Will Spain catch Portugal

8th April 2011

Yet, when it comes to Spain, those markets have remained relatively calm. The amount Spain has to pay to borrow money for ten years has not increased for many months, remaining at just above 5 per cent while Portuguese 10 year paper was at 9 per cent and its five year debt in double figures.

The Spanish finance minister Elena Salgado is also adamant that the country's financial position is solvent and sound and is giving reassuring interviews to anyone who will listen, reported here on egovmonitor.

But not all commentators are convinced of the strength of Salgodo's case.

The Economist magazine gives a bearish view here, suggesting that markets may not like what they see when they take a closer look at Spain's stricken savings banks known as cajas in Castillian, caixas in Catalan. Those regional divisions may be part of the problem but more on that later.

Here the Guardian's City editor Nils Pratley suggests that poor old Portugal has merely bowed to the inevitable by seeking a bailout which is why the European Central Bank wasn't particularly worried about making their bad situation worse and raising Eurozone rates. Pratley sees the real risk of the rate rise as that of creating a two speed Europe. While the price Spain is paying to borrow on the bond markets has remained steady, he is concerned about Spanish unemployment – nearing one in five of the workforce – which does impact on a country's ability to service debts and could make the situation of the Spanish banks much worse.

Another Guardian stalwart, economics editor Larry Elliott warns in this webcast that the EU may not have the funds to bail out Spain. To put things in perspective, Ireland, which has had its bailout, has an economy the same size as Hamburg's, he says. Spain has 40 million people and is of a whole different order. Elliott expects markets to put Spain's mettle to the test in the coming weeks.

Here Citywire takes a very long technical look at the Spanish situation, reports the Goldman Sachs' view that Spain's banks could have astonishing credit losses of Euro 145bn and notes a very tepid response to an Italian bond auction last week.

It also reports that some analysts are concerned that Spain's devolved political structure makes concerted action to restructure those cajas/caixas much more difficult.

On Citywire commenter derek farman says the media is doing its bit to erode confidence.

"It's the media again !!!!!  Constant stories of doom and gloom will erode any confidence that Spain can handle the situation . There will then be a run on the banks and stalling of investment."

Pedrolx, who is Portuguese, also has a theory.

"This is my take on the so-called European sovereign debt crisis: Greek boomed because it WAS insolvent. They lied for years about their public finance. This started two things at the same time:

a) It started scaring away traditional bondholders. Who started to sell in the secondary markets.

b) it was seen as an opportunity for some sectors of the market to make profit, who bought those bonds.

This led to a self-feeding system, which was then pumped even further by speculative articles in the international media. The new investors in the bond markets didn't really fear much because they knew a bailout would occur so they basically would never lose money.

The Irish situation happened because when the new bondholders, hedge funds and vulture funds heard of the "haircut" they started selling like crazy and bond yields rose sky high. End of story for Ireland. Hopefully Portugal and Spain can still be saved from the greed of some of these markets sectors. So I am all for Portugeuse banks buying our bonds. The more they buy the better. And I am certain they have the ECBs approval to do so."

Perry Patel shares Pratley's unemployment concerns.

"Spain has a lower budget deficit than Britain(10,2%) and Ireland (32,3%) and a lower public debt level than both. The worrying issue is indeed the 20% unemployment rate, the largest employer in Spain is the building industry which is virtually at a standstill. The number of forced sales of homes and second homes at discounted prices is mind boggling and one can only wonder at the state of local banks holding such delinquent mortgages. With long-term mortgage rates being offered at 3%, one can wonder what else will it take to kick start the economy. Foreign buying of property seems to have dried up too, the Costa life style has soured somewhat."

In the view of Mike S, the UK is only safe because it can print money, not an option in the Eurozone with Germany keeping such a close eye on the ECB's printing presses.

Mike S says: "Why does the UK get a prim AAA rating? I believe that is because like all countries in control of their own currency the UK can just print more – therefore, all GBP debt can be repaid. Similarly, the highly indebted USA can and has been printing USD. Portugal, Ireland, Greece and other EMS members can't – they are at the 'mercy' of the EU and the Euro. For what it's worth I hope the Euro survives 'as is' but at a lower rate than its current level."

