he stressed the decision would not be taken by the ECB.</span></span><br />
<blockquote class="tr_bq">
While the bank’s “strong preference” is that Greece stays in the euro area, “the ECB will continue to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet,” Draghi said in a speech in Frankfurt today. Since the euro’s founding treaty does not envisage a member state leaving the monetary union, “this is not a matter for the Governing Council to decide,” Draghi said. </blockquote>
This is all a long long way from the days of "Hotel California", and the Euro as an institution where you can check in but you can't check out, and other such sentiments which typified the Trichet era, which now seems to far behind us. The decision would not be an ECB one, but what if preserving the integrity of the central bank balance sheet implied cutting of the lifeline to Greece's banking system? The decision might then be nominally Greek, but at the end of the day it would have been forced on the country by a proactive ECB.<br />
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<strong><span style="font-size: large;">In The Name Of God Go!</span></strong><br />
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While Mario Draghi may have been being strongly diplomatic, ECB Executive Board member Joerg Asmussen was far less so, and told Handelsblatt newspaper on May 8 that if Greece wanted to remain in the euro, it had “no alternative” than to stick to its agreed consolidation program. The influential German magazine <a href="http://www.spiegel.de/international/europe/why-greece-needs-to-leave-the-euro-zone-a-832968.html">Der Spiegel went even further</a>. Under the header "Time To Admit Defeat, Greece Can No Longer Delay Eurozone Exit", the magazine said what had previously been the unsayable: "After Greek voters rejected austerity in last week's election, plunging the country into a political crisis, Europe has been searching for a Plan B for Greece. It's time to admit that the EU/IMF rescue plan has failed. Greece's best hopes now lie in a return to the drachma"<strong>.</strong><br />
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The inconvenient problem is that things don't look that way in Athens, where even the anti-establishment Alexis Tsipras is only talking about ending austerity, and renegotiating agreements, at the same time making it abundantly clear he has every intention of staying in the Euro. The fact of the matter is that there are very few Greeks who actually want to leave, and it is hard to believe that those arguing the country's best hopes are either this, or that, really have the true interest of the country and its citizens at heart. <a href="http://www.ft.com/intl/cms/s/0/748f4152-a0b7-11e1-9fbd-00144feabdc0.html#axzz1vCdySJeT">The FT's John Dizard sums the situation up thus</a>: "There has been an astonishing quantity of nonsense written in the past couple of weeks about the prospect of “Grexit”, or Greece's exit from the Euro". <br />
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One of the key additional reasons that much of what has been written has been "nonesense" is that few have stopped to think about what the real cost to core Europe would be of a Greek default (see below). But then, they never have been that strong on financial arithmetic in Berlin.<br />
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So whether push comes to shove at the next review, or the one after, no one is really clear what gets to happen next, and this is part of the reason why there is so much nervousness in the markets at this point. Many assume that after the tap is turned off the country would quickly run out of money, but there are a variety of devices that the Greek government, in conjunction with the central bank, could use to keep the cash flowing. Some think the country would follow the Argentinian example, and start issuing internally valid scrip money, like the ill fated Patacos or Lecops. But Argentina was not in a currency union with the United States, the country had simply unilaterally decided to peg the Peso to the Dollar. Argentina could not print Dollars, but Greece can - in a variety of ways, the best known being Emergency Liquidity Assistance (ELA) - generate its own Euros, and enable the government to, for example, sell T Bills to Greek banks in order to pay pensioners, civil servants, government suppliers etc.<br />
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Then, so the story goes, the ECB would have no alternative but to shut Greece off from the Eurosystem. To some this might seem like an act of war. This wouldn't be Greece leaving, this would be Greece being turfed out. Yet this secnario was just what the markets got a scare about this week, <a href="http://www.bloomberg.com/news/2012-05-16/ecb-stops-lending-to-some-banks-as-draghi-talks-exit-correct-.html">when the ECB announced it was cutting off liquidity to four Greek banks</a>. Ominous echoes of Mr Draghi's words about the ECB protecting the integrity of its balance sheet. As it turns out, the move was less sinister than it seemed, since part of the problem was that the Greek government bureaucracy was inefficiently holding up the recapitalisation of some Greek banks, a move which had left them with negative capital, and the ECB was understandably reluctant to continue accepting collateral from them under these circumstances. Part of the problem here is that very few people, <a href="http://ftalphaville.ft.com/blog/2012/05/16/1003391/shifting-ecb-liquidity-to-ela-greek-bank-recap-edition/">as FT Alphaville's Joseph Cotterill points out</a>, really understand what ELA is, but this is not really surprising as the ECB itself has hardly been forthcoming with information and details on how ELA is being used. <br />
