Economic Resources

Is There Really

2011-05-08T23:15:00.000-07:00

America, we know, has a currency union that works, and we know why it works: because it coincides with a nation — a nation with a big central government, a common language and a shared culture. Europe has none of these things, which from the beginning made the prospects of a single currency dubious.
Paul Krugman - Can Europe Be Saved?

All theory depends on assumptions which are not quite true. That is what makes it theory. The art of successful theorizing is to make the inevitable simplifying assumptions in such a way that the final results are not very sensitive.' A "crucial" assumption is one on which the conclusions do depend sensitively, and it is important that crucial assumptions be reasonably realistic. When the results of a theory seem to flow specifically from a special crucial assumption, then if the assumption is dubious, the results are suspect.
Robert Solow, A Contribution To the Theory of Economic Growth, 1956

One of the key premises underpinning the establishment of the Euro as a common currency to be shared by a number of individual national states rather than one single nation was the central idea that the several economies of the participating countries would eventually converge to one common typology. That is to say, even if the individual nations would not be dissolved into one single superstate, then the idea was that the difficulty this could obviously create would be overcome by the generation of a number of different, but to all-important-economic-effects identical economies, each one a replica (in minature or "a lo grande") of the other. Absent this, it is hard to see how people could have convinced themselves that having a single currency and a single monetary policy could possibly work in the longer term.

Convergence Towards a Common "Steady State"

This critical idea of convergence was based on a simple (and possibly rather simplistic) application of the kind of neo-classical economics widely taught in the modern university. Every economy, it is postulated, is capable of generating some sort of relatively constant "steady state" growth rate , and given the application of sound common monetary policy and an appropriate mix of relevant structural reforms these relatively constant growth rates should not diverge too much one from the other, since if they did, and continued to do so on a sustained basis, then a fiscal mechanism would need to be created to serve as a stabiliser able to redress the consequences of such steadily diverging rates of growth with the associated large differences in living standards. Political consensus could never realistically be maintained behind a process which was manifestly generating inequality between participating countries.

Naturally, if there was no eventual convergence then any fiscal mechanism which was created would need to be something more than an ad hoc fund for handling the impact of a one-off asymmetric shock (like the bursting of a property bubble), since it would need to be permanent and systematic and operate in a way which is broadly similar to the internal redistribution mechanisms which operate between north and south in countries like Spain and Italy, or between rich and poor states in the USA. Naturally, in the course of the current crisis, no one with any degree of institutional authority even in the most desperate of moments has been prepared to publicly contemplate the possibility that the creation of such a territorial equalisation mechanism might eventually be need, even though, as will be argued here, successfully saving the Eurozone will almost inevitably mean putting just such a fiscal compensator in place. Just think about it: the Greeks never had a fiscal deficit problem at all, since what was lacking was adequate compensation for their growth imbalances! You can just see the anxious (or enraged) look on all those German faces. Yet just this is the conclusion that I think can be drawn about the creation of a common currency area among a group of countries where convergence is not operative, since the consequence of not doing so, as is now becoming clear enough, is that the countries with lower underlying growth profiles become steadily weighed down by the burden of their indebtedness to the higher growth economies - that is to say debt obligations are created where fiscal transfers are lacking.

Now, as we all have come to know only too well, this kind of fiscal mechanism was neither contemplated by the founding fathers of the Euro, nor has anything even remotely resembling it been envisioned as part of the collective response to the present crisis. Indeed the need for its creation remains one of the most highly controversial topics in the current debate (rivalling in the emotional charge it engenders only the suggestion that some sort of internal devaluation might be needed for the zone's struggling peripheral economies). Advocacy of this move has been restricted to commentators outside the mainstream, most notably among them Wolfgang Munchau (see here, and here), and for his pains he has acquired the honorary title of "Enemy of Spain" from the Spanish newspaper El Mundo, who presumably found his suggestion that Spain might need to be a beneficiary of such a mechanism an insult to their national honour.

Diverging Not Converging Economies?

Meanwhile back in the world of the real economy, nothing could be more evident from all the signs we are seeing during the present recovery than that the Euro Area economies are not converging - indeed they are visibly diverging in all manner of different ways. Some economies are now called "peripheral", and others are called "core". Yet neither the core, nor the peripheral economies resemble the other members of their sets in a way which standard theory might lead you to expect that they should.

France is a domestic consumption driven economy, running a goods trade deficit, where manufacturing industry seems to be losing competitiveness, while Germany has weak domestic consumption, is completely export driven, runs a large external surplus, and German manufacturing industry seems to get more (rather than less) competitive by the day.

Among the peripheral economies Greece would seem to distinguish itself for its extreme fiscal profligacy, while Italy and Portugal have just passed through a decade of slow growth, which contrasts with the case of Spain and Ireland where fiscal deficits and government debt were not a large issue during the first decade of the Euro's existence, but where a growing mountain of private sector debt (fuelled by negative interest rates and a growing housing bubble evidently was) evidently was.

The consequences of needing to accommodate policy to this diversity of economic "types" have, however, still to be recognised, yet the lessons of why convergence hasn't occurred do need to be assimilated, otherwise effectively staying in denial will only raise the chances of an eventual disorderly disintegration of the zone itself. Interestingly, Poul Thomsen, IMF Mission Chief for Portugal recently emphasised in the context of the bailout there that as far as the IMF is concerned, "Every country is different and there is no one-size-fits-all for the programs we support". How long will it be before this message reaches Frankfurt?

As an anecdotal aside, I cannot help having the feeling that the practitioners of academic neo-classical economics spend far too much of their time building models based on premises which remain far from self-evident in order to tell the world how it ought to be, leaving the pathways through which empirical facts-on-the-ground could work their way back to influence or modify the initial assumptions rather obscure, to say the least.

To give one example, on a recent visit to the monetary policy department of one of Europe's smaller central banks I found myself engaged in a rather frustrating debate about the relative merits of competitive devaluation and structural reform as ways of getting heavily-indebted export-dependent economies back to economic growth and job-creation in sufficient volume to be able to start paying down the debt. Unfortunately the discussion became a rather unrewarding "dialogue of the deaf" of the kind to which I have by now become so accustomed. In fact the whole think so evidently became so tiresome that one of the ever courteous central bank particpants took me aside on my way out to reassure me that "there was of course nothing personal in our exchange". Well, of course not! But that being said, the debate did seem to me to be rather asymmetric and one-sided, because while I am absolutely convinced you need structural reform alongside any (hypothetical) competitive devaluation (otherwise all the old ills simply return), the other side of the argument obviously does not accept the need for competitive devaluations to accompany structural reform. Au contraire, the one is seen as the complete and much more desirable alternative to the other.

During our discussions, in my frustration at the fact we were obviously getting absolutely nowhere, I asked the central bank representatives what it would take to convince them they were wrong. Surely, I asked, if the economies in question did not return to a reasonable and sustainable growth rate within the next 3 to 5 years, then they would need to ask themselves whether or not they had been doing something wrong. I for my part clearly recognise that if those economies I consider to be in need of competitive devaluations to underpin structural reforms do achieve significant and sustainable economic growth over the next five years without them then I have been missing something, somewhere (in fact I consider such recognitions of reality to be in my own best interest, to be taken on board on a "sooner the better" basis). Yet,“no”, came the answer, loud and clear, “that would simply mean that the structural reforms had not been deep enough or sufficiently energetically implemented”.

I am now put in mind of a recent (and rather infamous) press conference given by the Real Madrid football club coach José Mourinho. When asked by one of the journalists what responsibility he felt his players and he had in the recent series of defeats by their rival Barcelona FC, "zero" was the answer he gave to the astonished journalist. Well, there you go, learning by doing in action!

Am I the only one to find something strange (and even frustrating) about this kind of answer? What is the connection between the fundamental assumptions of the kind of economics that is being applied in this crisis on Europe's periphery (which in many ways means prioritizing micro and ignoring the core theorems of applied macro) and reality? And how do we test these assumptions? Surely anyone with any kind of scientific frame of mind should look for facts that can confirm (or better, following in the footsteps of Sir Karl Popper refute) the hypotheses they advance. Which brings us back to the lack of symmetry in the argument we are having at the moment. I personally do consider the lessons learnt from our attempts to handle the crisis to form a vital part of the knowledge acquisition process. As I say, I for my part am clear that if these economies do return to reasonable and sustainable growth within a 3 to 5 year time horizon, then there will be something wrong with the way I have been going about things. On the other hand, since several hundred million Europeans are currently being subjected to a massive social and economic experiment, it would be a pity if economic theory were to prove itself unable to learn anything substantial from the eventual outcomes.

In the meantime I find myself gasping for air, trying to pin down threads in the argument that can be examined and tested, which is why I think the convergence issue is important, since either convergence is taking place or it isn't. Put another way, is convergence taking place across a meaningful, in the here and now, time horizon, or is it simply one of those things which is only destined to happen in the longest of long runs by which time, as Keynes so tactfully put it, we will all be well and truly dead? Evidently the future of the Euro depends on the kind of answer you give to this question, and the conclusions you draw from that answer.

The Eurozone Credit Cycle

Now one of the areas in which mainstream economic theory surfaces in search of some real world air is in the context of what many analysts call the “credit cycle”. This concept is interesting, since it allows for the introduction of some data, and enables us to take a look and see if the real world is as theory (and all those models they work with) imagines it should be.

In fact, the idea of a credit cycle is a natural offshoot of the idea of a business cycle, insofar as central banks pass though an interest rate cycle which maps to some extent movements in the business cycle (that is to say as the economy slows rates come down, and as it accelerates they go up), while demand for credit in the private sector of the economy tracks movements in both of the aforementioned cycles. That is to say, private demand for credit declines during recessions (despite the fact that interest rates fall, and public sector demand for credit rises to offset this drop and cushion real economy impacts), while the subsequent recovery in the demand for private sector credit can be seen as one of the key indicators influencing central bank decision taking when it comes to interest rate policy, since an over-rapid expansion in credit can produce excess demand which can lead to inflation, and in a “normal” world central banks tend to want to fend off any unwarranted surge in inflation or in inflation expectations.

The problem with all this is that business cycles are not such straightforward beasts as they are often assumed to be, nor is it really clear how useful conventional business cycle theory really is during a structural (as opposed to cyclical) crisis like the one we are presently living through. Evidently in every economic expansion (or contraction) there is a structural and a cyclical component, and normally the former is less important than the latter in explaining short term movements in output, but during the present crisis this situation has been reversed in both the developed and the developing economies. Take the following charts illustrating recent growth patterns in the Spanish and Chinese economies, can anyone really spot the cyclical components, since I sure as hell can’t.

Spain didn't have a single quarter of contraction following the ending of the 1992/93 contraction until the great global economic crisis broke out, and China hasn't had one during this century at least. Obviously in each case there are reasons for these phenomena (catch up growth, inappropriate expansionary monetary policy lifting you through the roof), but the only point I want to make is that they are clear examples of where structural elements far outweighed cyclical ones, and I would argue that this situation is much more common than is often admitted.

So, we need to be very careful, and in the context of the current global recovery we need to be be at great pains in trying to distinguish between cyclical and structural components in growth, whether this is in the context of growth in GDP or in private sector credit.

Now one of the points of core dogma which is institutionally enshrined at the heart of the ECB is that aggregate Eurozone data has some sort of useful, or valid, or interesting interpretation. So strongly is this belief held that the central bank representatives seldom examine interpretations of the data that drill down and try to identify what is happening (and more importantly why it is happening) at the individual country level. This is hardly surprising since as suggested above, the very existence and survival of the Euro is seen as hanging on the idea that (given the appropriate country level structural reforms) all the individual economies will converge, and any recognition that tailor-made monetary policies are needed for individual countries would be tantamount to accepting that the founding assumptions of the monetary union had sprung a leak.

However, as we will see, credit conditions do in fact vary widely across member countries, and this uneven availability-of and demand-for credit across the Eurozone has become just one more headache to add to the far from small number policy-makers at the ECB currently have, since the growing economic recovery in some countries is being facilitated by the relatively easy availability of credit, while in others problems resulting from a debt overhang and a lack of competitiveness are only reinforced by the difficulties their banking systems face when trying to provide new credit to viable enterprises and solvent households.

In any event, starting with the aggregate data released by the ECB such as it is, we find that Eurozone-wide bank lending - which has (truth be told) remained far from strong since the official ending of the recession - lost some of its limited momentum in March, suggesting any real recovery in aggregate Eurozone domestic demand is still a long way off. Private-sector lending increased during the month by 2.5% over March 2010, after rising by 2.6% year on year in February. In fact, the recovery from the economic and financial crisis has been characterised across the Eurozone by weak bank lending, particularly to businesses, and although the annual growth rate of loans to non-financial corporations rose in March, it continued to expand at the relatively modest rate of 0.8% following a 0.6% rise in February. Loans to households have been doing slightly better, and grew at a 3.4% rate compared with the 3.0% registered during the previous month. The annual growth rate of lending for house purchases grew to 4.4% in March from 3.8% in February.

At the same time broad money, or M3, rose by an annual 2.3% (M3 comprises currency in circulation, overnight, short-term deposits and debt securities of up to two years, repurchase agreements, and money market fund shares), and the three-month moving average of the annual rate of change of M3 was +2.0%. Thus monetary growth still remains well below the ECB's reference value of +4.5% for the three-month average, a monetary growth rate it considers to be broadly in line with an inflation rate of just under 2% over the medium term, implying there is little risk that broad money growth will push up inflation in the eurozone, although it is unlikely that this particular detail will cut much ice with policymakers at the ECB in relation to their interest rate decisions, since it is not monetary fuelled demand-side pull that worries them, but rather commodity induced supply-side push, and in particular the impact this could have on inflation expectations.

The latest ECB quarterly bank lending survey suggested only a moderate tightening of credit standards for both enterprises and households in the current quarter. But as I am saying, this appreciation of the aggregate sitution conceals significant differences at the individual country level. In Italy, France, Finland and Germany (for example) credit seems to be widely available, while in Spain, Portugal and Greece credit conditions remain very tight. The Bundesbank noted only last week that in Germany there had been a "marked easing of credit standards in lending to both enterprises and households" in the first quarter of this year and that surveyed banks expect little change in credit standards in the current quarter. This view was reinforced by the Ifo Institute who reported that the percentage of German firms which have difficulty accessing credit fell by 1.1 percentage points in April to a record low of 22.6%.

Meanwhile in Spain, the central bank state in their latest quarterly report on the economy that notwithstanding the reduced tension in capital market attitudes towards the country, "accessibility by the resident private sector to funding became somewhat tighter".

The peculiar thing here though, is that if you look at the comparative inter-annual rates of change the two countries don't seem to be that different.

What is apparent is that in each case (Germany or Spain) and regardless of whether or not we are talking about total private sector lending, corporate lending or mortgage lending, the rate of increase in borrowing is extremely low, with the only significant difference between the two countries being that in the German case such extremely low rates of credit growth date back to the turn of the century, while in the Spanish case they area recent phenomenon following the bursting of the housing bubble. (I have dealt with this comparison between Spain and German at greater length in this post here).

The big difference between these two countries is, of course, the level of international competitiveness of their economies, since Germany is well able to live with such low levels of domestic credit growth due to its strong export capacity, which enables the country to generate significant GDP growth (currently over 3% annually). Spain's economy, on the other hand, has been unable to expand export capacity fast enough to compensate for the sharp loss in domestic consumption, and hence what little growth there is has been supported by a substantial government fiscal deficit and even this has still left the economy continually flirting with recession.