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26 thoughts on “Will Spain catch Portugal”

  1. Anonymous says:

    Despite all of the commentary as to divergence, your article does set out with unnerving clarity the gap between the two economies.

    It is often said that convergence will come in the EU when, like the USA, there is an economic, political and fiscal union.

    What your article brilliantly highlights is that we already have a control for this experiment, namely East Germany. I would say that your article clearly sets out the intractability of the problem in Europe as opposed to the USA, as follows:
    1. Where there is a common language, with complete freedom of labour as a result and a flexible workforce able to integrate easily into a new economy, you have success. This is accompanied by a single tax regime, with transfers controlled centrally between regions, but from the same tax base. It is based on popular consensus as to the desirability of the union from both sides of the equation. This is called Germany and worked even where an inappropriate one to one DM exchange rate was used;
    2. The contrast with Greece could not be greater. There are language, geographical, cultural differences which mean that you don’t have the mass freedom of movement that you have between the two sides of Germany (or, for that matter, took place in the 1920s in the USA). There is no common tax base between Germany and Greece and no popular consensus as to bailing Greece out. I have no idea  as to how flexible the Greek workfocre is so will not comment on that.

    In other words, where there is huge popular will to make something happen on all sides, given the right cultural conditions, you get a German success story. I would conclude from your article that, however unified Euroland becomes, this success story will not replicate in the periphery, as these conditions are not met.

    1. JW says:

      Excellent summary together with Shaun’s ( as usual) superb piece.
      I would add that as well as these cultural differences, there is a profound economic difference. The German economy has not been ‘financialised’ to anything like the extent of other economies, that is why they bounced out of recession, there was not the debt overload to stymie growth. The introduction of an ‘EFSF’ mechanism, to socialise the European Bank debts ( including German Bank-held debt) would increase this financialisation in Germany.
      Every way you look at this, the path advocated by the US to save their Bank losses ( via credit insurance exposure to Europe) is terrible for all the general populous Europe. Unfortunately it may well happen. 

      1. Anonymous says:

        very good point. I went to Cyprus on holiday this summer and, according to people there, their banking sector is much larger than the Uk’s as a proportion of gdp. Does anyone know if this is true? If it is and following your point, they are in deep trouble.

        1. Anonymous says:

          I have heard and indeed read that this is a fact. I also understand that their exposure to Greek banks is somewhere in the region of 30%+ due a) to the number of Greek banks with offices on the island and b) a sense of “solidarity”……

  2. Bkester says:

    German reunification, and the subsequent exchange of one Ostmark for one Deutschmark, was only politically possible because West Germans regarded East Germans as fellow countrymen.  The UK is also a sort of currency union in some ways and even there one reads in the British press frequent moans about fiscal transfers heading north especially to Scotland.  The Eurozone is fast developing into a North-to-South fiscal transfer union with this situation likely to remain in place for several years into the future.  But there is little ‘fellow countryman’ sentiment in Europe.  So while the transfer might be fiscally possible, I just cannot see it as a semi-permanent political reality. If, for any reason, there were a serious economic downturn in Germany, Holland, Austria etc. then all Hell and all Hades together will break loose.

  3. Jason Aris says:

    Shaun very good again, bottom line is there is no European polity and therefore no empathy across the various States in terms of cross subsidy. The irony is one of the many triumphs the EU trumpets about is it exists to prevent the recurring European disease of war (incorrectly in my opinion Nato, read US, and the threat of the Soviet Union done that whether the European left like that or not) which seems to be where we are heading if this ignoring of reality on the ground continues.

    1. John donnelly says:

      Jason, like many others on blogs of this type, you seem to associate the EU project with the “left”. Believe me, if you are too young to remember, the European “left” was utterly opposed to the European project. It was the creation of the European right, mainly Christian Democrats, together with Social Democrats (not considered “left” by anyone back then) from some of the Northern European countries. But then the word “left” in the political sense seems to have now acquired the meaning attributed to it by tea party types in the USA- i.e. anyone who doesn’t agree with them. 

      1. Anonymous says:

        Hi John and welcome to my part of the blogosphere

        I do not know how often you have read my blog so I would just like to point out that I run a policy of strict political neutrality on here. I have a view on our political leaders/class as a group that they in general have performed badly but this covers quite a lot of different political views!

