25 July 2012

Can Anyone Tell Me What is Wrong With Spain?

I was going to write about my favorite Eurozone subject, i.e. whether Greece should default or not. And in the course of checking up some statistics, I realized that something was rotten in the state of Spain.

And it is not what you think.

You see, I kept reading story after story that Spain was in trouble, its economy was in shambles, the austerity measures its conservative government introduced needed to be redoubled, etc. But I couldn't find a single piece that explained to me why this was the case. Not one.

All the articles pointed to the pre-2008 real estate and construction boom and the subsequent bursting of the bubble. The only other element they all mentioned was high unemployment.

I realized that there was something wrong with this picture as this was supposed to be a crisis caused by countries living beyond their means. That's why we need austerity measures, right?

Well, according to Wikipedia, at the start of the crisis period, Spain's public debt was 36.2 percent of its GDP. Even in 2010, Spain's debt was lower than Britain, France or Germany. And according to this map at 63 percent it is still one of the lowest in Europe. Take a look at France, Germany, Belgium and Britain in that map.

Wikipedia puts the debt a little higher than 63 percent but remarks that it is still lower than the Eurozone average: "As of June 15, 2012, Spain's public debt stood at 72.1% of GDP, still less that the Euro-zone average of 88%."

As for unemployment, well, it "stood at 7.6% in October 2006, a rate that compared favorably to many other European countries." Sure, it rose to over 17 percent when the crisis hit, as the construction sector accounted for almost 16 percent of the GDP. And it reached 25 percent with several rounds of austerity measures. But unemployment was not a structural issue, as it has since been commonly reported. It was the dependent variable in the equation, not the causal factor.

Okay, you say, let's take a look at other issues. People wouldn't make such claims if they weren't true. Spain had a successful export oriented economy. So exports must be hurting, right?
With growth of 17.4% to 185.799 million euros in sales, the export sector has recovered to pre-crisis levels, according to data released by the Ministry of Industry. (...) The year 2011, Spain is among the countries with overall export growth, according to OECD forecasts. The international institution puts Spain in fifth place in the ranking, with estimated exports of goods and services 9.9%. Spain is placed after Germany and Slovakia, which will increase its sales abroad by 10.4%.
This is annoying. Export sector has already recovered to pre-crisis levels and growing.

Surely, there must be something wrong with...OK...what about tourismwhich represents a huge chunk of the economy?
July 2011 has witnessed historic revenue in tourism as compared with the same period over the years in Spain, figures showed Tuesday.

The EGATUR study, published by the Spanish Ministry of Industry and Tourism, showed that international tourists in Spain spent 6,942 million euros (10,054 million U.S. dollars) this July -- a 9.6 percent rise over the same month in 2010.

Spending by foreign tourists this year also surpassed that of 2007, when visitors to Spain contributed 6,587 million euros (9,485.28 million dollars) in the country in what had previously been the best July on record.
I am beginning to lose patience. I am certain that there is something deeply and fundamentally wrong with the Spanish economy, otherwise, these Very Serious People would not have called for crippling austerity measures.

Wait a minute. I think I got it. Maybe the economy is composed of old and aging industrial structures and it needs to diversify itself and to transition to new and green technologies. Right?
[T]he Spanish economy is very diversified among the most important emerging countries. (...)
Spanish companies lead fields like renewable energy (Iberdrola is the world's largest renewable energy operator), technology companies like Telefónica, Abengoa, Movistar, Hisdesat, Gamesa, Indra, train manufacturers like CAF, Talgo, global corporations such as the textile company Inditex, petroleum companies like Repsol and infrastructure, with six of the ten biggest international construction firms specialising in transport being Spanish, like Ferrovial, Acciona, ACS, OHL and FCC.
This is not good. Let me think. What else is there? Hmmm, yes, trade deficit. Why didn't I think of that before? They must have bought more than they could sell, hence austerity. Apparently, not anymore:
Spain's trade deficit shrank in October 2011, 1.9% to 3.632 million euros, announced the Ministry of Economy. The Spanish exports grew 11.5% compared to October 2010, to reach 19.394 million euros, the statement said. The increases were highest in exports of capital goods, which rose 14.8% over the first ten months of 2010 and the automotive sector, up 14.3% in a year. Spain recorded a trade surplus in trade with the European Union (EU), of 3,043 million euros in the first ten months of the year. While domestic consumption shrank, its exports continued to grow despite the global slowdown.
It is like somebody is doing this on purpose to make me and the Very Serious People look bad.