Further, in the German case credit conditions are comparatively loose even though there is no great demand for additional credit, while in the Spanish one credit conditions are tight (for a variety of reasons) so potential home-buyers and companies have difficulty getting as much credit as they would like to have, and this despite the fact that prevalent interest rates in both countries are broadly similar, and result from one common monetary policy.

In fact Spain is not unique in this sense, even if the country does offer a somewhat dramatic example of a larger problem. Credit conditions in Portugal are also now tightening, and demand for loans is falling.

And we find a similar picture in Greece.

What is most remarkable about these charts for Spain, Portugal and Greece is how they so resemble each other in the sharp decline in credit to the private sector. Nor should any up-tick be expected since all these countries are already heavily in debt, and the only serious way for them to attain sustainable growth is to de-leverage via export-induced saving. That being said, this transition is likely to prove, as we all know, pretty painful. Even during the German transition from 1999 to 2005 things weren't entirely easy, yet these three countries now face a far more difficult and far more demanding challenge, given the scale of their external debt and the current market conditions.

To help them move through that challenging process what they arguably need, in the same way as the UK and the US do, is some form of quantitative easing. Unfortunately excessive reliance on aggregate data leads ECB policy-makers to miss this relatively self-evident fact. So these countries are being asked to make a structural transition of almost monumental proportions without carrying out a competitive devaluation, with accompanying monetary and fiscal tightening. It is hard to see a successful outcome, and indeed I imagine we won't see one.

But the monetary union's problems don't end here, since there are another group of countries where monetary easing from the ECB does appear to have been having an impact, and where credit growth has, to some extent taken off. The first of these would be Italy.

Now there is little to alarm us here, since Italy's private sector is not especially indebted, but it is interesting to see how the pattern varies, and how credit conditions in Italy are very different from those elsewhere in Southern Europe. On the other hand, if we move across the continent to Finland, once more we find little sign of difficult credit conditions:

Indeed, the low interest rate policy of the ECB during the crisis really does seem to have worked in the Finnish case, in that housing demand and private consumption never really collapsed (see this earlier post on the property boom in Finland). Finally, in this brief survey, there is France, where even though corporate borrowing remains restrained, demand for consumer and housing credit seems to be really kicking back to life.

Evidently France is becoming a very special case, since France's private sector is not heavily indebted, although looking at its comparatively young population profile it could easily become so. If there is one country where a property bubble could be produced, that country is France - for both demographic and low-indebtedness reasons (just look at the line of take-off for household mortgages in the above chart). So evidently, at least in the French case ECB tightening makes perfect sense, as it does when we look at the inflation expectations chart.

So Just How Many Sizes Do We Need To Fit All?

The purpose of this brief survey of credit conditions in a number of individual Eurozone countries has been to draw attention to one rather neglected area of policy difficulty. It is common knowledge that having a "one size fits all monetary policy" can prove problematic, in that the application of negative interest rates to an economy that is essentially booming can lead to significant structural distortions, and even produce asset bubbles of one class or another.

But the issue of credit conditions and credit availability is normally given far less attention, even though it is an equally important one. It is clear that it is hard to identify one common "credit cycle" among the zone's diverse economies, and indeed the need for credit is always going to be very different in an economy which runs a large and continuing external surplus when compared with an economy (like France's) where domestic consumption remains strong and the country continues to run an external deficit.

It is clear that some of the difficulties which were likely to be faced by countries attempting to handle the rigidities associated with participating in a common currency were well anticipated in advance, even if few of those involved in setting it up were able to listen at the time of its creation. Other problems which were not so clearly foreseen have emerged with time. The difficulty presented by surrendering powers from your own central bank with respect to monetising government debt is only now becoming clear, as is the problem created by acquiescence in the kinds of structural distortions which permit the accumulation of high levels of external debt, debt which fickle markets may suddenly decide they are no longer willing to support. The fact that cheaper interest rates might lead to larger fiscal deficits and growing government debt was foreseen, but the danger presented by ever larger private indebtedness funded by external borrowing surely was not.

However, the problems entailed by the absence of any meaningful common credit pattern and the consequent difficulty of maintaining the core idea of ongoing convergence raises perhaps one of the most serious obstacles to Euro credibility and continuity, since, as I try to argue at the start of this study, even the issuing of Eurobonds and the creation of a common fiscal treasury can only represent a stopgap measure in such a situation given that what this then produces is a constant and ongoing transfer of resources from one set of countries to another. This outcome is neither sustainable nor is it desirable, since voters in the funding countries will eventually grow tired of it (even under the rather dubious hypothesis that they were willing to entertain it in the first place) while those who are funded would find themselves in the unpleasant situation of having their long term dependency institutionally re-inforced, even as they find themselves watching a steady trickle of their educated youth moving towards the funding countries in search of better remunerated work.

Basically it is not clear at this point whether this growing mountain of associated system-management problems really is capable of being resolved, but one thing is surely very evident, and that is that not talking about them won't make them go away. It really is high time the ECB stopped boxing itself into a corner by examining monetary policy impacts only at the aggregated data level, and started to analyse and identify policy implementation impacts at the individual country level. Simply throwing the issue back to the various national governments by saying "this is your problem, what you need are more structural reforms" is no response at all. This will be especially true if the proposed structural reforms prove not be sufficient to handle the scale of the problem, since this will only produce an even greater loss of confidence in the Euro than that which has been sustained to date, precisely the outcome that ECB governing council members must be anxious to avoid. Or will we be told that the structural reforms implemented simply were not deep enough. What has been argued here is that the idea of a common Eurozone-wide credit cycle and ongoing convergence between member state economies are "simplifying assumptions" in the sense used by Robert Solow in the quote at the start of this study, assumptions which underpin the whole theoretical apparatus on which the common currency is based. The question is, after ten years of operation, do they still remain plausible and reasonably realistic assumptions.

Navigating Between Two Crises?

2011-01-09T13:15:00.001-08:00

The implications of the coming demographic revolution for the solvency of Europe’s periphery

Ours is an age of rapidly ageing societies. What is so modern about our current situation is not the ageing itself, but its velocity, and its global extension. West European societies have been ageing steadily – in terms of their median population age - ever since the coming of the industrial revolution, but now, following a sharp fall in birth rates and a sustained rise in life expectancy, we are ageing far more quickly than any previous generation could have contemplated. Median ages in several countries are now around the 45 mark, and by 2030 the first pioneers will be breaking the 50 year barrier,

The economic and social implications of this are going to be profound, and, as the credit rating agency Standard & Poors noted in a recent report on the topic, seemingly irreversible. Indeed, no other single force is likely to shape the future of national economic health, public finances, and policymaking in the coming decade as the unprecedented rate at which the world's population is ageing, and the fact that the process is seemingly irreversible. Yet, strangely, the issue receives only a fraction of the attention that has been devoted to global climate change, even though, arguably, ageing is a problem our social and political systems are, in principle, much better equipped to deal with.

Among demographers, and economists interested in demography, the problem has been long been a source of anxiety, and a cause for preoccupation, and as a result a good deal of research which can help us understand and anticipate events has already been carried out, even if policymakers have, to date, been reluctant to act on findings or draw the necessary conclusions.

The problem is, potentially, massive. According U.N. data, the proportion of the world's population aged over 65 is set to more than double by 2050, rising to 16.2% from 7.6% currently. By the middle of the century, about 1 billion over 65s will join the ranks of those currently classed as being of non-working age. The cost of supporting and caring for all these people will inevitably profoundly affect economic growth prospects and dominate public finance policy debates worldwide for many years to come.

As far as we are able to understand the issue at this point, population ageing will have major economic impacts and these can be categorised under four main headings:

i) ageing will affect the size of the working age population, and with this the level of trend economic growth in one country after another

ii) ageing will affect patterns of national saving and borrowing, and with these the directions and magnitudes of global capital flows

iii) through the saving and borrowing path the process can influence values of key assets like housing and equities

iv) through changes in the dependency ratio, ageing will influence pressure on global sovereign debt, producing significant changes in ranking as between developed and emerging economies.

As can be seen, the consequences are far reaching, and will serve as a challenge to our current models of economic growth, and consequently to our existing welfare systems for many years to come. Many of the issues involved – global economic imbalances, sovereign debt worries, the raising of retirement ages – are far from being unfamiliar topics in the context of the present financial crisis, as they have, one after another, come to the forefront. And it is here the greatest concern lies: given the difficult and protracted exit from the last global crisis, may we in fact find ourselves in the unfortunate position of saying goodbye to one crisis only to find ourselves saying hello to another, the ageing population one?

Structural and Numerical Change In the Labour Force

The problem of population ageing is universal, as it is triggered by the decline in fertility that accompanies economic development, and will affect all the nations on the globe one day or another. The short term impact of population ageing, however, will be much more localised, since the pace of aging varies greatly across countries and regions. The effects of the process are expected to be most pronounced in those countries that remained complacent in the face of ultra-low fertility rates (those with total fertility rates of 1.5 and under), which in effect means Japan, the German speaking countries and much of Southern and Eastern Europe. It is estimated that the median age of populations in Europe as a whole will increase from 38 today to 49 in 2050 (although this aggregate number hides significant differences between countries), and by that time Europe will be some 20 years older than the estimated average for Africa (which will be the youngest continent).

Spain - with half its population older than 55 by 2050 – is expected to become the oldest country in the world, followed closely by Italy and Austria, with a projected median age of 54. These numbers are very high, and command respect, especially given the notable structural changes we have already seen in the German and Japanese economies, even though these countries have still only median age landmark of 45.

Another way of looking at such demographic changes is in terms of the dependency ratio,
which can be defined in a number of different ways depending on the problem being addressed. One of the most common practices is to take the overall demographic
dependency ratio, which is conventionally defined as the ratio of the “dependent” age
groups (0-14 and 65+) to the population in what have been traditionally considered to be the working age groups (15-64). Both the sub-components to the overall ratio are expected to change significantly over the next 50 years, with the important detail that they will move in opposite directions, with ever fewer young people, and ever larger elderly populations, although it is the second component – the elderly dependency ratio - which is the principal centre of interest in the present study.

During the years belween 1960-1995 the overall dependency ratio fell across the developed world, with decreases in the proportion of young people more than offsetting the rise in the old age dependency ratio, and working age populations rising everywhere. These were the years of economic bonanza, economic growth and exceptional returns in the property, fixed income and equity markets.

Since the mid 1990s the situation has been gradually changing, and the overall dependency ratio is now rising steadily again, this time thanks to the increase in life expectancy, and smaller generations entering the workforce as a result of the substantial long term drop in fertility. The ratio is forecast to increase over the next 40 years by a “mere” 15 percentage points in the United States, and by as much as 22 and 40 percentage points in the EU and Japan respectively. If we consider the elderly dependency ratio alone, in 1985 the EU ratio of over 65s to those between 15-64 was 20% i.e. there were five potential workers for every one retired person. By 2050 that ratio is expected to deteriorate dramatically to only about two economically active workers for every person over 65.

In terms of the velocity of change, Japan’s situation seems is clearly the most problematic in the short term, since the country is set to experience the steepest climb in dependency ratios roughly 10-15 years before the EU and the US. Of course, it is important to note that Japan has already started to react to the problem, and labour force participation rates among males in the 70 to 75 age range in Japan are currently not dis-similar to those to be found among males in the 63 to 65 age group in many European societies.

It is important to realise that in most cases not only will populations get older, they also will actually shrink. Aside from extreme situations like the black death or major wars, Western societies have no real experience of dealing with ongoing population ageing and sharp population decline.

In Germany, for example, the total population is expected to fall from its current level of 82 million reaching anything between 69 and 74 million by 2050, depending on the future course of life expectancy, immigration and fertility. And the proportion of people aged 65 and older is projected to rise from just under 20% today to just over 33% by 2050. At the same time, the number of very elderly (those aged 80 and over) will nearly triple to as much as 15% of the total population.

Future population developments in Spain involve a greater than normal level of uncertainty at the present time due to the very rapid population increase produced by immigration during the first decade of the century. Migration not only increases population size directly, but also indirectly, due to a higher level of births which results from the sudden increase in those of child bearing age. Bearing this in mind, the INE currently estimate that Spain’s population should continue to grow, and increase by something like 2.1 million over the next 40 years with the country having a population of approximately 48 million in 2049. It should be emphasied though that this increase is dependent on continuing inward migration, and therefore, since the majority of migrants reaching the country are economic migrants, their arrival is very sensitive to the actual levels of GDP growth attained.

As elsewhere, Spain’s elderly population will continue to grow, both in relative and absolute terms, and the population of 65 and over looks set to double in size, coming to represent almost 32% of the total population on the INE estimate, while the working age population is expected to fall by nearly a fifth. The result will be that for every 10 persons of working age, by 2050 there are expected to be almost nine potentially inactive persons (either under 16 years or over 64). That is, the dependency rate is set to rise to 89.6%, from its current 47.8%. Life expectancy at birth is expected to reach 84.3 in males and 89.9 in females by 2050, meaning there could well be an increase of something like 6.5 and 5.8 years, respectively, from their 2007 levels.

Among emerging economies, the East of Europe stands out as by far the worst case in the short term. In 2025, more than one in five Bulgarians will be over 65 - up from just 13 percent in 1990. Ukraine’s population will shrink by a fifth between 2000 and 2025. And the average Slovene will be 47.4 years old in 2025 – one of the oldest populations in the world. Indeed, between 2000 and 2005, the only countries in the world with population declines of more than 5,000 people were 16 countries in Eastern Europe and the former Soviet Union - led by the Russian Federation, Ukraine, Romania, Belarus, and Bulgaria. So the fastest aging countries on the planet over the next two decades will be in those of Eastern Europe and the former Soviet Union, the result of unprecedented declines in fertility and rising life expectancies. The entire region (excluding Turkey) is projected to see its total population shrink by about 23.5 million, with the largest absolute declines taking place in Russia, followed by Ukraine and Romania.

Indeed, the impact of the population decline will be much larger in some of the smaller countries, which will lose a significant share of their populations over the next two decades. Latvia (2.3 million people) and Lithuania (3.4 million) will lose more than a tenth of their population. Poland will lose 1.6 million, or about 4 percent of its 38 million people.

And in the East as elsewhere the impact of the changes will pricipally be felt through
the rising proportion of the elderly people. Most countries had old-age shares (defined as the percentage of the population older than 65) of less than 15 percent in 2000, but this benchmark will be exceeded by almost all of them come 2025 with the largest increases (8 percent or more) being expected to occur in countries that already have older populations, such as the Czech Republic, Poland, and Slovenia. Bosnia and Herzegovina will see the fastest increase, with its elderly dependency ratio almost doubling. For nine countries, between one fifth and one quarter of the population will be 65 and older by 2025 - comparable to the situation in Italy, where the proportion is projected to be about 26 percent. even further increases, to as high as 47 years in the Czech Republic and Slovenia, approaching Italy’s median of 50 years.

And the problem goes well beyond the confines of the EU or the G7. If our experience to date is anything to go by, all societies will experience a similar ageing process as they develop. In particular China stands out among developing economies, since the degree of ageing we should anticipate, when viewed in terms of absolute numbers and velocity, is simply staggering. By 2040, assuming current demographic trends continue, there will be 397 million Chinese over 65 - more than the total current population of France, Germany, Italy, Japan, and the United Kingdom combined. While the forces behind China’s ultra rapid demographic transformation - falling fertility and rising longevity - are similar to those to be found elsewhere, China’s ageing is characterised by the unusual speed with which it is occuring. In Europe, the population over 65 passed the 10 percent threshold back in the 1930s and will not reach the 30 percent mark until the 2030s, one century later. China, on the other hand, will traverse this same distance in a single generation.