        1. John donnelly says:

          Hi Shaun,

          Thanks for your reply. I think we would differ greatly on what constitutes “a lot of different political views”.  I would not say that “Jason Aris” made a politically neutral contribution, which is why I commented, but that, of course, depends where you are starting from. So goodnight and goodbye is the only response open to me.

  4. Anonymous says:

    Great piece Shaun – I thought
    I would read the 1989 Delors Report out of interest :-

    ” Financial markets,consumers and investors would respond to differences
    in macroeconomic developments in individual countries and regions, assess their
    budgetary and financial positions, penalize deviations from commonly agreed
    budgetary guidelines or wage settlements, and thus exert pressure for sounder policies.
    However, experience suggests that market perceptions do not necessarily provide
    strong and compelling signals and that access to a large capital market may for
    some time even facilitate the financing of economic imbalances. Rather than
    leading to a gradual adaptation of borrowing costs, market views about the creditworthiness
    of official borrowers tend to change abruptly and result in the closure of
    access to market financing.” Delors Report 1989


    So, monetary union was to be accompanied by economic
    union with fiscal rules so as not to leave EMU victim of market stress. It’s
    the “rules” bit that has failed and Delors anticipated the result.
    Let it not be said the warning was not given.Now, we have globalised banking sectors connecting inside / outside the EMU exacerbating
    and amplifying the stress of what Delors foresaw. I take the view that these issues are the central and aggravating causes.

    1. Anonymous says:

      knowing all this and still they went ahead. I hope that all this is used as evidence when the eurocrats are put on trial for gross mismanagement (I know it’s just a dream…).

      1. Anonymous says:

        Yes, Delors predicted problems. Markets are not efficient because the are subject to instability and large mood swings – sometimes everybody simultaneously heads for the exit. Look at Greek bond yields over the last few years as an example. Markets however do work better than communist price controls ….

        This crisis is caused by a failure by banks to price risk correctly. Loans were sold too cheap. Germany and Greece can have the same base rate, but Greece should have paid a higher premium over base rate. The
        correct capitalist response is for banks to take losses on bad loans
        they should not have approved. Bailouts should restricted to savers
        only, shareholders and directors do not deserve taxpayers money.

        I agree that the Eurocrats should be put on trial for

        1 ) Wasting taxpayers money on subsidies rich bankers – the poor subsidizing the rich. Definitely gross mismanagement.
        2 ) The EFSF is a Violation of the Lisbon treaty

    2. Anonymous says:

      Hi Shire

      Thanks for the quote. In a way Delors sounds a bit like Paul Krugman in that he wants to use markets to suit his case and at times help but then interfere heavily in them and wonder where it has gone wrong!

      1. Anonymous says:

        Thanks Shaun and Berlioz58. What I thought interesting was the statement that markets with access to such a large EMU capital market might finance the imbalances caused by the lack of rules in EMU. Contrary therefore to the norm of current reporting, I think the markets have made their own misjudgments for which they need to accept full liability and responsibility.Delors was quite perceptive…..in line with notayesman thinking, who knows :)

  5. Anonymous says:

    One mustn’t be surprised that the Euro Zone whirls around Germany; it is simply obeying a law of mass action.   Other states mayn’t like this but Germany is the biggest national economic unit in the EMU and so Interest rates etc will be dictated from Germany.   It really is up to other economies to measure up.   This they failed spectacularly to do.    In the pre Euro days a nation could lie about and then screw its savers and lenders by having a devaluation.   Brilliant, fiddling the money became an art form which is no longer necessary, but ministers of finance are lost without it.
    What I still don’t understand is that medieval Europe “the Sterling” was a preferred currency though it was minted in England; the USD is the currency of trade today with some countries using it as their currency.    Why can’t the Euro be simply used as a stable currency without carrying all the blame for failure?   
    Many years ago I travelled around the US and was struck then by the different prices of the same article, from petrol to pineapples, in different places.    The dollar was just a local exchange currency.   Why can’t the Euro be the same?     I’m sure there is a song in there – Rex Harrison singing “Why can’t a woman be more like a man?”
    In two minds whether to post this or not, it seems naive.