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In any event, continuing the supply of liquidity to Greek banks, and including or excluding the Greek central bank in/from the Eurosystem are likely to become key issues as we proceed. As Mr Draghi argues the issue is a political one, not a banking one, which means the bank is going to be very constrained if it wants to act as a bank without the relevant authority. This is the kind of hot potato which is likely to be passed from one desk to the next (Yes, Mr President, but...) with no one really being willing to go down in history as the person who might have torn Europe apart, which leads us to the conclusion that the "muddle through and fudge" stage might last quite a bit longer than many are expecting.<br />
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<strong><span style="font-size: large;">If I Owe You 10 billion I have A Problem, But If I Owe You 300 billion..........</span></strong><br />
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As John Paul Getty famously said, "If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem". Never a truer word was said in the Greek case, and it is the reality that Mr Tsipras and those around him have, I suspect, understood. Now I fully appreciate that the Troika are a group of people who are motivated largely by principles not by money, but when your principles could cost you, and those providing you with the money you spend, 200 billion Euros, 300 billion Euros, or whatever, then dare I suggest there is food for them to think.<br />
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Estimates of just how much the Troika are on the hook for should Greece default vary, <a href="http://www.reuters.com/article/2012/05/17/us-ecb-greece-idUSBRE84G0DA20120517">but a common number is somewhere in the 200 billion euro range</a>. Of course, some of this would eventually be recoverable, one day, and assuming Greece were able to pay, but in the meantime (given the super senior status of the IMF participation) it is highly likely that governments and taxpayers in the other Euro Area countries would need to cover the shortfall, and this, to put it mildly, is unlikely to be popular with voters. Yet another reason for "fudge and muddle through".<br />
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There are three main sources of Troika exposure to Greece, bailout loans, sovereign bonds owned by the ECB, and liquidity provided to the Greek central bank thorugh the Eurosystem via what is known as Target2. Now according to estimates by Commerzbank analyst Christoph Weil, between loans and bond purchases Greece owes a total of €194bn, which breaks down into €22bn owed to the IMF, €53bn to Euro Area countries, €74bn to the EFSF and €45bn to the ECB. On top of this there are Target2 liabilities of the Greek central bank vis-à-vis the ECB - and indirectly to the German banks - to the tune of €104bn.<br />
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As Christoph says in his report: "It would undoubtedly be bitter for the German government to have to tell taxpayers they would have to fork out €75bn if the debts were not repaid, but the alternative of continuing to throw good money after bad, would not make it any more popular either". Methinks he is being a bit too blasé here, since while it is surely the case that a 75 billion Euro bill for the German taxpayer would cause a furore, I'm not sure he has grasped just what a problem this would then present for continuing with further bailouts as needed with other troubled countries.<br />
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<strong><span style="font-size: large;">Can This Really Be Europe?</span></strong><br />
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Nonetheless, despite the fact that Mr Tsipras would now appear to have Germany's leadership by the short and curlies (something Barack Obama's US advisers will surely have been spelling out to them in Camp David this weekend), it is not at all clear what turn events will take from here on in. History is, after all, often more about the unintended consequences of unexpected accidents than it is about plans.<br />
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Nevertheless, several things are clear. In the first place, the Greek economy is in unremitting decline, under the weight of the healing measures being applied by the IMF and its European partners. GDP was down by approximately 17% at the end of 2011 from its Q3 2008 high. Not as steep as the Latvian 25% fall - but then the IMF are still forecasting a further 5% decline in 2012, and without devaluation don't expect any sharp bounce back. Both reputationally and infrastructurally the country is being quite literally destroyed. The medicine has evidently been worse than the illness, and maybe it is just coincidental, but the Marshall Plan type aid which the country now obviously needs was originally applied in Europe following the destruction of WWII. <br />