And the scale of the Chinese phenomenon should alert us to another looming problem. Up to now, Western societies have managed to slow their ageing rate down, and smooth the transformation of their population pyramids, by resorting to immigration to fill the gaps in the labour force. China’s labour force growth has been driven in recent years, as it was in the Spain of the 1960s and 70s, by internal migration. But now that process is coming to an end, and with the working age population now about to peak, labour supply may well (incredible as it may seem) start to become a scarce factor, and since immigration on any meaningful scale is not a realistic alternative for China, wages are bound to rise, and the economy is bound to become more capital intensive.

With its extra large baby boom cohorts now in its thirties and forties, the full force of China’s ageing challenge still lies out in the future, and the elder share of China’s population has risen only modestly to around 12 percent, compared with an average of 20 percent in the developed countries. For the time being, the big challenge is finding jobs for China’s large working-age population. It is during the 2020’s that China’s age wave will arrive in full force. The elder share of China’s population seems set to rise steadily from 11 percent in 2004 to 15 percent in 2015, and then leap to 24 percent in 2030 and 28 percent in 2040. Over the same period, China’s median age will climb from 32 to 44. A median age of 44 will not make China the oldest country in the world. Germany’s median age is already 45 and is heading for 50 by 2040. Japan’s is already 45 and is heading for 54. A median age of 44, however, will make China an older country than the United States.

Evidently, with these sharp declines in working age populations, rates of economic growth are sure to decline, and may even turn negative. The only factors which can conceivably offset the decline are changes in participation rates, and increased productivity, but with the median age of the workforce rising, and higher participation rates implying an lower average rate of educational qualifications, even measures which lengthen the working life are unlikely to be fully able to extend the impact, and we may well be facing a decline in living standards in the OECD countries in the years to come, especially when compared with the rapid growth and youthful workforces which will be found in many parts of the developing world.

Saving and Borrowing Across The Life Cycle

Crucial to any analysis of the likely economic consequences of population ageing is the impact the process will have on patterns of saving and borrowing. The motives which influence the levels of household saving have been the topic of much debate over the decades, and a variety of explanations have been put forward in the theoretical literature. Essentially the interpretations can be grouped together under three headings with, as one would intuitively expect, assumptions about the time horizon over which the individual takes decisions being one of the key factors which sets one competing hypothesis apart from the next.

The life cycle model of Franco Modigliani (Modigliani and Brumberg, 1954), which is perhaps the most widely accepted version of the saving and borrowing story, assumes the relevant time horizon to be the lifetime of the individual, arguing that what the individual attempts to do is maximise his or her own consumption. In this model, the desire to smooth one’s lifetime consumption path by evening-out cyclical income fluctuations provides the fundamental driving force behind saving/dissavings decisions during different periods, with the need to provide sufficient resources for retirement being the clearest example of such life-cycle effects.

Normally, those working with life-cycle hypothesis models assume a lifetime planning horizon for the individual consumer, with no net lifetime savings being envisaged and transfers to heirs being treated as equivalent to the individual’s own initial inheritance. Leave the world as you found it seems to be the maxim guiding the individual.

The principal modification to the initial life cycel idea – the bequest or “overlapping generations” model - assumes that the individual’s time horizon is multigenerational with strong ties linking current generations to their descendants and with individuals driven to maximize not only their own utility but also that of future generations through a bequest motive. Unlike the “finite” life cycle consumers therefore, their more “Ricardian” counterparts are assumed to have “infinite” lives in the sense of having strong links to their descendants via the above mentioned bequest motive. Leave the world as you would like to have found it seems to be the maxim here.

Finally, the precautionary or “buffer stock” theory of saving is built on the view that a major motive for holding and accumulating assets is to shield one’s consumption against future uncertainties, such as unpredictable fluctuations or disruptions in income or extraordinary health expenditures. One of the intuitive implications of this “buffer stock” model is that individuals with higher income uncertainty should amass a greater stock of wealth to allow for this, and obviously those entering the later stages of their lives face more potential uncertainty than most, and in this sense the implications of the model for our current concerns are not that different from those of the Modigliani model.

When it comes to the empirical modelling of consumer behaviour, and especially in the larger multinational models, some variant of the permanent income/life cycle approach (PIH/LCH) is typically applied, with virtually all mainstream models emphasising the importance of forward looking consumers and consumption smoothing as a way of managing significant changes in their incomestream . The success of the PIH/LCH approach has been based not only on the clear compatability with standard microeconomic utility maximising theory but also on its empirical explanatory power since the predicted outcomes are reasonably compatible with the available evidence both in the the short and long run. Over the long run, the hypothesis suggests that wealth (i.e. permanent income) is the main factor determining consumption with the key consumption-to-wealth ratio being a relatively stable one. In the short-run the PIH/LCH approach is reasonably compatible with Keynesian attitudes to demand management, since it helps explain why consumption fluctuates less than disposable income over the business cycle, due to the presence of consumption smoothing by consumers.

On the other hand the LCH framework is not without its problems, and some of these are important for our present purposes. In particular the savings behaviour of retired people turns out to be very different what might be expected given a simple application of the LCH model. Ageing populations, for example, would be expected to show a lowering of the private savings ratio if the savings pattern of consumers was to comform with the traditional interpretation of the “life cycle” hypothesis. In particular savings propensities and the elderly dependency ratio would be expected to be negatively correlated. Consumption smoothing over a lifetime suggests that the savings rate should be high when a large proportion of the population are in middle age, with savings being accumulated to finance post-retirement consumption, and then drawn down as the individual ages. But while there is clear evidence of increased saving as the retirement age approaches, the evidence for post-retirement dis-saving is far from clear and even contradictory, suggesting that the bequest motive, or at least the negative utility associated with running down savings may be greater than the original version of the life cycle hypothesis postulated

What the numerical examples and the empirical studies suggest is that it is important to measure pension wealth correctly, since failure to do so can have a major impact on estimates of saving, since mis-measurement of pension income may account for the striking discrepancy between what life cycle models imply about the age/saving relation and estimates of saving rates by age that are derived from looking solely at household data in isolation from information on the value of funds that back pensions. The reason for this is that in the case of those contributing to individually funded pension schemes, wealth dynamics conform a lot more closely to the simple life cycle pattern, since it is steadily built up during the working life and is run down in retirement.

Current Account Implications

That the global economy as it stands is characterised by serious and important imbalances is no longer really a controversial point, since the recent global financial crisis has brought their presence into bold relief. The perception that unsustainable imbalances exist between countries like the US, the UK and Spain on the one hand, and China, Germany and Japan on the other has been widely identified as one of the key forces which lay behind the build up to the recent global economic and financial crisis. But just what dynamic lies behind the creation of these imbalances?

In fact, economists have long recognised that demographic shifts play an important role in determining long-term trends in global capital flows, and hence in global current account balances, and a variety of models have been developed to help explain and understand this important phenomenon. However, since the start of the present century the degree of interest has heightened, and the implications of the ongoing shifts in demographic structure have been highlighted and widely discussed (see, for example, the IMF’s 2004 World Economic outlook or the Boston Federal Reserve Conference in 2001, or the Kansas Federal Reserve’s Jackson Hole Conference in 2005).

Viewed at the most simple and basic level, the current account is literally equal to the ‘net’ saving (total savings minus total investment) that occurs in a given economy over a discrete time period. Given this, a tendency to save more in one economy will be more or less automatically tranformed into a tendency to borrow more in another, since without the presence of a “counterparty” the global books simply would not balance. Increased saving in a given country tends towards the generation of a current account surplus, which in its turn is transformed into an outward flow of capital towards other countries.

Now since, as explained above, savings behaviour generally varies across the age ranges, the relative age structure of a country’s population plays a significant role in explaining the borrowing and lending patterns between that country and the rest of the world. Using models that link demographics, growth and current accounts, a number of economists have attempted to show how demographic shifts have driven global current account trends in recent decades, and tried to determine what conclusions can be drawn about the future evolution of the current balances and imbalances.

One of the key points to grasp, is that the proportion the population which is to be found in one of the ‘prime’ age groups at a given moment in time, is absolutely critical, and much more important for understanding the processes at work than the mere size of the working age population. When we speak of “prime” here, we are talking in terms of prime savers, prime borrowers, and prime productive workers. Where these actual age brackets lie, and the extent to which they may overlap, is still a subject of some controversy, even if the existence of the phenomenon in itself is not in doubt: certain age groups tend to borrow more, others to save more, and worker productivity does not remain constant over the working life, but reaches a peak, and then declines.

Estimates of the exact age extension of the different groups vary, but 25-40 would be a good rule of thumb measure of the borrowing range, 40 to 55 for the peak savers, and 35 to 50 for the prime age workers. Beyond this, the question is an empirical one of measuring and testing to determine more precise boundaries and frontiers.

And the hypothesis being advanced here is that since a country’s credit expansion is driven by the prime borrowing group, the size of this group in relation to the rest of the population is key for determining the overall credit dynamic, and for deciding whether any given nation is going to be a net borrower or a net lender. Looking at the evolution of current account balances from a historical perspective this demographic dimension would appear to have far greater explanatory power than the more traditional “cultural differences” approach.

Obviously the corrolory of the prime borrowers are the prime savers, a group which the IMF defines as lying in the 40 to 65 age range. The share of the developed economy population falling within this bracket is currently increasing rapidly, although it is again important to note that there is great variance across countries in this regard, and while in some cases this population group has already peaked (Germany and Japan) in others (the United Kingdom, France, the United States) it will still not peak for many years to come.

As suggested above, it is Franco Modigliani’s life-cycle theory that provides the most coherent framework for interpreting just how the demographic structure of an economy (how many prime borrowers, how many prime savers, how many children and how many dependent elderly there are) may influence the general desire to save or invest across an entire economy. As also explained above, and by definition, the current account (together with the capital flows that accompany it) is the measure that registers the difference between an economy’s level of savings and investment. When economies are closed to trade and capital flows, savings and investment must be equal and interest rates move up and down to bring these into balance. Traditional monetary and fiscal policy was in fact built on this edifice.

Since the advent of financial globalisation, however, the vast majority of the world’s economies have become relatively open, with funds flowing in and out, with the result that the accumulation of sizeable current account imbalances without sharp short-term shifts in interest rates has become commonplace. So it makes sense that those economies that have younger populations and more “prime borrowers” borrow (on average) from those who have more “prime savers”. And, as a result, it is also plausible that relative demographic profiles can have important effects in determining savings and investment outcomes across countries, and hence the current accounts and capital flows between them. The challenge facing monetary policy in the age of globalisation is to find mechanisms to regulate such flows, since otherwise excessive imbalances accumulate (as we have seen), with economies becoming either excessively export dependent on the one hand, or totally uncompetitive internationally on the other.

And we are steadliy accumulating a large body of evidence which strongly suggests that this is exactly what has been happening. The basic insight that demography matters for the current account, has now been shown to be important in a wide number of studies which have looked at the way in which demographic shifts help to explain changes in growth, savings rates and with them the global economic imbalances .

This formulation of the problem constitutes a great advance, since it has enabled researchers to start to map the impact that having people in particular age groups has on the current account position. Up to a median population age of 40, the demographic structure appears to act as a stimulant for more consumption than can be financed in the short term, and hence acts as a drag on the current account position. As populations age beyond the 40 median age threshold, the credit driven component in consumption tends to decline, and people on average appear to save more than they borrow and spend. Thus the society becomes characterised by a preponderance of so-called ‘prime savers’, with the current account position tending to improve markedly. Hypothetically a further turning point is reached when the steady increase in median age driven by a rise in the elderly dependency ratio means the population once more tends to become a drag on the current account, as a growing number of older people start to spend more than they earn – the so called “dis-saving” phenomenon. To date no society has shown these characteristics, which tends to suggest that people pass more on to the following generations than early versions of the life cycle theory tended to assume, either due to the presence of a bequest motive, or due to uncertainty over the exact length of life. Apart from this empirical observation, it is hard to see what happens to a society in a condition of irreversible ageing as and if their level of national saving turns negative.

This understanding of the prime saving and borrowing phenomenon is important because much of the discussion of demographic issues to date has focused on the size of the working age population (normally defined as those in the age range 15-64) and the evolution in the dependency ratio. Conclusions reached using these two measures differ and the difference can be highly significant. The problem of having a declining working age population can be, to some extent, offset by legislative changes that facilitate higher labour market participation rates, and longer working lives. But there is no such easy answer to the long term decline in the prime borrower group, and this becomes obvious when we look at the frustration which is produced among leaders in Japan and German when G20 meeting talk about the need to set firm figures for permitted current account surpluses.

Demographics and the ‘Savings Glut’

Given this kind of understanding of the demographic component of saving and borrowing patterns it is not hard to see how demographic forces may have played an important role in the run up to the most recent crisis, making possible what Federal Reserve Chairman Ben Bernanke once called the ‘savings glut’. It was this “glut” that lay behind the large volume of cheap liquidity which was available across the planet in the years prior to the outbreak of the financial crisis. Demography may well have contributed to falling global real interest rates as the proportion of ‘prime savers’ in the developed world rose steadily. The global pool of ‘prime savers’ is expected to keep rising, and as a result, the tendency will be for more, rather than less, net saving globally, and the ‘savings glut’ (and lower real rates) may become a more persistent feature of the world than many think.

The notion of the ‘savings glut’, has been a widely debated issue ever since then-Fed Governor Ben Bernanke coined the phrase in a speech on global imbalances in 2005. Evidently, the aggregated global current account balance has to be zero, so if there is a tendency for some of the world’s richest economies to want to save more than they invest (i.e., run a global current account surplus), then the balance can only be resolved by a fall in global real interest rates which produce current account deficits elsewhere. Since this rise in desired global savings was not directly observable, the prima facie evidence was the surge in current account imbalances alongside the presencce of lower real interest rates. This was seen as evidence since the liquidity needed to hold the rates down would only be there in the presence of an significant global savings oversupply. Explanations for why exactly the desire to accumulate savings may have surged vary but since that time the debate has been ongoing about whether the theory is correct and if it will prove fleeting or persistent. The framework for global capital flows and current accounts set out here provides an interesting perspective on this issue.

The Slowdown In Developed World Economic Growth

While demographic changes taking place in the developing countries mean that global growth is currently running at historically unprecedented levels, there can be little doubt that trend growth in some of the older developed economies has been progressively slowing. Trend growth in Italy is now not far above zero, and in Germany and Japan it is only just sustaining the 1% level. This phenomenon will become increasingly important as the number of those in the key 35-54 age group falls relative to those aged over 65 in one country after another. On the global scale the ratio is expected to fall from the current level of 3.25 to 1 to a mere 1.58 in 2050. But the really worrying numbers come from the countries who will have more people aged over 65 years old than between 35-54 by the time we reach 2050. Those in this category are Japan (who fall from a 1.19 ratio to 0.58 over the period), South Korea (a dramatic fall from 3.05 to 0.65), Italy (1.28 to 0.69), Germany (1.19 to 0.69), Spain (1.80 to 0.70), France (1.61 to 0.87) and Canada (2.12 to 0.92). So without significant extensions in working life over the next few years, there will be more retirees than those in their economic prime across large swathes of the Western World as we approach 2050. But even with the increase in working life the productive capacity of the workforce is sure to be affected its the average age rises.