    1. Anonymous says:

      I think that the Euro gets the blame as being a failure in contrast to the dollar because:
      1. It was designed so faultily, in the sense that governments kept their national fiscal policies distinct;
      2. The ECB acts like a Bundesbank lookalike, raising interest rates this year, for example. It hates its role as a Federal Reserve (see the latest resignations over buying debt);
      3. There seems to be no way of achieving decisions in Europe, again a design flaw. Barroso comes up with a plan on Tuesday and it is shot down by Germany on Wednesday just this week, for example;
      4. There is no central presidential figure to appoint a democratically legitimate cabinet. Please do not mention Rompuy, as I do not count him or believe he has a democratic mandate. This means that there can be no clear articulation of policy from the top;
      5. To be blunt, I think that a lot of people resent the fact that Germans have been so damned good at living within the Euro and I feel that a lot of Europeans are not so keen on Germany telling them what to do (see the lebensraum comment above in Shaun’s blog). It has rubbed everyone’s nose in it that they have failed to match the German machine.

      And, to cap it all, there is a deep resentment across many countries at the Euro being pushed through as an entirely undemocratic means of achiecing the real goal, i.e. a unites states of Europe.

      1. Anonymous says:

        It’s your point 1 that I’m having all the trouble with.   Why shouldn’t they keep their fiscal policies separate?   My very point is that this has been done many times in the past and the present in various currencies with no particular problems.   The fault lies not in the Euro but in the users thereof.   It may have nothing to do with convergence or divergence – just cheating for local political reasons like re-election, or even old fashioned corruption.
        I agree with all the other points you make I just see them as extensions of political arguments.

        1. Anonymous says:

          You are right and my comment was shorthand. I meant that there is a design flaw in a system where countries which are used to running large deficits and prinitng money to cover borrowing (and never mind currency depreciation) were unlikley to stick to the type of German-type modest deficits. In turn, this meant that thier debts would increase, but now the escape valves of devaluation/printing money have gone. The interest rate paid, while the game looked sustainable, was held near that of Germany, with everyone happy. As soon as it stopped looking sustainable and interest rates went to crazy levels, the game was up.

        2. JW says:

          Yes, in the US states and cities go bust, bad budgeting etc, they cannot create their own money but system works because they are ‘rescued’ by the centre. This works because of ‘one flag’ etc. Without common culture, heritage etc you need ‘rule based system’ which will get ‘gamed’ regularly. You either decide its worth it or not.
          If Banks etc were just conduits of finance to the real economy, this could be worked out through elections/referendums etc. But the whole EZ has been put enormous strain by the greed of Bankers making loans that could never be repaid except through taxation. 

  6. Anonymous says:

    Hi Shaun
    Sorry to add a question on the EFSF approved by Germany : on reading Msr Trichet’s answers to some questions, is it possible for the EFSF to buy the E156bn SMP bonds of the ECB – as if refinancing the ECB? Could it alsl buy the E60bn covered bonds of the ECB?

    1. Anonymous says:

      Hi Shire

      Looking at the EFSF agreement we see this on bond purchases.

      “facilities for the purchase of bonds in the secondary markets on the basis of an ECB analysis recognizing the existence of exceptional financial market circumstances and risks to financial stability or facilities for the purchase of bonds in the primary market”

      So strictly no as the circumstances are not exceptional for the bonds on the ECB balance sheet, however we have seen such things get twisted have we not? So I cannot rule out the EFSF taking over the SMP in some form and frankly it would be more logical.

      Covered bond purchases are not really in the agreement and would be more of a stretch I think as

      “facilities to finance the recapitalisation of financial institutions in aeuro-area Member State (through loans to the governments of such MemberStates including in non-programme countries”does not absolutely rule out purchases but  it definitely implies the provision of capital rather than liquidity.Actually I think the biggest barrier is a shortage of funds. If we deduct the promised lending from the EFSF and then add to it not only the SMP but try to allow for future purchases the EFSF might start to use up a lot of its capacity. Also before then markets may suffer from indigestion from buying its bonds…
      euro-area Member State (through loans to the governments of such Member
      States including in non-programme countries”

      does not absolutely rule out purchases but  it definitely implies the provision of capital rather than liquidity.