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But in Greece it's going to be worse, since no one back then had the kind of ageing population problems the country is now about to face. And while the problem remains awaiting resolution, industrial output and retail sales continue in what has all the appearance of terminal decline, while unemployment - which hit 21.7% in January, second only in the EU to Spain - is still on the rise. <br />
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So something patently isn't working, and excuse me for saying it, but I find it hard to think of a leading applied macroeconomist who wasn't warning about this right from the start. But no, the creed of the the micro people and their structural reforms (which, <a href="http://www.economonitor.com/edwardhugh/2011/05/15/greece-last-exit-to-nowhere/">as I keep stressing</a>, are needed) was preferred, and we have ended up where we have ended up.<br />
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Right now there are two, and only two, options on the table as far as I can see: help Greece with an orderly exit from the Euro (and crystallise the losses in Berlin, Washington, etc), or print money at the ECB to send a monthly paycheck to all those Greek unemployed. This latter suggestion may seem ridiculous (then go for the former), but so is talk of printing to fuel inflation in Germany (go tell that old wives tale to the marines). If Greece isn't allowed to devalue, then some device must be found to subsidise Greek labour costs and encourage inbound investment - and remember, given the reputational damage inflicted on the country this is going to be hard, very hard, work.<br />
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In fact, as I jokingly suggested on my Facebook (and this is a joke, really) on one reading you could come to the conclusion that what lies behind Paul Krugman's recent tantalising play on the association between Wagner (<a href="http://krugman.blogs.nytimes.com/2012/05/13/eurodammerung-2/">Eurodammerung</a>) and Coppola (<a href="http://www.nytimes.com/2012/05/18/opinion/krugman-apocalypse-fairly-soon.html?_r=1&smid=fb-share">Apocalypse Fairly Soon</a>), is Ben Bernanke's idea of a helicopter drop. <br />
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Could it be that the message he was trying to subliminally sneak in to camp David this weekend was that unable to afford either Greek exit (colloquially known as Grexit) or Greek Euro Membership, the world's leaders now find themselves trapped in a Gregory Bateson-type double bind. <a href="http://en.wikipedia.org/wiki/Double_bind">According to Wikpedia</a> "a <b>double bind</b> is an emotionally distressing dilemma in communication in which an individual (or group) receives two or more conflicting messages, in which one message negates the other. This creates a situation in which a successful response to one message results in a failed response to the other (and vice versa), so that the person will be automatically wrong regardless of response. The double bind occurs when the person cannot confront the inherent dilemma, and therefore cannot resolve it or opt out of the situation".<br />
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The only viable way to cut the gordian knot without confronting and resolving the underlying problem which at the end of the day afflicts many of the countries on Europe's periphery (devaluation and aided default) would be the organising of weekly helicopter drops of freshly printed Euros all along the beaches of southern Europe (oh, we will fight this one on the beaches, and in the chiringuitos, Mr Tsipras told a shocked group of assembled journalists) at a stroke resolving a large part of the youth unemployment problem, and generating demand for products from core Europe (after all, who would go and work in a dreary old factory when you can get the same income lying on the beach). I can just here them over at the ECB, "whohay, am I on a roll man!", as the printing presses go to work.<br />
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And to cap it all, I can just see Paul requesting to fly one of the choppers. "The surfing looks pretty good down there at the moment, Mr President". As one commentor said, you can just smell those Euros burning through the morning mist.<br />
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But of course, joking apart, Krugman does have a point. The G8 leaders are now in a ridiculous situation, one they should never have put themselves in. Apart from the cost of disorderly Greek exit, just imagine how Spanish or Italian deposit holders would react to the sight of Greek Euros being forcibly converted into New Drachma, or some such.<br />
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Then <a href="http://www.guardian.co.uk/business/2012/may/13/greece-leave-eurozone-five-difficult-steps?newsfeed=true">there is the Guardian's Julia Kollewe</a>, who last week spelt out for us a number of highly unpleasant consquences which would follow, including a rush for the door by a lot of young Greeks. Kollewe indeed paints a bleak picture of Europe's future:<br />
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The Argentinian example shows that a Greek debt default and exit from the eurozone are likely to have dire economic and social consequences, at least in the short term. The country will become isolated. With lending drying up and accounts frozen, small businesses will go bust, exports plunge and the country will lurch deeper into recession. "Consumption could drop by 30%," says Nordvig. "There will be some pretty extreme effects."<br />