And historical data reveal a relatively good longer-term correlation between risk-asset prices and the proportions of those who are in the 35-54 year age group when compared to those in the child and elderly dependent groups. In principal this age group constitute the main income producers for an economy and their ability to drive activity and invest in assets may well be influenced by the level of economically inactive population they have to support either personally or through taxation. With high and rising rates of economic dependency the burden on the economically active population may become such that consumption is negatively affected while the pool of available money to invest becomes significantly reduced. This implicit ‘productivity ratio’ may well give us one of the best measures available of the likely capacity of the net accumulators of assets in an economy to influence asset prices as the population ages.

In this sense Japan already offers us a clear warning as to what may await the rest of the developed world as a significant part of their population hits the old age dependency stage. In terms of the ‘life cycle hypothesis’ Japan becomes a fascinating test case for what may happen in many countries in the years to come. While it may be statistically difficult to establish whether the bursting of the Nikkei bubble at the end of 1989 and the bursting of the dot.com bubble in 2000 had a common root in changing demographics, it is clear that financial markets have become more prone to bubbles as the pool of potential savers has grown.

Surely it is more than a simple coincidence that the Nikkei peak was hit at exactly the same time as the key 35 to 54 age group arrived at its highest value relative to the dependant groups. That the Nikkei then spent the best part of two decades failing to show any meaningful recovery could also have much to do with the ongoing aging of the population and the decline in the number of those in their economic prime.

Most observers are in agreement that if demography matters then the US will most probably not be the next Japan, although parts of Europe might well be. While the US and Europe have demographic similarities to that Japan has faced for the last two decades, the US does have one key area which could help it escape the fate seen in Japan. This is the simple fact that its population is growing and looks set to continue as far as the eye can see. Japan's population is now falling after broadly stagnating for 20 years. Europe's population has also been stagnating for at least a decade and will continue to do so for the next decade before declining as far as the eye can see, albeit at a slower pace than Japan will continue to do. In contrast the US population continues to grow, with the slowdown in growth quite gentle. A similar picture is seen when we come to the percentage change in the 'economically active' 15-64 year old group. Europe is about to start losing people in this age group as Japan has been doing for the last decade.

So if you accept that having a growing population (especially those in their working age) has formed a key component of growth in many countries in what we have come to call the moden growth era, then it was seem those parts of Europe where labour forces look set to stagnate have a much are much higher risk of an eventual Japan style outcome than the US does.

On The Shoulders Of Giants - How Spain Is Destined To Follow In Germany's Footsteps

And nowhere could this situation be clearer than in Spain. The Spanish economy sustained several years of what was clearly above par growth by increasing labour inputs dramatically, while productivity growth remained between low and non exist. In the Spanish case the labour force growth came not from natural population growth, but from labour migration from other parts of the globe, while the demand which supported the growth was also not organic, but fuelled by the very cheap and ample liquidity which had become available with the creation of the Eurowide capital markets. In order to see how this problem may have arisen, and what may now happen to domestic saving in Spain, a comparison between the recent history of the Spanish and German economies can prove illuminating, especially since, as I will argue below, there are strong structural homologues to be observed in the evolution of the two economies, with a time delay of about a decade between the process in one country and that in the other.

The first, rather surprising discovery which an examination of the recent historical data for Germany reveals is that it simply is not true that the Germans are a group of "non consumers", and inveterate savers. Back in the 1990s German private consumption enjoyed a substantial boom, a boom which ground itself to a halt around the year 2000. It is only since 2000 that German private consumption growth has been lacklustre, and seemingly incapable of driving GDP growth. And when we come to Spain, it is immediately evident that Spanish household consumption growth enjoyed a similar expansionary cycle between 1999 and 2007, demonstrating the same kind of "blossoming" (if on a rather larger scale) that German consumption had experienced in the mid 1990s.

More than the phenomenon of the consumption boom in and of itself, what is really important is what it was that was driving it. Unsurprisingly perhaps, what we find when we come to examine the data is that same old "usual suspect" – a very rapid increases in private sector credit. And examined carefully the figures belie the idea that Germans have always been a nation of meticulous savers. The Spanish history of mortgage growth tells a very similar (but even more exaggerated) story to the German one. And, as can be seen, it wasn't only households who were doing the borrowing, corporate entities were rapidly increasing their leveraging too. Interestingly, after years of being almost dormant, corporate borrowing seems to have had a brief renaissance in Germany on the back of the current crisis.

But one more time, when it comes to corporate borrowing the only aspect in which the situation in Spain distinguishes itself is in the magnitude of the phenomenon. Spanish corporate indebtedness has become a much, much bigger issue than German corporate indebtedness ever was. Indeed, while total private sector debt in Germany around the turn of the century was not that different from Spanish private debt today, German GDP at the time was (in relative terms) around twice as large as Spanish GDP is today. And moving forward, if we come to look at the long tail on the stagnation in German year-on-year borrowing, this is the point where we should be able to discern something of the future which awaits Spain, and especially in an environoment where the financial markets have little willingness to finance yet more indebtedness. Interannual lending in Spain simply isn't going to climb back up again towards its previous levels, and we should expect it to trawl around the zero percent mark in the years to come, as Spain's private sector steadily, and somewhat painfully, deleverages itself.

But there is another aspect of the situation which should attract our attention here, and that is the close association between ongoing lending booms and current account balances. Germany was no exception to the general rule here, since all through the duration of its consumption boom the country ran small current account deficits. Deficits which then became surpluses in the wake of the huge structural adjustment the country passed through during the transition from being a consumer-driven to being an export-driven economy.

And this is the path that the Spanish economy will now surely have to follow, even if we should again not miss point that there is a very significant difference in scale between the two cases. In comparison with the process Germany was submitted to between 1999 and 2005 Spain's adjustment will need to be quite literally enormous. As some economists have observed the transition which awaits the Spanish economy is one without precedents, and is certainly right off the map as far as recent historical experience is concerned.

So what is going on here? Certainly the close similarity is too striking to be merely coincidental. The economic literature is replete with examples of countries who experienced financial crises, and then dug themselves out of the hole they found themselves in by increasing their exports (Reinhardt & Rogoff). The reason for this is obvious. Once the private sector in a country gets itself into crisis precipitating excessive debt, there are only two realistic possibilities: restructure the debt, or pay it down. There isn’t a third possibility of getting into even more debt (via for example government fiscal deficit spending), since as we can see at the present time, such attempts have a relatively short life, and the markets rapidly lose patience with this kind of attempt to flee into the future. So given that the restructuring option isn’t an especially attractive one either, most countries ultimately solve their problem, by exporting their way out of difficulty, in order to then restart the credit cycle.

But the conjecture advanced here goes beyond this, since what is being postulated is not the idea of economies which are temporarily export driven, but of ones which become completely export dependent.

The argument than now follows is more of a hypothesis than anything else, but if we look seriously at all the above argumentation above about how demographic processes affect patterns of national saving and borrowing, and if we accept that ageing is (whatever the drivers of fertility declines may be), as a matter of fact, an irreversible process, and if we pay careful attention to the recent historical experience of countries as they age, then it does seem not unreasonable to postulate that there is a transition which occurs, and that this transition has at its centre a steady transformation of the current account balance.

As we have seen, it economies transit from being consumption driven to export driven, and it would appear that the process is not merely random, a question of options or “growth models”. There is not a choice here, since there are deep underlying structural dynamics at work, and these dynamics seems to be intimately associated with the dynamics of the demographic transition. As I am trying to argue in the German case, the shift doesn't seem to be a cultural one, or a pure question of public policy. And the hypothesis is empirically testable, in the sense that if Spain does follow Germany down the exactly the same road then this will count as additional corroboration for the thesis.

But what could be really be driving this transition? Well, as the young Danish economist Claus Vistesen and I have suggested on a number of occasions, the close association of the export dependent phenomenon with population ageing and the demographic transition which lies behind it may well provide us with the key. Using Modigliani's life cycle saving and borrowing idea, and the Swedish demographer Bo Malmberg's idea of population "ages" (child, young adult, middle aged and elderly), Claus Vistesen has prepared the adjacent chart which attempt to illustrate the process which might be at work.

The current account balance is here associated with dependence, or lack of it, on exports. Very young societes, such as those which are to be found in the African Sahel, or Uganda, or Pakistan, or Bolivia, have very low saving rates due to the high preponderance of those under the working age, and as a result are dependent on current account deficits and imports to maintain a minimum standard of living for all. If markets were completely rational in this context, they would be prepared to finance these deficits conditional on policies to reduce fertility and raise female empowerment, which are sure ways to reduce the level of child dependence, in the same way they are prepared to finance elderly but highly indebted European societies conditional on policies to raise labour force participation rates and extend the working life via reform of the pension systems.

At the other extreme, elderly societies become increasingly dependent on exports to avoid falling into dis-saving, and negative current account balances, since the once the current account balance deteriorates into negative territory it is unclear how the situation can ever correct itself, given the absence of homeostatic processes.

Of course, all of the above remains for the time being at the level of hypothesis. What is beyond doubt is that Spain’s boom bust cycle followed Germany’s by a decade, while their demographic profile also reveals a ten year lag between one country and the other. In term s of median population ages Spain is roughly at the same point today as Germany was at the turn of the century. And when we come to the percentage of the 25 to 40 age group in the total population, we can see that this peaked in Germany at the end of the 1990s, while it is peaking in Spain at the present time.

A Delicate Balancing Act

Returning to the issues raised at the start of this chapter, three major issues arise from this demographic perspective on capital flows and current accounts. First, we have significant empirical confirmation that the recent global imbalances were, in part, offshoots of slow-moving underlying demographic determinants of global capital flows. While some progress has been made towards reducing them (and in particular in the US), there is still a long way to go. In particular further adjustments in global demand and currency patterns are still needed, and in particular more contribution is needed from China.

Second, while the near-term adjustments will mean more emerging market deficits and less developed market ones DM deficits.

Third, at a global level, demographic pressures will continue to imply that the increase in desired saving will exceed the increase in desired investment. This has one clear implication: globally interest rates can be expected to remain low. As argued in the “savings glut” thesis, population ageing in the developed world may have been more important in pushing real interest rates down globally over the last 10-15 years than is often acknowledged. This process surely has still more to run and real interest rates may stay low for longer than many currently expect. Those who worry that the ageing of developed markets may put upward pressure on their interest rates and downward pressure on their asset markets in the short term may prove to be underestimating the safety valve which global demographic processes will offer. Taking these forces together, it seems likely that significant net flows of capital across border are likely to remain a feature of the landscape and may be set to grow further. This means that developing the infrastructure, policy tools and regulatory settings to be able to cope with them is likely to remain an urgent task.

On the other hand, looking at the savings, investment and capital flows story exclusively from the perspective of the large developed markets may end up being misleading in a world where the global picture is increasingly changing. Crossborder capital flows are likely to remain significant given that the impending demographic shifts may increase rather than diminish them. Efforts to improve the quality of global financial regulation and the monitoring of cross-border capital movement may assume an added importance, as will the coordination of monetary policy, and agreements on currencies at the G20 level. The lessons of the recent crisis suggest a particular need to ensuring that the financial markets in the developing countries can cope with substantial capital inflows without producing a serious misallocation of resources and structural distortions in the receiving economies. In particual a deepening of capital markets in some key Emerging Markets may well reduce some of the excessive pressure to ‘export’ savings.

In terms of policies to address the pressures of ‘ageing’, the debate in terms of social security and healthcare often focuses on raising retirement ages to reduce dependency rates and alleviate fiscal pressures. The impact of those kinds of shifts on net savings is a little less transparent, since the shift to private savings patterns at different points in the life cycle in response to a higher retirement age are less obvious than the impact on incomes, retirement payments and tax receipts. However, the fact that demographic pressures seem to be currently pushing most developed economies towards larger current account surpluses is arguably indicative that these countries are unlikely to become significant “dis-savers” in the near future.

Extending working lives relative to the time spent in retirement will not only help address the pension issue, it should also serve to accelerate the tendency towards larger current account surpluses accross most developed economies, in particular in those parts of Europe which are in the process of private sector deleveraging as part of their fiscal sustainability programme. What this willl effectively do is raise the upper bound on the ‘prime saving’ age and extend the threatened “dis-saving” era well out into the future.

Running behind such shifts are not just the changes in the prime saving and borrowing populations as between developed and developing markets, but also changes in relative economic size and importance of the economies in the two groups, as withnessed by the recent rapid rise of countries like China and India. This process carries with it the implication that the relative weight of the two groups in the global economy will change sharply over the coming years with the result that GDP in the devloping world will rise significantly, from around the current level of 33% of global GDP to something like 70% by the time we reach 2050.

This is what makes it theoretically possible for both developed economy surpluses to rise and emerging market deficits to deteriorate (as percentages of GDP) at one and the same time. Since the Emerging Market share of GDP is rising, relatively modest deficits are all that will be needed to offset the large developed market surpluses which will be produced. And as is being stressed here, shifts in the relative proportions between the various ‘prime age’ population groups are not identical to the shifts in the share of the working age population in terms of their timing and their potential impact, although the two are clearly related. The working population issue is much better known and has been important in defining acceptable levels of fiscal liabilities as well as a whole battery of structural policy issues. But the general profile in terms of the varios peaks in the prime goups is different to the profile suggested by the peaks in working age population shares, and since it is common practice to use these latter in order to estimate the evolution of the current account (see, for example, the IMF 2004 World Economic Outlook study of the problem), such distinctions are potentially important and hence a more detailed empirically grounded study of impacts of these demographic changes in all their complexity is an urgent necessity.

What Are The Risks Of A Meltdown In Housing and Equity Markets?

Given the relative distributions of wealth and income between countries, it is evident that the rapidly ageing developed economies currently account for the overwhelming majority of global investable assets. And as we have seen, basic life cycle theory suggests that as the large baby boom generation cohorts slow their saving rate (and eventually even draw down on their savings) the steady retirement of this generation can have a significant impact on asset prices, effectively driving them down. The big question is, of course, to what extent. Will ageing lead to a global asset price meltdown? The current consensus (see Poterba, 2004) is that while ageing will undoubtedly have a significant negative impact on asset prices, an asset price meltdown of the kind some have predicted (see Mankiw and Weil, 1989), is unlikely.

But saying there will not be a meltdown is not the same as saying that there will be no impact. In a recent study of ageing and asset returns (From The Golden To The Grey Age) Deutsche Bank analysts Jim Reid and Nick Burns argue that the ‘Golden Era’ for equity returns seen between the early 1980s and mid-2000s was at least in part demographically led, and is unlikely to be repeated. Instead, the authors argue, what we are likely to see is more volatility in stock values, shorter business cycles, significant quantities of liquidity, and sub-average returns in many asset prices.

However, even if most of the attention has so far focused on values in equity markets, the impact of changing demography on house prices is likely to be equally (if not more) important. Demographic factors have clearly contributed to real house prices increases in many countries in recent decades, even to the extent of producing housing bubbles in some. For instance, favourable demographic changes are estimated to have added an additional 80 basis points per annum to United States property values over the past forty years as compared with what would have happened with neutral demographics. On the other hand the looming negative demographic impact which awaits the US over the next forty years has an estimated value of around 80 basis points per annum. And as we have been arguing, the position in Europe and Japan is expected to be even worse. In fact Japan seems to have been the pioneer in this case, and property and land prices are still well below their peak 1992 values. And given the existence of a negative wealth effect, the impact of changes in property values on global asset prices could also be significant.

