Eurozone: A new low for Spain

23rd July 2012

One of the features of the Euro area crisis is that some events seem to take place in slow motion. Indeed it is my contention that there is something in human psychology which makes responses to this type of crisis delayed. As a group we human beings seem to adjust to new situations only after a lag and often our first response as a group is to send financial markets in the opposite direction. This has happened with the proposed bailout of Spain’s banks by her Euro area partners which inspite of the many flaws in its construction was met with market rallies.

I think that sometimes people hear what they want to hear rather than what they are being told. Of course this is not helped by politicians and officials who misrepresent both events and their response to them. Back on June 11th for example Prime Minister Rajoy of Spain declared that the bailout of his countries banks was a “victory”. As we examine the latest events we will see that this is an entirely different type of victory to those achieved over the weekend by Bradley Wiggins and Ernie Els. It for example required some of the untruths that Eurogroup President Jean Claude Juncker has admitted to and indeed claimed are necessary.

The Eurogroup Agreement

On Friday the Eurogroup agreed in a teleconference to set the aid plan for Spain’s banks in motion. Of course they have been announcing this for over a month now! And it appears that they have been taking lessons from the former British Prime Minister Gordon Brown who gained a reputation for regularly reannouncing the same things. However this following bit seemed to suggest that there was a lack of urgency in actually doing (as opposed to announcing) anything:

"As required by EFSF/ESM procedures, the specific amount will be determined based on a thorough bottom-up assessment of capital needs for individual banks, which has been launched and is expected to be finalised in September."

This slow response time has been a regular feature of my critiques of the bailout mechanisms of the Euro area. They would be no good at all as a fire brigade because the building would be smoking embers on the ground before they ever arrived.

Spain takes the pain

As I discussed earlier human psychology meant that Spain’s financial markets tried to take the impact of all this in one day on Friday. Her equity markets had a grim day as the IBEX 35 fell by nearly 6% and her government bond yields surged as prices fell. For example her ten-year bond yield rose from 7.02% to 7.26% and her two-year bond yield rose from 5.16% to 5.79%. I have often argued that rises in shorter dated bond yields are more significant in this sort of situation as they illustrate a loss of control. For example the official Euro interest-rate if 0.75% but Spain on Friday had a rate some 5% higher. That simply does not work when someone else with the same currency (Germany) has a two-year yield of -0.06%.

Spain’s economic problems mount

If we move from financial markets to economic we have new data today from the Bank of Spain’s monthly bulletin:

"On preliminary estimates, based on still-incomplete information, economic activity in Spain fell again in Q2. The pace of decline was estimated to be sharper than that of the two previous quarters, with a quarter-on-quarter rate of change of -0.4%……..In year-on-year terms GDP declined by 1%, set against -0.4% in Q1."

Actually although they have caused a media stir today those figures are better than they might have been. In essence the better news according to the Bank of Spain has come from exports:

"…net external demand softened the adverse impact of the decline in national demand on GDP, as it made a positive contribution of 0.8 pp, up on that of the previous quarter, thanks to a moderate pick-up in exports"

Care in needed with this sort of thing as I remember Greece claiming something very similar. What happened next? Her economy collapsed! Not a good omen. Let me explain how this can happen by looking at this below:

"National demand fell off more markedly than in the previous quarter (-1.2% against -0.5%), since household spending and general government demand shrank at a quicker pace."

This is a problem on two counts. Firstly we see that if we look at internal or domestic demand in Spain it is very weak right now and declining. So her demand for imports is  declining too (“Imports fell once again”). And net external demand depends as much on imports as exports. So in a period of economic weakness (where Spain is right now) her “net external demand” would improve her Gross Domestic Product figures even if exports were unchanged. This is a flaw in GDP calculations where a nation being poorer (falling domestic demand) flatters GDP numbers initially. As I discussed above this has been a feature of the Euro area crisis with Greece in early 2010 being a clear example.

This is not to say that Spain has not improved her export performance but simply that there is more going on than that. And we have the continual problem that trade figures are very inaccurate and often heavily revised so relying on them alone has plenty of dangers.

Continue reading…


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