Deconstructing Spain’s Lazarus-Like Economic Recovery

By Don Quijones, Raging Bull-Shit.

If recent reports from the Spanish government and the international financial press are to be believed, the Spanish economy is now officially out of the woods. Not only is the worst behind it, but the economy is now positively humming along at a growth rate of, um, 0.1 percent per annum (give or take a decimal point or two).

It is, as Spain’s finance minister, Cristobal Montoro, put it, a “lesson to the world.”

Spain’s premier Mariano Rajoy has been hardly any less effusive about the country’s Lazarus-like recovery. While addressing a group of Japanese business dignitaries last week, he said:

“A year ago everyone was talking about when Spain would be rescued. Now that is all history and instead people are talking about how big the economy’s recovery will be,” he said.

According to Rajoy, the main reason for this improvement is the raft of labour reforms his government passed last year, thanks to which unit labour costs are now performing “much better than in other EU countries”.

While clearly not of the “don’t-count-your-chickens-before-they-hatch” school of thought, Rajoy and Montoro are not alone in talking up Spain’s economic recovery. Many overseas observers are also changing their tune. They include ECB Chairman Mario Draghi, who earlier this year tentatively acknowledged that there were “signs of improvement in the Spanish economy.”

A team of Morgan Stanley analysts took it much further. “Spain, where unit labour costs are falling due to recession and reforms, and where export performance is strong, is on its way to become the euro area’s next Germany,” wrote analysts Joachim Fels and Sung Woen Kang in a weekly note on the global economy. 

Does this all mean that Spain is finally out of the woods of economic stagnation and malaise? Could it really be set to become the next Germany? The new exporting powerhouse of Europe?

Well, let’s be honest: it’s pretty hard to imagine. Don’t get me wrong, Spain is a beautiful, exhilarating country that offers better quality of life than most, but can you imagine it ever adopting a Germanic work ethic? And while Spanish exports have undoubtedly improved in recent months, much of the improvement in Spain’s current account is actually a result of the unprecedented collapse in Spanish imports.

What’s more, apart from slightly lowering unit labour costs, what else has this government done over the last year to improve Spain’s economic fundamentals? Has it stabilised the banking system? Helped small and medium size businesses? Boosted business innovation? Cut government waste? 

In the words of Angela Merkel, “Nein, Nein, Nein, Nein”.  

No, quite simply it doesn’t wash. All this talk of Spanish economic miracles is nothing more — at least in my humble opinion — than economic propaganda aimed at: diverting public attention from the increasingly damaging revelations coming out of the Bárcanas corruption scandal; oh, and of course, making Spaniards feel a little better about themselves and the country’s financial health, in the hope that they might loosen their purse strings somewhat.

Its other purpose, I believe, is to sell to the world the wonders of austerity economics. After all, biting austerity is what ultimately awaits all Europeans, assuming the Troika gets its way. And for that to happen, they must first market austerity to us as both a necessary good and a highly effective solution — something they’ve roundly failed to achieve in the case of Greece, Portugal or Ireland.

Virtuous Circle vs Vicious Cycle

While the Spanish government, Troika and financial press may wax lyrical about the virtues of austerity, not everyone is convinced. According to Steve Keen, one of a select few economists to actually foresee the 2007-08 sub-prime crisis, all austerity actually achieves is to accelerate economic deleveraging as the rate of economic activity all but grinds to a halt. And the more the economy slows, the more loans it needs to sustain its debt dependence.

This is precisely what has happened in Greece and Portugal, and is now playing out in Spain, where public debt recently reached 90 percent of GDP, its highest point since 1909. Since 2008, the debt has almost doubled, and no matter how much the Rajoy government lays the blame for this trend at the feet of Zapatero’s socialist government, the fact of the matter is that Spain’s public debt has increased more in the last two years under Rajoy than it did during Zapatero’s entire legislature.

What’s worse, it’s a trend that is escalating. Indeed, in spite — or perhaps better put, because — of the Rajoy government’s broad program of austerity measures, including higher direct and indirect taxes, dramatically reduced government spending, breakneck privatisation of the country’s health-care system and sweeping pension reforms, its fiscal balance has worsened over the last year.

And as public funds decline, the need for more external debt increases.

To keep meeting its growing debt obligations, Spain has begun playing a very dangerous game indeed — that is, to turn increasingly to short-term funding from the international markets, as BusinessWeek recently reported:

Pressure from the European Union and the European Central Bank to rein in the budget deficit has forced Spanish officials to skew debt sales to shorter-dated paper where investors accept cheaper interest rates to avoid locking in the cost of financing. Those short-term gains leave the country’s deficit reduction program dependent on investors sustaining a rally that has cut about 490 basis points from two-year borrowing costs

…”Spain has benefited from falling interest costs by selling shorter-dated debt, but is now more vulnerable to a withdrawal of ECB liquidity or a re-ignition of the crisis,” Michael Michaelides, a London-based strategist at Royal Bank of Scotland Group Plc, said in an e-mail.