      Actually I think the biggest barrier is a shortage of funds. If we deduct the promised lending from the EFSF and then add to it not only the SMP but try to allow for future purchases the EFSF might start to use up a lot of its capacity. Also before then markets may suffer from indigestion from buying its bonds…

  7. Old Chris says:

    Hi Shaun

    Is it me or is that a train coming this way?

    Anyway, what if:-

    EFSF fails ratification, as seems likely, but is pushed through by four or five countries, with a bit of horse trading to keep the others quiet.

    Then, with its limited firepower, the ECB is prevented from completing the necessary leveraging arrangements in time to head off the markets.

    What if Greece is then forced into default, but stays within EZ. Followed by Portugal’s default, causing Italy to slide into recession. (I don’t think Ireland or Spain will jump, I just don’t.)

    Are you sure that train isn’t coming this way?

    Anyway, in the resultant period where headless chickens are running around, what if the IMF stands into the breach and promises to cover any eventuality. (Going by past history of those now running it.) The result being a five fold revaluation of SDRs from $1.58 to nearer $7.90 to cover the Grand Plan.

    The question is, with Team BG already leveraged to the hilt. How are we supposed to cover British exposure, an additional 700billion, or so. Surely not more QE and inflation.

    In my naivety I was wondering, should all this leverage unravel, wouldn’t Goldman et al. end up owning the world. After all, CDSs are swaps. So wouldn’t they then own whatever assets the CDS was swapped for, be it houses, museums or football stadia.

    I only hope they will be making Soylent Green in Marmite flavor, or Peach Melba.

    1. Anonymous says:

      Hi Old Chris and welcome to my part of the blogosphere

      I hope that we can do a lot better than indulging in cannibalism particularly if it is marmite flavoured!

      As to your train I cannot rule it out. I have a couple of thoughts for you.

      1. I expect the EFSF to struggle to ratification but there will be more delays. Whilst Slovenia or Slovakia could stop it by saying no I expect them to pass it in the end. What I think thsi struggle will do is in effect block further expansions.

      2. Much of the IMF’s funding is based on fantasy these days in my view ( it probably always was) and I think I detect a growing groundswell against it even amongst those who like the idea of a supra-national saviour.

      As to Goldmans I think that with their wide-ranging influence it would not be easy for the Vampire Squid to become more influential. US Treasury Secretary’s, Heads of the ECB, new member of the MPC ….

  8. Rods says:

    Hi Shaun,

    A exceptionally good article, even by your always excellent standards of economic analysis.

    If my memory serves me correctly, I seem to remember that Germany paid a high price in the late 1990’s and early years of this century, with their 1:1 currency conversion for reunification, with high unemployment and falling real living standards. Hence, this contributing to their current competitiveness. I suspect that this is still quite fresh in the memories of Western German citizens, with the bailout of EU countries, representing a potentially even bigger bill and German people suffering even more and this is part of their reluctance to get involved.

    I was watching a documentary last night on “Attila the Hun”, where a historian compared the collapse of the Roman empire with that of the Soviet Union, where they both went from Superpowers to minor powers in about 10 years. He attributed it to the following:

    1. Political corruption.
    2. Lack of faith in the leadership (Roman men would cut off their thumbs to avoid being drafted into the army).
    3. Over regulation / repression
    4. Excessive taxation.

    Does this remind you of any current political system / empire?

    Best Regards


  9. Anonymous says:

    Hi Shaun, I hope it is ok to post this link to an online petition re bank bailouts and rewards.
    If not, just delete it my friend. All the best and thanks again for your amazing reporting and analysis. Ipis. http://www.avaaz.org/en/eu_people_vs_banks/?vl

  10. I think the German reunification had a large effect on germany, and the way germans think about how macroeconomy (should) work. It made for more austerity than Germany had had before. After propping up east germany, germans are more afraid of having to prop up southern Europe. To add on, I believe it’s a true fact the EU devotes much more of its budget to agricultural subsidies >$50 billion I think, than does the US. The EU social safety net is strong for the small farmers, not for the unemployed, which is left to the individual nation.

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