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"Mass unemployment is likely, as is an exodus of young skilled workers. If tens of thousands of Greeks headed to the borders, they might even be closed. Greek soldiers patrolling the roads and ports to keep their fellow citizens in? It is not impossible".</blockquote>
In fact, the last time something like this happened – in Argentina in 2001 – 175,000 Argentinians arrived in Spain alone.<br />
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So I ask myself, is this Europe we are talking about here, or is this some kind of dream I am having? Is this where all those high minded ideals of a European Community have lead us, to a Greece where the young people get locked in, like in the old days of the USSR, or locked out as in the days before Schengen. Is this what the real outcome of the election of Francoise Hollande as President of France is going to mean? I hope not, since if it is it would surely split Europe right down the middle, and not just by drawing a line running from East to West.<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-3950127.post-76922616533646956342012-05-13T17:54:00.001+02:002012-05-21T22:35:55.053+02:00It's Time to Stop Using Chewing Gum And Chicken Wire In Spain<br />
<blockquote class="tr_bq">
"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 />
<br />
<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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<br />
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 />
<br />
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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<br />
<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 />
<br />
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.com0tag:blogger.com,1999:blog-3950127.post-26702974151040374532012-05-08T22:14:00.000+02:002012-05-08T23:16:23.370+02:00Global Economy Heading Downhill?According to the JP Morgan Global Composite PMI report, "Growth of global economic activity eased sharply to a fivemonth low in April." The authors of the report found that on aggregate across the countries surveyed - 30 across the globe - both new order inflows and job creation fell back, leading them to the conclusion that "the world economy is set for a softer growth patch heading into midyear". Looking at the chart below, this certainly seems to be the case (the composite index is a measure derived from a weighted average of the manufacturing and services findings).<br />
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So momentum is weakening across the entire global economy at the present point, not just in say Europe, or China. Global output is still growing but it is growing at an increasingly weaker pace. What could change that? Well QE3 naturally. Why do I say that? Well look at the three significant surges in the chart. The first coincides with QE1, <a href="http://fistfulofeuros.net/afoe/an-unusual-but-interesting-argument-which-may-help-to-understand-why-qe2-is-now-almost-inevitable/" target="_blank">the second with QE2</a>, and the third, much weaker one, fits in with the so called Operation Twist. <br />
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This tells us a number of things. In the first place these massive liquidity injections are not self sustaining, ie they give things a hefty push forward but even so they don't manage to jump start the various economies, especially in the developed world. They work for a bit, and then run out of steam. The fact that they systematically run out of steam tells me, at any rate, that something somewhere is broken, and that re-iterated injections on their own won't sort the problem out.<br />
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In Japan this very same "something" has now been broken since 1992, and continual liquidity injections and mounting government debt have not made it better. This is not the point to go in depth into what the something is, my story on this is scattered here and there across the various pieces of analysis I write. Suffice it to say that excessive debt and rapid population ageing have to form part of the picture. Both constitute an important drag on growth. But the principal aim of this post isn't to add to the debate about what it is that broken, it is simply to plead for a recognition that something is, and that, as a result, the situation won't simply "right" itself. This time there is no hidden helping hand.<br />
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What the various liquidity injections do do is buy time. Some people scorn that, and would rather take their armageddon full face and now. Each to his taste. If I get to die tomorrow and rather than today I am not ungrateful.<br />