One of the reasons for Spain’s increasing dependence on ECB liquidity is the continued rise of bad debt in its banking system.

Bad Banks, Bad Debt

Stemming primarily from defaulting property loans, bad debt now accounts for 11.4 percent of the country´s total credit. This represents the highest level since November 2012, when the bad debt ratio dropped slightly after the launch of the so-called “bad bank” designed to swallow up large amounts of toxic real estate that had already brought down several Spanish banks.

Given the opacity of the banking system, not to mention the widespread practice of mark-to-model reporting, it’s virtually impossible to accurately quantify the size of the black hole in the Spanish banking sector. One thing you can safely bet on, though, is that its capital deficit is considerably larger than the amount reported by the U.S. management consultancy Oliver Wyman — 51-62 billion euros — in its stress tests of mid-2012.

As Zerohedge noted at the time, the figure put forward by Oliver Wyman is premised on a set of wildly optimistic assumptions, including that:

  • The expected loss is offset by €98 billion of exiting provisions (which will have to be offset by something and if deposit outflows continue, instead of reverse, then this merely accelerates the under-capitalization);
  • New profit generation of €64-68 billion – remarkable for a banking system which is inextricably tied to its sovereign and entirely bust itself;
  • An excess capital buffer exists in the broke banking system worth some €33-39 billion

What’s more, as Mike Shedlock recently pointed out, Oliver Wyman’s stress tests looked only at the domestic lending books; foreign assets were not included — an oversight that could end up proving very costly, especially given that many Spanish banks’ books are filled to the rafters with foreign sovereign debt, in particular that of Portugal, a country whose public debt is expected to reach 125 percent of GDP next year.

If, as is likely, Portugal eventually requires another bailout, it will trigger, as Greece did, a massive haircut of sovereign debt, leaving many Spanish banks holding the bag and all of a sudden desperately in need of their own cash infusion.

An even worse-case scenario would be if Spanish sovereign debt were to begin retracing some of its recent gains — especially given that the biggest holders of Spanish sovereign debt are Spain’s last remaining banks (Santander, BBVA, Caixa Bank, Bankia, Sabadell and Bankinter), and by a long shot.

Fortunately for the banks and for the government, the risk premia on Spanish debt recently reached three-year lows — the supposed result, at least according to Rajoy’s government, of rising investor confidence in Spain’s economy.

The reality could not be further from the truth. The rising value of Spanish bonds is owed almost exclusively to Draghi’s infamous pledge to do “whatever it takes” to save the euro. The result — at least until now — has been to restore investor sentiment in European peripheral debt, while dissuading bearish investors from betting against a European recovery.

A win-win for all concerned (apart from, that is, the hundreds of millions of taxpayer marks who will one day have to pick up the bill).

The Real Situation

Yet while Draghi’s posturing may have helped bring down bond prices for countries like Spain, it has done absolutely nothing to help companies and households gain access to credit.

According to the ECB’s own data, banks throughout the euro-area have continued to tighten credit standards and reduce lending. So, despite saving them with billions and billions of our own (or at least, our children’s) hard-earned euros, the banks refuse to lend it out into the economy. And so the deleveraging continues, propelling the real economy — i.e. that which truly matters but which politicians and economists prefer to ignore — closer and closer to the edge.

After falling by one percentage point in the second quarter of this year, unemployment in Spain has already resumed its upward march. With fewer and fewer wage earners, internal demand continues to crumble, pushing more and more companies through the door of liquidation. The result, predictably, is more unemployment, higher government spending and reduced tax revenues, prompting the government the government what it does best — tax more and spend less. Pensioners are next on the chopping board, to be followed no doubt by public hospitals, public universities and what remains of public transport.

All in the name of fiscal tightening!

But then, just when it seems the government might actually save some money, another bank begins to teeter. Yet another injection of tens of billions of hard-earned taxpayer euros will be needed, followed by more austerity and rising debt.

This is the real reality of Spain today — not the one served up by our political and business leaders and their loyal mainstream media. In essence, the wonders of austerity — that is, the destruction of the internal market — are being celebrated while a massive transfusion of life-blood is siphoned from the real economy to the terminally insolvent banking sector.

As Steve Keen said a few years ago, as long as this austerity is forced on the public, they’re the ones that are going to feel the pain:

“And they’re being told by the elite who actually benefitted from the bubble in the first place that they need to suffer to overcome the mistakes the elite made… This is a recipe for demagogy.”By Don Quijones.


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