Both the lifecycle and the overlapping-generation models of saving and borrowing are based on the simple idea that the young save for old age by buying assets, while the old sell assets to finance retirement. The asset transfers involved can occur directly or involve the intermediation of institutions such as pension funds, but regardless of the details, the change in the relative size of the asset-buyer group and asset seller one has clear consequences for future asset prices.

In particular, the asset purchases of a large and wealthy generation, such as the United States baby boomers, passing through the prime saving age range, evidently drives asset prices up well beyond a demographically neutral mean. Conversely, as a country’s population ages, generations become relatively smaller, causing asset prices to decline below their demographically neutral historic mean. Stylized ageing and asset price trends in countries like the United States and Japan seem to support the theoretical conclusions that can be drawn from these kinds of model. In the 30 years leading up to the financial crisis, during the prime economically active years of the baby boomer generation, US asset prices rose substantially. Ex-ante real interest rates fell, equity P/E ratios increased and the real level of house prices climbed. Standard theory then seems to suggest that asset prices propelled by the boomers’ savings will be come under continuing pressure as this large generation retires and starts to sell its assets to the relatively smaller generations that follow. Coincidentally or otherwise, the start of this boomer retirement process occured at precisely the same moment as a major drop in US house prices took place.

Empirical studies examining the correlations between ageing and asset prices basically fall into two main groups: single country investigations of financial asset and house prices, and international studies of financial asset prices.

In the case of single country studies, identifying the impact of ageing on asset prices is difficult, because ageing progresses at a comparatively slow rate and there is no clear consensus on how best to measure population ageing. Although ageing can be viewed at the present time as primarily a developed country phenomenon, as we have seen the differences between the rate of ageing in one country and another may be highly significant.

Also, the focus of the studies that have been carried out have varied. Some have looked at a variety of age cohorts: Mankiw and Weil (1989) and Hendershott (1991) focused on adult populations; Yoo (1994) and Bergantino (1998) examined a number of age cohorts in detail; while Poterba (2004) studied prime savers (who he considered to be individuals between 45-60 years of age). Others, for instance, Bakshi and Chen (1994), used average age. These different measures make it very easy, as Brooks (2006) argues, to make the casual and econometric link between ageing and asset prices in a single country study. However, this implies that the causal identification established could be questionable. For instance, Engelhardt and Poterba (1991) showed that the demographic factors identified in Mankiw and Weil (1989) for the United States do not fit Canadian house price and demographic data. International studies can improve on single country studies as they offer the possibility of investigating several ageing trends simultaneously. Davis and Lee (2003) found, for example, that prime saving cohort size is significantly correlated with asset prices in a seven country sample. Brooks (2006) also extended sample size to include more countries and ageing trends. International studies are also useful to revisit single country results. Ang and Maddaloni (2005) found, for instance, that average age does not predict real returns outside the United States.

However, even international studies using financial asset price data present difficulties, because capital mobility is expected to dilute the impact of ageing. If ageing affects asset prices, investors living in ageing (ie low-return) economies should move their assets to more youthful (ie high-return) economies until expected returns equalize. Indeed, Higgins (1998) and a long line of subsequent studies show that this is exactly what is happening: capital flows from ageing economies to relatively younger ones. Thus, the presence of capital flows make it even harder to identify the precise impact of ageing on financial asset prices.

In principle house prices might be considered to offer better identification criteria than financial asset prices as capital flows are less likely to dilute the link between ageing and asset prices. Cross-border investment in residential housing is more complicated and consequently less common than cross-border financial investment. Hence, using real house price data collected by the Bank for International Settlements (BIS) covering 22 advanced economies between 1970 and 2009 Elod Takáts (Takáts, 2010) found there was sufficient heterogeneity in both house prices and demographics to offer a solid basis for isolating and identifying the impact of ageing. Unsurprisingly the model found that a combination of real economic factors and demographic ones drive asset prices.

Thus a one percent increase in real GDP per capita roughly corresponded to a one percent increase in real house prices. Similarly, a one percent increase in population implies was associated with a one percent rise in real house prices, while a one percent increase in the dependency ratio lead to a drop in real house prices of two thirds of a percentage point. The differing demographic impacts on real house prices aross countries was a reflection of variations in the rhythm of the ageing process. For instance, while in the United States, the model estimated that favourable demographics added around 80 basis points per annum to house prices between 1970 and 2009, in faster ageing countries, such as Germany or Japan, the demographic impact was already found to be negative.

Extending the model to a broader group of countries, and using the UN (2008) population, the author carried out projections in an attempt to estimate the future impact of ageing on real house prices. Unsusprisingly he found that house prices will face substantial headwinds over the next 40 years. Ageing will decrease United States real house prices by around 80 basis points per annum compared to neutral demographics, while the effect was found to be much stronger in both Europe and Japan. However, even though the impacts are somewhat larger than those to be found in most of the prior literature, the estimates are still short of the Mankiw and Weil’s (1989) asset price meltdown projection, which suggested around 300 basis points per annum real house price decline.

Whatever the empirical fine tuning we will see in the future, it is clear that house prices in the developed world are going to suffer a negative demographic impact in the years to come . In addition, since movements in house prices are normally a close correlate with movemements in financial asset prices, if house prices face headwinds, then so should financial asset prices. Using estimated coefficients and global population forecasts, Elod Takats found that asset prices would face headwinds up to a full percentage point. This impact is substantial, but based on historical returns would not necessarily imply real asset price declines. Furthermore, even if ageing continues as expected currently expected, a variety of other factors can interven which affect the relationship between demographics and asset prices. These uncertainties along with the magnitude of ageing related asset prices changes suggest that more research is needed before too many conclusions regarding public policy are drawn.

And The Dangers of Sovereign Debt Default?

Lastly we have the impact of population ageing on Sovereign Debt. One of the most striking features about the difficulty many economies are experiencing in exiting the current crisis, is the degree of sensitivity of the financial markets to negative dynamics in the sovereign debt of countries which were classified as AAA as they entered the crisis. This sensitivity is hard to understand if the difficulty were only one of resolving the immediate difficulties created by the crisis. What seems to be happening is that two crises are merging, the one we are in the process of leaving behind, and the one which lies out there in front: the sustainability of welfare commitments in the face of rapidly changing population pyramids.

According to a recent report from Standard & Poor's Ratings Services (Standar & Poor’s, 2010), the cost of caring for the growing numbers of dependent elderly will both affect growth prospects and dominate public finance policy debates across the globe, and for many years to come. Even if most governments have long been aware of the need to prepare for the looming problem, the rapid build-up of government debt over the past three years has effectively heightened the need to do more to advance reforms aimed at containing the risks to sovereign budgets, especially in countries with high expected future increases in age-related spending. Currently, relatively high general government deficits are complicating efforts to rapidly improve public finances, particularly in a number of advanced economies and this will surely lead to further debt accumulation over the medium term, even, in extreme cases producing the need for debt restructuring

In principle, during the next decade many governments were expected to have some breathing space given the relatively moderate pressure from age-related spending that was anticpated over the period. However, as S&P’s point out, while this window for implementing fiscal sustainability strategies still remains open, the need to make changes is becoming urgent in the face of the expected strong acceleration in spending which will start in 2020. Against the backdrop of large deficits in some countries, the process of carrying out budgetary consolidation and pension or health-care system reforms simultaneously will prove politically challenging in the countries which are furthest behin in their reform agendas.

As indicated above, population ageing will lead to profound changes in economic growth prospects for countries in the developed world, at the same time as the most affected countries will experience heightened budgetary pressures from greater age-related spending needs. In the absence of appropriate budgetary adjustment, additional reforms to pension and health-care systems, or structural measures to improve growth potential, the future fiscal burden will increase significantly across the board. This burden will not fall equally, though, since the deterioration in public finances over the period 2010-2030 is expected to be particularly significant in Japan, Germany and most of Southern and Eastern Europe. The relevant characteristics of this group of countries is the presence of a relatively high level of existing social security coverage combined with a rapid worsening in the demographic profile.

And the numbers are preoccupying. Assuming no policy change Standard and Poor’s estimate that developed country deficits could rise from 5.7% of GDP currently to over 7.4% of GDP by the mid-2020s. The interest cost of the growing debt burden may exacerbate the budgetary impact of demographic spending pressure. And if nothing is done deficits will rise inexorably to 10.1% of GDP in 2030 and 24.5% by the middle of the century. This would lead the general government net debt burden to increase to 78% of GDP through to 2020, only to then accelerate thereafter. By 2030, the net debt burden is projected to be at almost 115%, at the same time as being on an explosive path to which would see average developed country sovereigns hitting 329% of GDP by 2050. And under such a scenario the economic size of the state would increase significantly with government spending rising to almost 68% of GDP in 2050, up from 46.7% today.

Of course, such numbers are not either fundable or sustainable. They are only a simple illustration of what would happen if changes are not made. Clearly the main driver of the projected deterioration is the long-term increase in age-related spending, which only serves to underline the importance of addressing the projected increases in ageing costs. Simply having the objective of attaining a balanced budget by 2016 would contribute significantly to reducing the overall future budgetary burden, although the strongest pressure on government budgets is expected in those sovereigns where reforms to pay-as-you-go (PAYGO) pension systems are still pending.

In the face of rapid shifts to their demographic profiles, governments in a number of countries (Spain and Slovenia, for example) are currently preparing reforms to their PAYGO pension systems, reforms which are likely to include raising the statutory retirement age, changes to pension indexation formulas, and other measures, while in other (like South Korea and Slovakia, where demographic profiles appear to be the most unfavorable) future increases in pensions have already been cushioned to some extent by earlier systemic reforms.

Evidently, emerging market sovereigns are in general in a relatively better position due to their current level of economic development and their relatively lower pension system coverage. With a few exceptions, these sovereigns are characterized by significantly lower median pension spending to GDP (6.4%) than advanced economies (9.2%). Nevertheless, risks do exist for future pension spending even in this better case scenario. In particular, given that these countries currently have quite young populations, their old-age dependency ratios will eventually deteriorate even faster than they will in a typical advanced economy, albeit even by the time we reach 2050 they are still expected to have relatively lower old-age dependency ratios than the advanced economies. It is important to note that long-term pension projections for Emerging Market countries are based on the assumption that the policy coverage and adequacy don't change. Any broadening of the coverage of the pension system in the future is not incorporated in the current projections, and it is not unreasonable to assume that as these economies develop, government welfare spending may grow faster than GDP as has been the trend in advanced economies during the last half of the 20th century. Clearly, in this case, the current projections are likely to be optimistic.

Conclusions

As we have seen, the challenge represented by the current wave of demographic changes is almost without historic precedent. Large changes in fertility and life expectancy have occured in the past (at the time of the industrial revolution, for example), but these have almost always had positive impacts on the workforce and on economic growth potential. No we are enetering an epoch when the opposite will be the case, and demographic processes will work to slow growth, and to make it more difficult to sustain the standards of life to which we have become accustomed.

The coming decade will be a challenging one for public policy in Spain. Not only have the consequences of the earlier crisis still to be fully addressed, but preparations have to be made for the one which is to come. The recent proposed reforms of the pension system should be seen in this light, as a measure which has more to do with difficulties which are to come then with concrete steps to emerge from the long recession. And as we have seen, in the years to come the whole structure of Spanish economic life is facing a massive transformation. It is not only a question of plugging a gap left by the decline in the construction industry. What is involved is a whole change of mindset, from being a nation of borrowers to one of savers, and it is important that those who manage the nations financial institutions are aware of what this change is, and why it is taking place.

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Latvia compared to Iceland: A tale of “The Harder They Come, the Harder They Fall*”

2011-01-06T10:01:00.000-08:00

Paul Krugman, Nobel Prize winner in economics 2008, when in need of the antithesis of a role model for economic policy often chooses Latvia. He has been very critical of the insistence of the authorities to maintain the fixed exchange rate when the country faces recession and double-digit unemployment and of course he has a point. For me it is still not clear that the strategy of internal devaluation is better than an external one although I (still, especially if the authorities support it with reform-friendly 2011 and 2012 budgets) support the former. His Riga Mortis piece was fun but this post from 17 December 2010 lacks balance, I think, and certainly deserves some comment. Not to defend Latvia – the reckless boom-time ultra-procyclical fiscal policy in particular is very much the culprit of the current woes as I have argued previously (**) and its effects rightly produces comments and interest from Prof. Krugman and many others.

Prof. Krugman’s 17 December piece compares Latvia with Iceland. Facing banking crisis and recession Iceland let its currency, the krona/kronur, depreciate in order to increase export competitiveness to stimulate economic activity. The kronur was trading at around 92 ISK/EUR in 2006-07, increasing (depreciating) slightly in 2008 to some 120 ISK/EUR, to 160-180 ISK/EUR in 2009 while it has appreciated somewhat in 2010 and currently stands at 153 ISK/EUR. Check for details here. All in all a pretty substantial depreciation of about 40% of the Icelandic currency between 2007 and 2010. To the extent this has helped export competitiveness (which I am certain it has) it should have softened the blow to the economy from the banking crisis and resulted in a lower GDP fall – which is exactly what Prof. Krugman’s graph shows. Conclusion: Icelanders are smart, while the internal devaluation will soon have reduced the Latvian economy to nothing, a desert. Hm!

Allow me a similar graph below, only with a different starting point.

It is old news that Latvia’s economy grew rapidly in the early parts of this decade and it was not due to particularly smart policy; rather it was a consequence of catching up (and some OK policy, true…). Iceland is rich, Latvia is poor and thus has potential for catching up.

And the fall of the Latvian economy is indeed spectacular and is the reason for receiving so much attention from abroad: From peak to trough, Q4 2007 to Q4 2009, GDP fell an accumulated 25.1%, the highest, well…, anywhere. Similarly, Iceland’s economy lost 13.5% of GDP between Q3 2008 (the recession started later) and Q2 2010, thus just over half the loss of Latvia.

But I think two more points should be noted. Firstly, the time from peak to trough in Latvia was eight quarters while in Iceland seven quarters, thus roughly the same amount of time and it would be stretching it quite a bit if someone were to say that currency depreciation speeded up recovery (Note: Such a point hasn’t been made by Prof. Krugman but it often surfaces). Secondly, at the low point, Q4 2009, Latvia’s GDP had reached the level of Q4 2004 – one could say that the economy had been “bombed back” five years. This is actually also exactly what happened in Iceland: At the bottom, Q2 2010, the economy had the same size as Q1/Q2 2005.

Different currency regimes, similar performance: Both countries saw GDP decline for about two years, both countries saw GDP bombed back five years. Latvia’s cumulative fall was bigger than Iceland’s because its previous growth had been similarly bigger as is of course easily visible from the graph above.

But was Iceland’s much smaller GDP decline really driven by exports due to a more competitive currency? Everything is in the eye of the beholder but the graph below does not exactly portray a lean, mean, Icelandic export machine. True, 2009 saw diverging export performances, possibly due to currency depreciation in Iceland – but then one can just as well argue that by 2010 the internal devaluation has started to work in Latvia (please see Fig. 3***) where exports are up 15.5% y-o-y (Q3 2010 over Q3 2009) while in Iceland they are down 2.1%.

Note: Seasonally adjusted data for Iceland but not for Latvia but the picture should be clear nevertheless.

Perhaps capacity constraints are at play in Iceland (see The Economist, 18 December 2010, p. 127-8, European edition) but similar problems exist in Latvia a) due to underinvestment during the crisis and b), perversely, in the face of 18% unemployment, lack of qualified labour and this leads me to my next point here.