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Liquidity injections are not quite the same thing as debt generation, although obviously there is a link - injections which involve straight monetisation of government debt (ECB LTRO lending against government guaranteed bank bond collateral in order to enable the bank to buy government bonds, for example) are clearly facilitating the generation of debt. While liquidity provision for its own sake in a deflated economic system is generally positive, debt generation for its own sake isn't necessarily so, since someone, someday, will have to pay it back, and if in the meantime we don't fix the problem (that "something" that is broken) then the somebody may be poorer than we are, in which case we are directly transferring income intergenerationally, from them to us. Debt to buy time for something which won't fix itself is not justified, and the money should be spent structurally, on implementing a fix. Grandiose infrastructure plans which have no real efficiency componenty <a href="http://regex.info/blog/2007-03-25/403" target="_blank">were tried in Japan in the 1990s</a>, <a href="http://anyone%20who%20thinks%20spending%20huge%20sums%20of%20money%20on%20infrastructure%20will%20fix%20the%20part%20of%20our%20economies%20which%20is%20broken%20should%20think%20a%20bit%20about%20japan%20and%20read%20this.%20japan's%20economy%20is%20still%20broken,%20and%20the%20only%20legacy%20is%20a%20mountain%20of%20un-needed%20cement%20and%20a%20large%20debt%20pile./" target="_blank">and they didn't work</a>.<br />
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<blockquote class="tr_bq">
"Even today, Japan is having trouble climbing out of its cement pit. At its high, in the mid-1990s, infrastructure spending accounted for 6 percent of its gross domestic product, double what the United States allocated for infrastructure in the '90s and still higher than what politicians are considering spending today. In estimates of national debt, the world's second-largest national economy is near the top of the list, perched between Lebanon and Jamaica. Last year, Japan's public debt was far greater than the size of its economy, a burden that makes its demographic challenges more difficult to address".</blockquote>
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We face a situation which seems neither to have been contemplated in either the Austrian or the Keynesian theoretical frameworks (since both assume some sort of homeostatic corrective mechanism is ultimately at work) or in the any of the various versions of neoclassical growth theory, where some sort of semi-constant equilibrium growth path is assumed to exist, and be recoverable via the application of an appropriate set of structural reforms. Yet the three oldest societies on the planet - Japan, Germany and Italy - have been losing growth momentum for decades now, and it is quite possible will drift into negative average growth rates at some point in a non too distant future. Traditional theory never really contemplated this possibility (for a brief summary of my argument on this, <a href="http://www.fairobserver.com/article/ageing-and-financial-crisis-more-meets-eye" target="_blank">see this recent interview I did with Andrew Pollen</a>).<br />
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Now for my second main point. Where's the missing link? That is, where is the link between the Feds quantitative measures (or those of the other main developed economy central banks for that matter) and global economic momentum? Well, that's a bit of a longer story - although empirically I think it is easy to see the link is there. Basically the story has to do with international "carry" (borrowing cheap in one currency to lend dear in another, preferably with the value of the first currency falling, and the value of the second currency rising, a set of relations which "carry" itself propagates in good circular fashion), and risk sentiment. The liquidity injection makes people more willing to take on risk (think ECB and the 3yr LTROs), and the existence of the carry trade enables them to do it. Nothing new here, banks by their very nature are about intermediation, and leveraging spreads, its just that in an age of financial globalisation that intermediation has a lot more distant geographical reach.<br />
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And then of course, all that extra money helps people <a href="http://www.blogger.com/High%20quality%20global%20journalism%20requires%20investment.%20Please%20share%20this%20article%20with%20others%20using%20the%20link%20below,%20do%20not%20cut%20&%20paste%20the%20article.%20See%20our%20Ts&Cs%20and%20Copyright%20Policy%20for%20more%20detail.%20Email%20ftsales.support@ft.com%20to%20buy%20additional%20rights.%20http://www.ft.com/cms/s/0/ecf9a4e8-80a1-11e0-85a4-00144feabdc0.html#ixzz1uGufw6Iy" target="_blank">from Rio</a> to New Delhi and from Ankara to Jakarta borrow up to the hilt to buy themselves a nice new flat, or SUV, or whatever. <br />
<blockquote class="tr_bq">
Across Latin America’s largest economy, record prices for the country’s commodities and surging foreign fund inflows – what the International Monetary Fund calls “favourable tailwinds” – are driving a historic boom. Property prices are soaring, consumer credit is booming and bank profits swelling. But there are growing concerns over whether Brazil is becoming addicted to this windfall of easy money. Increasingly, there are fears that Brazil is heading for a bubble.</blockquote>
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So excess liquidity which finds no outlet in developed economies floods into emerging markets, provoking unsustainable surges in demand and fuelling inflation, which leads the local central banks to penalise borrowing in one way or another, and bring the whole dynamic to a halt again. At which point we get another liquidity injection in one of the major developed economies, and off we go again.<br />