OK, OK, this time I know: It must be the regional governments that are pulling the economy down. Like the American states pulling the US federal government down.

Hey look, BBC just published a piece claiming that very point. That's serendipity. The 6 regions (out of 17) they cited as example -presumably the worst offenders- had a collective debt of €90.7 billion. Spanish GDP being €1.4 trillion you can see the crushing weight of that debt. In the article BBC acknowledges that their collective debt represents 2.9 percent of GDP in 2011.

Wow. Good God, how could the country even survive?

So, when you look at it, the Spanish economy seems diversified. Its exports are booming in a global downturn. They are world leaders in green technologies. They are in the top five in the world in tourism income. They have one of the lowest debts in Europe.

Sure, their unemployment figures are catastrophic but this was caused by the crisis and exacerbated by the successive rounds of austerity measures.

Can anyone tell me what is wrong with Spain?

Anyone? Please.

You said, the banking sector. Okay, good point, let's take a look at it.
The Spanish banking system had been credited as one of the most solid and best equipped among all Western economies to cope with the worldwide liquidity crisis, thanks to the country's conservative banking rules and practices. Banks are required to have high capital provisions and demand various proofs and securities from intending borrowers. Nevertheless this practice was strongly relaxed during the housing bubble, a trend to which the regulator (Banco de España) turned a blind eye.
So the Spanish banks, which are normally conservative and traditionalists and well capitalized, were somehow convinced that it was a good idea to risk everything during the real estate boom. I wonder how that happened and who convinced them?

As you know, what happened in Spain happened in Ireland and in the US and a lot of other places. You can read about it in Michael Lewis's excellent book the Big Short (click here for a lengthy excerpt). Basically, banks were given huge sums of cheap money and they were told to place as much of that as possible. With large bonuses waiting for them, they started giving mortgages to anyone and everyone on ridiculous terms.

While real estate prices continued to rise everyone made money, people flipped houses and lived beyond their means and construction sector kept churning out new buildings. When the bubble burst, prices collapsed, assets diminished in value, people lost everything and banks found themselves in red without enough capital to cover their losses.

But what is remarkable is that, even with all this, the three largest Spanish banks (Santander, BBVA and Caixabank) are still not in any danger and do not need any bailout.

The savings banks like Bankia which played a central role in that all-too-common greed tale might need €40 billion according to the IMF, €62 billion according to the consultancy firms Oliver Wyman and Roland Berger and €85 billion according to BBC Economics Editor Robert Peston (that includes the €23 billion given to Bankia). That's it.

Can anyone tell me why these are scary numbers in a €1.4 trillion economy? This is a fraction of what each of the Too Big To Fail (TBTF) banks lost during the 2008 crisis.

The main problem the Spanish banking segment is facing is their inability to borrow in the open markets. Why? I read maybe twenty articles on this. I found no actual explanations. They all mention the specter of Ireland. They all talk about negative investor perceptions. They all state that if Spain goes bust its banks will go bust and vice versa (Doh!).

But crucially, they never explain why Spain might go bust.

And, invariably, they all express concern about high unemployment.

This is like shooting someone and then, instead of giving them first aid, lamenting that they are bleeding out.

One final point: A week or so ago, the Eurozone countries agreed to put aside €100 billion in EFSF funds to help Spanish banks. This is more than they need apparently. Nothing happened. The markets remained unimpressed and Spain's borrowing costs went through the roof.

Around the same time, ECB Mario Draghi said that weaker Spanish banks should not be saved and holders of their senior bonds should suffer losses.

He said this despite the fact that 17 finance ministers of Eurozone countries had already agreed to rescue every Spanish bank.

What is remarkable about this statement is this: If you remember, during the so-called Greek haircut debate, the ECB adamantly refused to do exactly that, that is, to let holders of senior debt to suffer any losses.

Can anyone explain to me why the ECB changed their position?

And why "the markets" are trying to destroy the Spanish economy?

It is as if someone is desperately trying to convince us that Spain is in deep financial trouble. Just today a new piece on BBC is talking up "white elephants" or failed public sector projects. The article mentions only an airport south of Madrid.

I understand that wasted public funds are tragic but I would have liked to see some actual figures showing  how these "white elephants have destroyed Spain's €1.4 trillion economy.

Without that, I fail to see why almost everyday we have a new piece filled with ominous projections and Spain's terrible fiscal crisis. As I said, it is as if some people are trying to convince us of something.

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