As Prof. Krugman points out in yet another post, on 21 December 2010, Latvia has seen a much bigger decline in employment than e.g. Iceland. Very true and very sad but – even more sadly – not that strange either. Low unemployment is an anomaly in Latvia, not high unemployment as I have pointed out here. In 2007, at the height of the boom, this ECFIN Economic Brief estimated Latvian GDP at no less than 16% above the level consistent with full employment, a degree of overheating best described as sizzling. Unemployment reached 5.4% at its lowest point, a point way, way below the uncomfortably high equilibrium level. Or to put it simply: Any return to normality would have implied a huge drop in employment, no matter what.

It is easy to ridicule Latvia for its massive GDP decline and huge fall in employment but a more balanced analysis would see this partly as the result of the preceding rapid increases in GDP and employment – from boom through bust the numbers have always been more extreme here and this little entry just tries to argue that the magnitude of the current decline is very much a function of the size of the preceding boom.

And my last point. I have tried to argue that the very different exchange rate policy seemingly hasn’t produced that different an impact on exports in the two countries but the fiscal policy response certainly was different, see graph below.

Whereas Iceland went into surplus during its overheating period (unemployment hit 0.8% at its lowest), Latvia kept recording budget deficits despite the EU’s highest growth rates, despite ultra-low unemployment, despite severe overheating and despite massive increases in tax revenue. In short, Latvia’s fiscal policy was highly procyclical during the boom (Bank of Latvia estimates that 2007 saw a structural deficit (i.e. adjusted for employment being above its equilibrium value) of some 8% of GDP), thus adding to the size of the boom whereas Iceland pursued a more countercyclical fiscal policy, helping to smooth somewhat the economic cycle.

When the crisis struck Iceland moved into a massive deficit, thus continuing its countercyclical fiscal policy while Latvia, unable at the end of 2008 to borrow from anyone anywhere except from the IMF and EU, was forced to continue its procyclical policy (a budget deficit of 10.2% reflects very tight policy when the economy contracts 18% as it did in 2009), once again exacerbating the business cycle but this time on the way down. Latvian public finances – expenditure and revenue – were just ‘out of sync’ with fundamentals during the boom and had to be addressed at some stage. It hurts and hurts badly to do so during a recession but the political will did not materialize before.

I have tried to argue that I am not so convinced about the relative success of Iceland coming mainly from currency depreciation. Data does not seem to support that. But will the Icelandic currency depreciation ultimately be more successful than the Latvian internal devaluation? Perhaps, but I don’t see conclusive evidence yet.

I put more faith in the strongly procyclical fiscal policy of the boom times in Latvia as a culprit – it exacerbated the boom on the way up and it exacerbates the bust on the way down – plus a sort of ‘inevitability’: By 2007, with GDP operating some 16% above its full employment level and with unemployment several percentage points below its natural rate, the economy simply had to suffer a major GDP decline when the financial crisis struck.

This is not to say that Latvia is a ‘success’ or a ‘role model’. Some future text books might add an appendix about Latvia of successful internal devaluation during a recession but then they should also add one on reckless fiscal policy during a boom.

* Jimmy Cliff, 1972. I personally don’t particularly like that song but the title is brilliant when describing the Latvian economic performance in the first decade of this millennium.

** There are several such measures but they all point in the same direction: Some regaining of competitiveness from 2009. I am not trying, however, to address whether the LVL is overvalued or not.

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga

Spanish Treasury’s Reaction to Moody’s Announcement

2010-12-16T22:33:00.000-08:00

Dear all,

As by now you must know, only three months after a rating action with stable outlook Moody’s has placed the Kingdom of Spain’s Aa1 rating on review for possible downgrade.
...
Beyond any remarks regarding the timing of this announcement – one day before an extremely important benchmark auction – there are several considerations that the Spanish Treasury would like to make.

Firstly, it is important to state that Moody’s has not downgraded the Kingdom of Spain. It has simply changed the Aa1 Stable outlook to a Aa1 rating under review for a possible downgrade during the next 3 months. The downgrade may occur if the current macroeconomic situation, the prospects of which have actually improved since September of this year, deteriorates further.

Secondly, Moody’s insists that it does not question the solvency of the Kingdom of Spain and, in this respect, it is very clear in its belief that Spain will not require EFSF assistance.

Thirdly, Moody’s says that even in the worst case scenario in which the review process leads to a downgrade, the Kingdom of Spain would remain in the Aa area, i.e. close to the “safe haven” sovereigns and far from those which are currently most in doubt.

Regarding more specific aspects of the report, there are several points to be made.

• The Treasury’s financial requirements for 2011 will be significantly lower than in 2010, even without taking into account the privatisation of the State Lotteries and Bets agency, and Aena (the National Airport Management agency). Also, the Treasury will start the year from a very comfortable cash position, with no major bond redemptions until the month of April, coinciding with a large intake of taxation revenue. The Treasury would thus remain strong even if the current episode of market volatility were to be prolonged for the first quarter.

• Until now, even in the middle of a period of market turbulence, there have been no significant signs of vulnerability with respect to the Treasury’s ability to access the market. Demand in our auctions has remained strong, and debt holdings by non-residents have tended to increase.

• Although financing costs are higher now, their effect in the aggregate interest burden is not significant, since the cost of most of the debt that is being redeemed is greater than the debt that is being issued. Despite the latest increases, the cost of financing, still low both in historic terms and in comparison to our European peers, does not put its sustainability in doubt.

• As regards the situation in the Spanish banking sector: we must emphasise that, according to the Bank of Spain’s data, the system’s Tier 1 capital is currently at 9.6%. Therefore, Moody’s statement that the system needs EUR 15 billion additional funds to remain above the 8% mark can only be understood in a stressed macroeconomic scenario similar to the one used in July 2010, which is not being experienced today. In this sense, Moody’s does not explain which scenario it has in mind when it affirms that, in a more severe scenario than the current one, recapitalisation needs may exceed EUR 80bn.

• When Moody’s states that, in order to reach 12% Tier 1, the system would require an additional EUR 90 bn, one should be reminded that the 12% mark is an arbitrary one, far away from any present or future standard, even under the Basle III regime in 2019. If Moody’s believes that this should be the standard, it should apply it to every banking institution in the world and not just to the Spanish ones.

• With respect to the Spanish Autonomous Regions, it must be made clear that only two of them will not fulfil their fiscal targets and that, even so, on aggregate they will fulfil these targets.

• As for non-complying Autonomous Regions and Municipalities, the Government has reaffirmed its resolve, backed by the law, not to allow them to incur in further debt operations until they provide sufficient proof of their commitment to fiscal consolidation. This resolve has been shown, for example, with the City of Madrid.

• Moody’s statement regarding the transparency of Autonomous Regions’ accounts, it does not seem to have considered the commitments reached in thelast Fiscal and Financial Policy Council to provide individual, homogenous, quarterly accounts... of their budgetary execution. We must emphasise that this commitment is a new international benchmark of transparency for other countries with sub-sovereign autonomous regional governments. As a sign of this commitment, next week the Government will provide the information on the Autonomous Regions’ budget execution for the third quarter of 2010.

• The calendar for structural reforms of the pensions and collective bargaining system has not been postponed, but actually brought forward: the date to finalise pension reform has been broughtforward to end- January 2011, and the one for collective bargaining has been set for March 2011.

The Government respects every opinion and takes note of what it deems valuable in each of them. It nevertheless believes that the current political economy strategy, with an aggressive and credible commitment for fiscal consolidation, and an equally bold programme of structural reforms – most of which, it must be stated, have already been implemented or announced – will pave the way for a steady economic recovery and a stabilisation of the market’s sentiment towards Spain. Beyond the relatively short-lived horizons of occasional publications that influence (and are also heavily influenced by) the market, we believe that investors will analyse Spanish fundamentals and continue to see Spanish Government debt as a valuable investment.

Many thanks,
Spanish Treasury Team

Cash Starved Catalonia

2010-10-19T14:50:00.000-07:00

Cash-starved Catalonia turns to locals

By Victor Mallet in Madrid

http://www.ft.com/cms/s/0/5737e0ee-d879-11df-8e05-00144feabdc0.html

Published: October 15 2010 18:38 | Last updated: October 15 2010 18:38

Shunned by international investors, the usually ebullient Antoni Castells, finance minister for the Spanish region of Catalonia, is so short of cash that he has turned to Catalans themselves to buy bonds to finance the deficit.

This week’s move by Catalonia’s Generalitat, the autonomous regional government, to raise up to €2.5bn ($3.5bn) by selling bonds through local banks has fanned the smouldering fires of Catalan nationalism and exposed the financial weaknesses of Spain’s devolved system of government.

The neighbouring Mediterranean region of Valencia is also in dire financial straits and the outlook for each of the 17 Spanish regions is listed as “negative” by credit rating agencies.

Total debt of the autonomous regions has doubled to almost €105bn in five years, according to the Bank of Spain.

Artur Mas, leader of the moderate Catalan nationalist party Convergència i Unió and likely winner of next month’s regional election, declared that Catalonia’s bond plan showed “the coffers of the Generalitat are bare”.

By paying a generous 4.75 per cent interest rate on the one-year bonds as well as an estimated 2-3 per cent commission for the banks, Catalonia is paying a high price to keep itself liquid.

But a downcast Mr Castells, member of a tripartite government dominated by the Socialists, described the bond issue as “attractive” and “necessary” and said: “It can’t be said that we’re bankrupt. No one would say that in a serious country.”

He predicted that other regions would take the same approach to fundraising from local citizens.

After years of rapid economic growth, abundant tax income and rising expenditure, the autonomous regions – as well as the municipal authorities in many towns and villages – are reeling from a crisis that has made property taxes evaporate and forced the central government to slash the public sector deficit.

The future of regional finances is of vital importance to the credibility of Spain’s austerity plans and the stability of the eurozone, because the regions account for more than half of all Spanish spending, mainly on education and health, while the central government controls 30 per cent and the social security system spends the rest.

Lorenzo Bernaldo de Quirós of Freemarket, the Madrid-based consultant, said on Friday the financial difficulties of the regions had revealed the “botched” nature of Spain’s decentralised constitution of 1978. With money likely to remain tight, he forecast that the reluctance of richer regions such as Catalonia to continue subsidising poorer ones such as Andalucía would foment political disputes and regional nationalism.

“It’s an explosive situation,” he said, noting that the two available solutions – regional bankruptcy or the bail-out of a region by the central government – were both bad. “It’s a scenario that leads inexorably to a drastic reform of the system for public sector financing.”

An additional difficulty for Spain is the lack of up-to-date information on the debt and budget positions of the regions.

Economists said the headline number for the overall deficit was being improved, partly by cutting transfers from the centre to the regions and municipalities, while the regions’ debts are higher than the published figures because of billions of euros of unpaid bills to suppliers and “off balance sheet” debts incurred by public corporations.

“It certainly seems the central government is making considerable progress in controlling its own deficit but the same cannot be said of the autonomous communities and municipal authorities,” said Edward Hugh, a Barcelona-based independent economist.

“It is clear from everything we have seen to date that the underlying regional deficit is deteriorating rather than improving.”

Turkey - Breaking The Mold?

2010-09-22T09:14:00.000-07:00

Turkey’s excellent second quarter GDP performance – second only to China in the G20 – has once more brought the country back into the focus of investor attention. Strong underlying fundamentals following major structural changes since the start of the century mean the economy is far more robust than it was. However, weaknesses remain, especially in the labour market and external trade balance, with the current account deficit continuing to be a cause for concern. Recent backtracking on the proposed fiscal rule legislation combined with loose monetary conditions raise issues about the willingness of the authorities to finally get the inflation driven external imbalances under control. Nonetheless Turkey remains the strongest economy in the CEE region, with low external indebtedness and substantial scope for above par catch-up growth.

Turkey’s economy surprised everyone on the upside in the second three months of 2010. The economy grew by a seasonally adjusted 3.7% over the first quarter, and by a China like 10.3% over the previous year. Turkey is one of the few countries in the CEE region to have strong independent domestic demand, making its economy relatively immune from short term movements in external demand.

While the general outlook is extremely positive for the Turkish economy, and rating upgrades can be expected, controlling the widening current account deficit will be the key to sustained success. In this context shelving of the fiscal rule legislation has sent out a strong negative signal to markets, not so much about current intentions as about the dangers of agenda slippage as we move further down the road. It is necessary to put this situation in some sort of perspective however, since government debt to GDP is still low, as is the level of household and external indebtedness. There are reasonable grounds, therefore, for optimism that once next years elections have passed, and with EU accession negotiations as an anchor, the overall policy mix can continue to evolve in a positive direction.

Turkey’s economy is now reaping the benefits of substantial structural changes on the macro front, aided by very strong underlying demographics. Turkey’s working age population is set to rise significantly in the years to come, posing a challenge for job creation, but offering the country the prospect of ever lower dependency ratios and strong internal demand momentum. In contrast to many of its regional neighbours the country has taken the opportunity offered by the strong underlying global environment of the early years of the century to set some of its ongoing macro problems straight, and in particular to put its national balance sheet in order. Thus it has avoided the accumulation of excessive debt, whether public or private, internal or external. Handled responsibly the country now faces the prospect of rapid convergence towards developed economy levels of activity and living standards between now and the early 2020s.

SOME BACKGROUND

It is not hard to see why many investors consider Turkey to be a compelling destination for their investments at the present time. With a growth rate which equalled that of China in the second quarter driven by a strong expansion in consumer demand - car, home and consumer durable laons have now risen every week since January - the logic behind a bullish stance towards the country is all too clear. And there is no real mystery about the country’s recent success, since following a series of substantial structural reforms introduced in the wake of the 2000/2001 crisis Turkey’s macro fundamentals are now strong, making the country stand out clearly from the majority of its Eastern European Emerging Market peers due to vibrant internal demand and the comparative absence of banking sector issues. In addition, despite some recent concern over the medium term position the country still has a relatively sound fiscal outlook (together with comparatively low levels of both government and private debt), a secular disinflation trend and very favourable demographics which see the country’s population set to grow by over 1.5 percent per annum over the next 25 years.

On the other hand, not everything is going to be simply plain sailing in Turkey. The trade and current account deficits are swelling at a worrying rate as imports recover from last year’s slump. The foreign trade deficit jumped from $5.6 billion in June to $6.4 billion in July, the highest level since August 2008. In fact contrary to the CEE trend, auto sector exports actually fell in July, with overall export growth slowing to 6 per cent year on year, while imports of motor vehicles surged, producing a 24.6 per cent surge in overall imports.

The latest data suggests the current account deficit could be well over $38 this year, double last year’s level, and if current trends continue it could be up in the region of $50 billion, or around 7 per cent of GDP, in 2011.

Also of concern is the inflation rate, which rebounded again in August after falling for several months. This ongoing inflation differential with its trading peers is putting pressure on the real exchange rate, and on the competitiveness of the manufacturing sector. In addition, the quality of the financing which Turkey is receiving could become a cause for concern, since the share of FDI has fallen, while the increasing dependence on short term sources of funding like loans and equities if not corrected raises the risk of an unorderly correction at some point in the future.

Vastly Improved Fundamentals

Before the turn of the century crisis, Turkey’s economy was effectively characterised by an ongoing series of booms and busts, as consumption booms generated by unrealistic wage increases lead to competitiveness losses, over-indebtedness and an inevitable erosion in investor confidence which caused the whole thing to unwind. The IMF supervised strengthening of the country’s macroeconomic policy framework in the early 2000s decisively broke this pattern leading to a considerable decline in country risk premia.