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It is perhaps a sobering thought that households will be about as indebted in Brazil coming in to the next football World Cup as they were in Spain at the time of the 1992 Olympics, and then remember what happened next in the latter case. Brazil isn't facing a devastating bubble yet, but it could be one day if we don't find a better way of doing things.<br />
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<strong><span style="font-size: large;">Global Manufacturing In LimboLand</span></strong><br />
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Even if it was services activity, rather than manufacturing, that showed the greatest global weakness during April, manufacturing was only able to gouge out a minimal improvement on what was already a weak March performance, and even then what growth there was was very unevenly distributed. </div>
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Overall output, new orders and employment all continued to rise during the month, but there was a marked divergence between the world's two largest industrial regions, the US and the Eurozone. In fact, the US remained one of the principal spurs of global manufacturing growth in April, with the US PMI rising to a ten-month high, provoking indirectly yet more debate about the desireability of austerity across the EU. Nonetheless, as can be seen from the chart, the surge in manufacturing output remains modest when compared with the two earlier waves, which is why I am among those who think that the arrival of some sort of QE3 is now only a matter of time.<br />
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The Eurozone manufacturing PMI, in contrast, posted its lowest reading in almost three years, as operating conditions deteriorated across all of the big-four Euro economies (Germany, France, Italy, and Spain). The US PMI is currently 8.9 points above its Eurozone equivalent, the greatest divergence in favour of the US since Eurozone data were first compiled in June 1997. <br />
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Meanwhile the Asia PMIs remained mixed with solid growth being signalled in India against only modest expansions in Japan, Indonesia, Taiwan and South Korea. Conditions also remained weak to subdued in China. So at this point in time, even the Asian economies as a group are hardly "powering ahead".<br />
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The most marked feature of the April reports as far as Europe is concerned is certainly the way in which conditions in core Europe continue to worsen. As the monthly report said,"the April PMIs also indicated that manufacturing weakness was no longer confined to the region’s geographic periphery. The German PMI fell to a 33-month low, conditions deteriorated sharply again in France and the Netherlands also contracted at a faster rate". The rate of decline in new orders accelerated, and jobs were lost in German manufacturing for the first time in two years.<br />
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Indeed it is the state of the once mightly German economy that is now starting to give cause for concern. The economy suffered a mild contraction in the last three months of last year, and the possibility exists that this will be repeated in Q1 2012, <a href="http://money.cnn.com/2012/05/02/markets/germany-recession/index.htm" target="_blank">in which case Germany will also be technically back in recession</a>. Whether or not this is the case we will know in a week or so, but either way, the fact that it is a close call, and that things are evidently getting worse as we enter the second quarter certainly undermines some of the force in Angela Merkel's argument that austerity leads to growth. <br />
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As Tim Moore, senior economist at Markit and author of the German manufacturing report put it:<br />
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“Germany started the second quarter of 2012 with its worst manufacturing performance for almost three years, as another month of weaker order inflows finally brought production levels back into contraction. With backlogs of work failing to support output volumes in April, manufacturers cut their staffing numbers for the first time since March 2010.<br />
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“The investment goods sector was at the forefront of the downturn in April, as jitters about global economic conditions meant clients in export markets sought to delay large scale spending decisions. Investment goods producers saw export orders fall at the steepest pace in nearly three years, and in turn job losses were the most pronounced of the three main market groups monitored by the survey.</blockquote>
Germany's economy is export dependent. This export dependency comes from having a very high median population age. It is not a cultural quirk of the Germans. There is no fundamental issue with German competitiveness, there is not some major structural reform that is missing, there is not even over indebtedness in the public or private sectors. The only reason the German economy has fallen back into recession is that demand for its products among customers has dropped off, while the long awaited second pillar of domestic demand has once more failed to appear. It is as simple as that. <br />