The post 2001 reforms vastly improved economic resiliency, productiveness and efficiency. The implementation of an IMF inspired programme of strict fiscal discipline meant the budget deficit fell sharply from 12.9 percent of GDP in 2002 to a low of 0.3% in 2005. While the level of deficit rose again during the crisis (hitting 5.9% in 2009) this uptick is not exceptional when seen in a wider context, and the fiscal position is now expected to improve rapidly as the economy expands. The government’s debt to GDP ratio also fell substantially, from 93 percent in 2002 to the current level of just under 45 percent. At the same time the Lira has become a much more stable currency and interest rate levels have fallen substantially.

Very Strong Second Quarter

After turning in an 11.7 percent annual growth rate in the first three months of the year, the economy continued to recover strongly in Q2, turning in an impressive 10.3 percent growth rate, which was only equalled by China among the major economies, while only Singapore and Taiwan turning in better performances globally. Quarter on quarter the economy grew by 3.7 percent, or at an annualised rate of 14.5 percent.

The growth leaders in Q2 were construction, fisheries and manufacturing industries, which posted growth rates of 21.9 percent, 15.7 percent, and 15.4 percent, respectively. Industry and Trade Following the announcement of the figures Minister Nihat Ergün suggested Turkey could well grow by an annual 7 percent this year (up from a previous 6 percent forecast) and we do not find this suggestion at all unreasonable.

Unlike many of the over indebted economies which are to be found in the region (where growth is totally export dependent) the main engine of growth in the Turkish case is domestic demand, and in particular household consumption and investment. The construction and manufacturing industries grew by 21.9 percent and 15.4 percent growth, respectively, and both of these have high potential “multiplier effects” which means that they can reinforce growth in other sectors like retail sales and services in the second half of the year.

In fact Q2 GDP growth was significantly stronger than we expected, and well above the 8.5%Y consensus estimate, suggesting that the recently revised IMF forecast of 6.1 percent growth for the whole year may well need to be further adjusted upwards. Certainly the governments expectation of around 7% is far from being unrealistic. Export growth, which was up 12.1 percent on the year, was one upside surprise as was the rise in private consumption (up an annual 6.2 percent), although the latter was reflected in a surge in imports (up 17.8 percent) which meant the net trade contribution was negative (by 2 percentage points). Investment was up an impressive 28.7 percent, but this is not quite as impressive as it seems, due to the low base effect of the 2009 performance.

Public spending also accelerated, growing by 3.6 percent, although since revenue was also up the deficit actually fell over the period. Inventory growth, which contributed strongly (8.3pps) to headline growth in the first quarter, was modest (only 0.6pps) in the second one, suggesting we may see a gradual slowdown in manufacturing growth in the coming quarters. Indeed recent PMI readings have already begun to confirm this impression.

However, given that the Turkish economy actually plunged by "only" 11.0% year on year in the first half of 2009, GDP in real terms in the first half of 2010 was actually marginally up relative to its level before the onset of the global crisis, implying some real economic gains were made in the first half of the year, and that we are now truly talking of “recovery” in the Turkish context. The annual growth rates will evidently slow in the second half of the year, since Turkish economic conditions began to improve in the second half of 2009, with GDP falling only 2.7 percent year on year in the third quarter and the economy actually growing a seasonally adjusted 2.3 percent in the fourth quarter as compared to the third. Because the recovery had begun in the second half of last year, the base effects will affect results in the second half of this year, bringing annual GDP growth rates downward relatively sharply.

As stated aboveTurkey stands out from many regional peers as not being export-dependent and has a dynamic domestic economy to complement the export sector, which means the impetus behind overall GDP gains is much more broadly based. The strength of domestic demand also gives the Turkish government a far larger and growing potential tax base.

Unemployment rate continues to edge downwards

One of the reasons that domestic consumption is doing so well is the continuing fall in the unemployment rate, which stood at 10.5 percent in June, down from 11 percent in May, and 13 percent a year ago. The drop is evidently leading housholds to have an increased sense of job security and purchasing capacity.

Just as importantly the country is creating jobs. When compared with June 2009 the number of those employed rose by more than 1.5 million (to around 23.5 million), with the share of those occupied in the industrial sector (19.7 percent) rising significantly. Compared with a year earlier employment in agriculture was up 0.2 percentage points, while in industry it rose by1.2 pps, and in in services the share was actually down by 1.6 pps.

Under the impact of the global financial crisis, Turkey’s unemployment hit a record high of 16.1 percent in February 2008. Two years later, and in sharp contrast with most of its regional peers, the country has achieved an impressive drop in the jobless rate, and government forecasts that the rate may well fall to the single-digit level in the coming months do not seem unrealistic. Even more significantly, Turkey has achieved this improvement even as the labour force has risen sharply, from 51.6 million to 52.5 million. This feature again puts Turkey in a very different position to its regional peers, most of whom have either stagnant or falling labour forces due to their negative demographic trends. Turkey is evidently benifiting from phenomenon known as the “demographic dividend”, whereby as fertility falls ever higher proportions of the population are to be found in the working age category, initially boosting employment and output, and then, in a second wave, fuelling credit and consumption growth. Turkey is thus rapidly approaching the demographic “sweet spot” where sustainable rapid catch up growth is totally realistic and achieveable.

However, this process is far from automatic, and depends for its effectiveness on continuing and deep structural reforms. As the OECD are quick to point out, the Turkish economy makes far from satisfactory use of its existing labour resources. There is constant pressure on the industrial and service sectors to create the jobs to absorb the rapidly growing working-age population and enable the authorities to cope with the high rate of migration from rural areas. Turkey’s employment rate, at just above 40 percent, remains the lowest in the OECD area. Deep rooted socio-cultural factors, combined with the steady drift from rural to urban areas, mean that many Turksih women continue to withdraw from the labour force on marriage, which means the employment rate for women remains stuck around the 20 percent level, 40 percentage points lower than the equivalent rate for men.

Three Challenges – Inflation, The Current Account Deficit And Fiscal Control

Despite the fact Turkey is experiencing a secular disinflationary tend, the inflation rate rose in August, to 8.3 percent from 7.6 percent in July, reversing what had previously been a three-month run of declines. The main culprit, as is often the case in Turkey, was an increase in unprocessed food prices, reinforced by seasonal factors such as the arrival of Ramadan. In fact the surge was not unexpected, since Turkey’s central bank had previously forecast just such a “noticeable increase” produced by the seasonal jump in the price of fruit and other foods. The Bank has now kept its benchmark interest rate unchanged at 7 percent since November 2009, even as the economy returned to growth, basing their argument on the fact that the core inflation rate is falling toward the year-end target of 6.5 percent. Given that one of the key objectives of the central bank has to be reducing the level of interest rates they are unlikely to move rapidly towards monetary tightening and could resort to other tools to keep inflation in check, such as increasing reserve requirements to control credit growth. They are also likely to be reluctant to do anything on the interest rate front which could lead to an increase in short term capital flows, focusing their attention rather on bringing long term rates down to encourage FDI inflows.

The bank’s preferred measure of underlying inflation, ie excluding energy and food prices, fell to 4.2 percent in August from 4.5 percent a month earlier. On the other hand, they will also have noted that producer prices rose 1.15 percent during August (or 9 per cent over August 2009), a much faster pace than consensus expectations, a detail which may not alarm them but will certainly give them food for though. At the end of the day we doubt any of this will have much impact on the Bank’s policy stance, since they will surely stress that of the 9 core measures of inflation they track, six still posted annual declines in August. Indeed Central Bank Governor Durmus Yilmaz indicated at the start of September that in his opinion interest rates should stay on hold for the rest of this year, with only limited rises to be antipated in 2011. At the same time he has stressed that his ability to deliver on this front is conditional on fiscal decisions keeping to anticipated targets.

Current Account Deficit Worries

Turkey’s current account deficit increased sharply in July, and came in well above consensus expectations (US$3.0 billion). This means the current account deficit for the first seven months of the year totalled US$ 24.2 billion, up from US$ 7.9 billion registered in the same period of 2009. Even the non-energy current account deficit was up significantly, hitting US$6.5 billion in the first seven months compared with a surplus of US$6.5 billion in the same period of 2009. The underlying deterioration reflects the strength of the domestic consumer rebound and the impact of the inflation-driven real exchange rate appreciation.

Turkey has a long history of persistent current account deficits, and following an easing of the problem during the recession, with the recovery the old problem has simply re-emerged. During last year’s sharp contraction, Turkey’s current account deficit fell back to 2.3% of GDP, and the issue subsided as a problem. But last year's narrowing was due to very exceptional circumstances (the sharp contraction in domestic demand during the global financial crisis), so the anticipated widening of the deficit to a possible 7% of GDP in 2011 is essentially a reversion back to the norm. Which does not make it any the less problematic.

In addition to the rapid deterioration in the deficit, a further concern is raised by the quality of the financing which is supporting it. Capital inflows are increasingly short term and debt-based, while FDI (which is one the most stable and desireable ways to finance) remains below 2009 levels. At US$ 3.3 billion, FDI inflows over the first seven months fell short of the US$ 4.1 billion which entered the country during the same period of 2009. During the first six months of the year FDI coverage of the current account deficit came in at just over 10%, compared with 46% coverage over the same period in 2009.

As a result Turkey is becoming dependent on capital inflows which are increasingly short term and debt-based, making the country vulnerable to any renewed bout of risk aversion, which could see a rapid reversal in flows, triggering an abrupt adjustment in the real economy. There is one saving grace though, and that is to be found in the Net Errors and Omissions (NEO) category. This captures capital flows which remain essentially unidentified, and these dramatically improved during 2009, accounting for roughly US$5 billion in inflows. Although the dynamic behind such flows is unclear, movements are widely believed to reflect funds held abroad by companies and individuals which are repatriated during times of financial stress. These flows could be considered as a kind of automatic financial stabiliser (or cushion) for the Turkish economy, and it is not surprising to find that as conditions have improved so last year’s massive NEO inflow has steadily subsided, falling back to 0.5 billion $US in the first seven months of the year, from the 6.3 billion $US level seen during the same period last year.

With Turkey’s 2010 growth set to be much stronger than expected, the rapid widening of the current account has once more emerged as a key policy issue. A recent comprehensive analysis by the IMF argues that the root of the problem is Turkey’s considerable competitiveness gap. The IMF draw attention to the following evidence for the existence of the problem: (i) an above-normal current account gap - the IMF consider something like 2.5% of GDP to be normal in the case of an emerging economy like Turkey; (ii) real effective exchange rate appreciation driven by inflation differential between Turkey and its trading partners; and (iii) stagnation in the market share of Turkey’s exports.

The IMF analysis has implications for the secular outlook for the lira, since given that Turkey has a floating exchange rate regime, since if the loss of competitiveness reaches unbearable proportions the lira inevitably adjust downwards, an outcome which would not be unduly disruptive given that the country's external debt ratios are still modest, and that Turkey certainly does not have the same sort of problems many other emerging economies in the region have in terms of forex loan exposure.

Fiscal Policy Connundrum

Despite increasing during the crisis, Turkey’s fiscal deficit has been low in recent years, and debt to GDP has fallen steadily. The deficit hit 5.6% of GDP in 2009, and the IMF project it will fall to 3.4% by 2011. Gross debt peaked at 45.5% of GDP in 2009, and is now set to fall back steadily.

government to shelve the proposed Fiscal Rule legislation which would have committed the government to target a 1% fiscal deficit has come in for a lot of criticism, most notably from the IMF in their latest Article IV country report. The decision seems to reflect government concerns not to prematurely tie its hands in the face of what might be a quite closely contested election in 2011. Turkey, in the words of Fitch country analyst Edward Parker “somewhat tarnishes its fiscal credibility” by delaying the decision to place limits on budget spending, especially as the move suggests it may run a larger budget deficit next year than planned. At the same time Fitch stressed that it does not make any direct linkage between legislating the rule and future ratings decisions - “Fiscal outcomes are more important than fiscal rules. The path of the budget deficit and goverment debt-to- GDP ratio are likely to be important drivers of future rating actions. The passing or non-passing of rules alone will not be”. Which is indeed fortunate for Turkey, since the latest data showed that the country posted a budget surplus of TRY3.1 billion in August compared with a TRY1.5 billion deficit in the same period last year. So despite credibility slippage, in the short term the strong economic expansion may well assuage concerns about longer term sustainability.

But looking further into the future, as the International Monetary Fund warns: “Failure to pass the rule quickly may forfeit the window of opportunity that could close ahead of the approaching election cycle, and risk weakening the credibility of the authorities’ commitment to fiscal discipline.” Thus by taking what seems to be the easier path now the government may be storing up trouble for the future. Spending the lions share of this year’s excess tax revenues is only stimulating an economy which is not in need of stimulation, whereas saving them would not only be building a cushion for the future, it would also help reduce pressure on the current account deficit by draining some demand from the economy. As Turkish Central Bank Governor Durmus Yilmaz emphasised recently, fiscal and monetary policy simply form different pillars in one common strategy, and the central bank’s ability to keep interest rates low enough to keep make investment sufficiently attractive depends in part on government determination to keep to a medium term plan which limits the deficit. In order to preserve and reinforce domestic and international confidence in the sustainability of public finances, the Turkish government would be well advised to establish a clear and transparent framework for the future development of the deficit. As has unfortunately become only too clear in the case of the current Eurozone crisis, good times don’t last forever, and weakening vigilance when the pressure to take decisions is low often simply stores up even bigger problems for the future. It is far easier to take hard economic decisions when the winds are favourable, than it is when you face a tempest head-on.

Outlook Stable - Gradual Monetary Tightening, Ratings Agency Upgrades and Growing Political Consensus

While Turkey's central bank left its policy rate of choice, the one-week repo rate, unchanged at this months meeting, this decision responds to a number of policy objectives and there is little room for complacency on either the monetary or the fiscal front at this point if undesireable distortions are not to be produced in the real economy.

During the course of the crisis the central bank lowered rates 13 times from their October 2008 high of 16.75 percent, bringing the one-week repo rate to its current level of 7 percent. Evidently the Bank’s objective is to bring the level of interest rates permanently down to well below their historic levels, but their ability to do this is conditional on their success in reducing the endemically high levels of inflation which plague the economy. And as if to offer us a timely reminder that the problem remains with us, as we have noted inflation ticked up again in August to 8.3 percent.

Thus, as the IMF argue, bringing forward a moderate tightening in the monetary environment now could obviate the need for a sharper and larger tightening later on. A delayed tightening could be counterproductive since it might well attract further sizable capital inflows and be detrimental to banks because of their maturity mismatch. Tightening should be broad based with the aim of raising real borrowing costs and moderating inflation expectations. And as Governor Yilamz is arguing even greater recourse to contractionary monetary policy - with all the attendant risks - will be needed if the appropriate fiscal adjustment is not forthcoming.

Monetary tightening does not necessarily mean ongoing hikes in interest rates, removing the vestiges of the credit easing measures introduced during the crisis would also help, for example by tightening loan classification rules and increasing provisioning requirements. Naturally these measures are just as unlikely to prove popular with banks (and the builders and developers they lend to) as are fiscal tightening measures likely to win votes with electors, but in both cases the moves are necessary to provide for the long term health and stability of the economy.