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With the results of the recent French elections in the forefront of their minds, people are now starting to ask themselves just how Germany will respond to a Francois Hollande Presidency, forgetting that elections are also looming in Germany next year, and that the CDU is busily loosing ground. Whether or not Germany technically confirms a recession when the results for the first three months of the year are out in a week or so, the performance of the economy is visibly worsening and German leaders are under pressure to show they are willing and able to respond. Otherwise Angela Merkel may face wrath not only from those irritated by the having to contribute towards the bailouts, she will also have to contend with those irritated by her economic ineffectiveness back home. And in any event, the party which would gain from a Merkel electoral defeat - the SPD - are not that far from seeing things the way Monsieur Hollande does.<br />
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Which is why Angela Merkel's approach was always far too simplistic. As I have said a number of times, I think she he right to search for some sort of financial stability in the face of the ageing population issue, but the best way to get from here to there is not necassarily to walk in a straight line. Naturally, austerity is a relative concept, but whether you are cutting your deficit from 10% to 9%, or from 3% to 2% as you go into a recession you still hit short term growth with a double whammy, as Italy is currently discovering. As can be seen in the chart below (which is the April Italian services PMI) domestic demand is plummeting on the back of the latest round of austerity, and this is leading <a href="http://www.reuters.com/article/2012/05/07/italy-austerity-idUSL5E8G76YN20120507" target="_blank">the main centre left party in the government to at least cry ouch!</a><br />
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At the very least European fiscal policy needs to allow for a counter cyclical component, even as you pull back from a very high deficit level, and not, as at present, insist on an entirely pro-cyclical one in a recessionary environment, thus magnifying the amplitude of the demand swings. If an economy needs more than 5% deficit (or more than 10% for that matter) simply to get meaningful GDP growth, then you need to understand why this is and find solutions, since as I say above debt itself doesn't cure anything, and arguably as our populations age accumulated debt only makes things worse. But if one of the engines on the plane starts to malfunction, the objective needs to be to get the passengers to the ground safely, and not necessarily by the most direct route.<br />
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Naturally infrastructure work on the periphery which needed German technology would help German export companies, so it wouldn't be that hard to sell in the heimat. But what use would it be to the receiving countries? That we won't know till we see the proposals in detail, and discover how it is going to be financed. If such infrastructure would help exports, both within and outside Europe, then it could be a plus. If it is only to built high speed train networks that lead nowhere (or as is currently under discussion in Spain up to a frontier with Portugal across which there will be no connection waiting the other side) then we are simply falling into the Japan trap, and applying a simplistic 1930s version of Keynesianism that doesn't work in the present context. But at the end of the day, the fact we are having this debate in the first place only serves to highlight the fact that we still don't have a roadmap for coming out of the crisis in Europe, and we still don't know what our future is going to look like.<br />
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And meanwhile, of course, there is Greece, and that blasted ongoing economic contraction to think about.<br />
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As Paul Smith, Senior Economist at Markit and author of the Greece Manufacturing PMI report commented:<br />
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<blockquote class="tr_bq">
“April proved to be another difficult month for Greek manufacturers, with latest data again showing steep contractions across a number of key variables measured by the survey. “In line with recent reports, the issues facing manufacturers – and the Greek economy as a whole – remain deep rooted. Panellists again noted problems in accessing working capital and a culture of cash payments, implying that credit lines remain either closed or that agreements will come with restrictive terms.<br />
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“At present, it remains hard to see how these issues can be solved suggesting that the manufacturing sector is set for continued struggle in the months ahead.”</blockquote>
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Following his cue, and looking over at the latest election results in that unfortunate country, it remains hard to see how the issues arising can be solved, and it isn't clear what gets to happen next. <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