A further measure which could prove useful would be increasing the volume of FX purchases by the central bank, this would serve the dual purpose of reducing liquidity and aiding competitiveness by reducing the impact any upward drift in the Lira produced by increases in the policy rate.

Rating Upgrades In View?

All the above is doubly to the point given that in the wake of the considerable strengthening of its macroeconomic policy framework and financial sector supervision, Turkey has significantly improved its terms of access to international capital markets. As a result, both during the crisis and in the current recovery period, Turkey’s risk premia has evolved very favourably, significantly reducing borrowing costs for government, banks and non-financial corporations. The country’s sovereign credit rating has been upgraded in recent months, although it has not yet reached “investment grade”. Further improvements in Turkey’s international capital market standing are to be anticipated, but in this context it is important that the subsequent lowering in long-term capital costs serves to stimulate long-term sustainable growth, and not get diverted into an unsustainable construction and consumer credit boom of the kind which we have just seen in some CEE peer countries.

Moody's Investors Service recently upgraded Turkey's government bond rating to Ba2 from Ba3, and the outlook was changed to stable from positive. An further upgrade from S&P’s, who raised Turkey's long-term foreign currency and local currency sovereign credit ratings to BB and BB+ in February, would not be a surprise. ." Among other comments of interest they said at the time they believed Turkey's banking system to be one of the strongest and least-leveraged in Eastern Europe and noted that local capital markets are continuing to develop, enabling the government to begin to place local currency debt at maturities as high as 10 years. Their decision to maintain a positive outlook on the rating is a reflection of the possibility of further upgrade over the next 12-24 months. Fitch’s last move was in 2009, when they rated Turkey BB+.

Moody's decision to only move Turkey up one notch was rather conservative, since for reasons best known to themselves the agency still rates Turkey one notch behind Egpyt, but it does reflect the way the agencies are, at least in Turkey’s case, rather behind the curve in comparison with the markets. Turkey CDS (in the 160 to 165 bp range) now consistently trade below higher rated counterparts such as Romania (BB+) and Hungary (BBB-, investment grade).

Turkey’s external debt ratios are still low (gross debt 43.4% of GDP, net debt 26.7%) and the country certainly does not have anything like the problems other emerging European countries have in terms of of the external liabilities of households and corporates. Thus they could live with a weaker currency and they have proven willingness to pay since they did so in 2000/01 when the temptation to restructure must have been very strong.

The principal obstacle to upgrades at the present time seems to be the shelving of the fiscal rule legislation, but matters may well change on this front after next years election.

Essentially, despite the fact that growth will slow somewhat in the second half of the year we still expect Turkey to be the fastest-growing economy in the region, with risks mostly centred on the external environment (growth in the EU, and global risk appetite) although evidently continuing domestic political stability such that consumer confidence is maintained is also critical, and it should be noted that confidence has slipped back in recent months. In this context the result of the recent referendum vote – which was solidly in favour of the government proposed reforms – augurs well for the future.

The outlook is then for growth in the 6 to 7 percent range in 2010, followed by a further 5 percent in 2011, especially with the likelihood of additional pre-election spending on the part of the government. Fixed capital investment should continue increase at a brisk pace in the second half of the year, buoyed in part by faster privatisation - Turkey’s state asset sales agency recently recieved 12 bids for a 36-year license to operate the Iskenderun port in southern Turkey. The port, one of the largest in Turkey, serves south and southeastern Turkey as well as Middle Eastern countries.

At the same time given the robust expansion in domestic consumption – bank credit to households is rising at a 40 percent annual rate – any slowing of demand for Turkish exports from Western Europe as fiscal tightening sets in will not have as much of a dampening effect on GDP gains as it will elsewhere in the region, although there will evidently be some impact. Despite pre-election spending we anticipate a somewhat lower growth rate due to base effects, tightening liquidity and an expectation that export conditions may well remain depressed.

Finally it should be stressed that the country needs to address the two major structural weaknesses which hinder growth. In the first place it needs to stem the loss of international price competitiveness which tends to occur during cyclical upswings, worsening the current account deficit. As growth strengthens, capital inflows gather pace, the exchange rate appreciates, and increases in minimum and average wages accelerate, leading the internal and external imbalances of the economy widen. To make lasting progress in breaking out of this cycle the inflation problem needs to be brought definitively under control via the utilisation of adequate and appropriate monetary and fiscal tools and the implementation of systematic labour market reforms. At the same time, the structurally low employment ratio needs to be corrected, in particular by ensuring improved labour market access for the country’s female population. Only in this way can the excessive dependency ratios be reduced, and the country’s saving ratio increased in a way which reduces dependence on external sources of funding.

More New Things On Spain

2010-09-09T03:27:00.000-07:00

National Bank of Greece plans €2.8bn fundraising

http://www.ft.com/cms/s/0/47bea202-bb22-11df-b3f4-00144feab49a.html

By Anousha Sakoui in London and Kerin Hope in Athens

Published: September 8 2010 09:44 | Last updated: September 8 2010 10:31

National Bank of Greece, the country’s largest bank, is planning to raise €2.8bn ($3.5bn) in new capital, in a move designed to bolster confidence in the Greek banking sector, according to bank officials.

News of the capital raising sent the bank’s shares off 9 per cent in early Wednesday trading, with other Greek banks also suffering – Alpha Bank’s shares were down 4 per cent.

Vassilios Rapanos, NBG chairman, told the Financial Times on Tuesday that the bank would raise €630m in a rights issue and another €1.18bn through a convertible bond issue with a maturity of seven days.

The issue comes amid an eight-month liquidity squeeze on Greek banks, which have been excluded from the wholesale banking market during the country’s sovereign debt crisis.

“This fundraising will give the bank one of the strongest capital adequacy ratios in Europe... it sends a message to shareholders and depositors alike that we can face the future with confidence,” Mr Rapanos said.

The plan is subject to board approval, but could be launched as early as next week. The share capital increase had been previously authorised and was fully underwritten.

On completion, NBG’s capital adequacy ratio would exceed 14 per cent, Mr Rapanos said. NBG plans to raise another €1bn early next year through a public offering of about 20 per cent of Finansbank, its wholly owned Turkish subsidiary, on the Istanbul stock exchange – a plan that has still to be approved by Turkish regulatory authorities.

Credit Suisse, Deutsche Bank, Goldman Sachs, Morgan Stanley and Greece’s state-controlled Postal Savings Bank are underwriting both issues.

The bank would use part of the funds to pay back a €358m capital injection from the Greek government made during the credit crunch. It could avoid drawing down funds from a €10bn bank stability fund set up by the European Union and International Monetary Fund as part of the €110bn bail-out package that enabled Greece to avert a sovereign default this year.

Spanish lenders hasten back to bonds

By Victor Mallet in Madrid

http://www.ft.com/cms/s/0/5eab8258-b9da-11df-8804-00144feabdc0.html?ftcamp=rss

Published: September 6 2010 19:16 | Last updated: September 6 2010 19:16

Spanish banks that were squeezed out of wholesale finance markets in May have returned in force with a series of bond issues since late July and raised more than $4bn in the first five days of September alone, according to company announcements and figures from Dealogic, the data provider.

But both bank executives and analysts say that recent issuance has been confined to the big five listed commercial banks and to La Caixa, the big Barcelona-based savings bank, and that the interest rate spread paid by even strong Spanish financial institutions remains relatively high.

Shunned by investors during the eurozone sovereign debt crisis, Spanish financial institutions issued no covered bonds – a previously popular form of financing secured on mortgage portfolios – in either May or June. Total debt issuance by Spanish banks fell to a negligible $2.3bn in May and $3.8bn in June, Dealogic said.

But since July the Spanish banks and savings banks have again been able to sell covered bonds to international investors. Total debt issuance reached $15.8bn in July, fell back to $1.7bn in the normally quiet holiday month of August, and accelerated again to top $4.1bn so far this month, including $2.5bn of covered bonds.

To add to the total, Santander, the biggest bank by market capitalisation in the eurozone, said it sold on Monday €1bn ($1.3bn) of three-year unsecured bonds at 145 basis points over the benchmark swap rate, amid brisk international demand

Other deals this month include €1bn of three-year covered bonds issued by La Caixa and another €1bn in two-year, mortgage-backed securities – double the initial plan – by Banco Sabadell.

Spanish bankers say they are relieved that wholesale finance markets – previously closed to all but the strongest banks such as Santander, and even then at prohibitively high rates of interest – are once again open.

“It’s a start,” said Iñigo Vega, a banks analyst at Iberian Equities in Madrid. “They are in the market again, which is a good sign. But it’s only six groups, which leaves 50 per cent of the system still out of the market.”

Big Spanish lenders such as Santander, BBVA and La Caixa are not only hogging the debt markets. They are also competing vigorously for domestic retail banking deposits by offering rates of interest to savers that their weaker rivals cannot afford.

In addition to raising medium-term debt, Spanish banks have also found it easier in recent weeks to access short-term liquidity, for example through “repo” transactions using Spanish government debt as security.

In this market too, however, the strongest banks are dominant, leaving weaker cajas, the unlisted savings banks, heavily dependent on the emergency liquidity provided by the European Central Bank.

Fears rise as EU nations aim to raise borrowing

By David Oakley, Capital Markets Correspondent

Published: September 5 2010 12:37 | Last updated: September 5 2010 20:16

http://www.ft.com/cms/s/0/abe5bf60-b8dc-11df-99be-00144feabdc0.html?ftcamp=rss

The eurozone debt crisis is about to enter a critical phase as governments prepare to step up borrowing in the capital markets to fund their faltering economies.

Some strategists are warning that some of the weaker economies could fail to raise the amount of money they need as eurozone governments attempt to issue double the amount of debt this month compared with August.

Eurozone governments will try to raise €80bn ($103bn) in September compared with new bond issuance of €43bn in August. Spain is expected to attempt to borrow €7bn in September compared with €3.5bn in August, according to ING Financial Markets.

Spain, Portugal and Ireland , so-called peripheral eurozone economies, are considered most in danger of being shunned by investors as worries persist over the health of their banks and economies. Greece is no longer a concern because it has emergency loans to cover its funding for the next two years.

Padhraic Garvey, head of rates strategy for developed markets at ING Financial Markets, said: “We are heading into a critical period as the chances rise that a government may fail to raise the money it needs.

“Spain, Portugal and Ireland are the obvious ones to worry about. Are investors willing to stay long, or buy the debt of these countries? I’m still not seeing investors willing to buy into the periphery.”

Some strategists say the return of most investors from holidays this week could increase volatility in these markets because many have put decisions on their portfolios on hold during the summer.

With most investors back at their desks, some could start selling peripheral debt in the coming weeks, particularly as the outlook for the global economy has deteriorated. In spite of some better than expected data out of the US last week, worries about a double-dip recession have increased.

But other strategists insist governments will have little difficulty in funding themselves, even if they have to pay higher premiums or yields to attract investors. They say countries such as Portugal and Ireland have already raised most of the money they need this year.

Government bond yields of the peripheral countries, however, may come under further selling pressure.

Yield spreads against Germany, the eurozone’s benchmark economy, could also widen. On Tuesday, Ireland saw the extra premium it has to pay over Germany jump to a record 356 basis points.

A double-dip recession would hit the economies of Spain, Portugal and Ireland particularly hard, although even core countries, such as France and Germany, could struggle to attract investors, say strategists.

In Europe’s Debt Crisis, Lending Was Still Strong
By JACK EWING
Published: September 5, 2010

http://www.nytimes.com/2010/09/06/business/global/06bi.html?_r=2&ref=business

Even as Europe’s sovereign debt crisis intensified early this year, banks continued to load up on debt from Greece and other countries with the most acute fiscal problems, according to a report released on Sunday.

The report suggests that the European Central Bank inadvertently encouraged institutions to increase their risk as it tried to stabilize the banking system.

Banks increased the amount of credit they extended to governments and the private sector in Greece, Ireland, Portugal and Spain by 4.3 percent, or $109 billion, in the first quarter of 2010 compared with the previous quarter, the quarterly report from the Bank for International Settlements said. The additional credit brought banks’ total exposure to those countries to $2.6 trillion. The Bank for International Settlements, in Basel, Switzerland, serves as a clearinghouse for the world’s central banks.

European banks increased their holdings to the four countries more than banks from the United States or other places outside of Europe, possibly because banks in the euro zone could use debt from Greece and the other countries as collateral for low-interest loans from the European Central Bank, the report said.

The European Central Bank has been lending euro zone banks as much as they want at 1 percent interest, provided the banks could provide collateral like government bonds. The liquidity has helped weaker banks survive periods when they were unable to borrow from other banks or outside investors.

The fact that higher-risk European debt was less liquid, or harder to sell quickly, “was less of a concern for euro area banks than for other banks since the former could ‘liquefy’ this debt in their operations with the E.C.B.,” the Bank for International Settlements said.

The data suggest that the European Central Bank was effectively encouraging euro zone banks to buy debt from Greece and the other troubled countries. The policy supported Greece and Spain as they sold new bonds but also meant that euro zone banks were taking on more risk at a time when the central bank had been trying to stabilize the European financial system.

The central bank has been trying to dial down its support for euro zone banks, but last week extended the policy of unlimited lending to banks at least through mid-January, amid signs that some institutions are still unable to raise all the money they need.

The central bank has tightened its criteria for the collateral. The bank now imposes so-called haircuts of as much as 29 percent on government debt used as collateral, meaning that banks cannot borrow at the full face value of the bonds. That policy could reduce the incentive for banks to buy the riskier debt.

German and French banks continued to be the most heavily exposed to debt from the countries on the periphery of the euro zone. French exposure to Greece alone was $111.6 billion, though only $27 billion of that was government debt. The rest was credit to Greek businesses and individuals, derivatives contracts or other categories. German banks’ exposure to Greece totaled $51 billion, of which $23.1 billion was government debt.

American banks hold $41.2 billion in debt or other exposure to Greece, the report said. Only $5.4 billion of that sum was government debt.

German banks were particularly exposed to Ireland, with total exposure of $205.8 billion, exceeded only by British banks, with $222.4 billion. Almost all the German credit to Ireland was in the private sector, the report said.

The Bank for International Settlements did not give any information on individual institutions, but Germany’s high exposure to Ireland probably stems at least in part from Hypo Real Estate, a bank in Munich. Hypo Real Estate’s subsidiary in Dublin suffered liquidity problems in late 2008. The German government now owns the bank.

Beware the Greeks, though not just yet
Posted by Cardiff Garcia on Sep 03 15:37.

http://ftalphaville.ft.com/blog/2010/09/03/333366/beware-the-greeks-though-not-just-yet/

Here’s an interesting chart ripped from the CFR Geo-Graphics blog:

http://blogs.cfr.org/geographics/2010/09/02/greek-debt-2/

Notice anything strange?

The European Stabilization Mechanism was announced on May 11, the date represented by the blue bar in the middle of each time-to-maturity listed. For maturities of one and two years, the market’s expectation for a default (represented by Greek-German spreads) remains lower than before the ESM was announced. For a three-year maturity, it’s roughly the same as before.

But if you go any further along the timeline, the market is now pricing in more risk than before the ESM came into play.

Why has the market increased its confidence in Greek short-term debt but reduced it for the long-term?

Some of this might be explained by a simple preference for long-term bunds driven by other factors, but CFR offers a less sanguine explanation (emphasis ours):

Greece will happily borrow from the ESM to avoid having to close its primary deficit (that is, excluding interest payments) too rapidly. Yet if Greece is successful in eliminating its primary deficit, its temptation to default will actually grow, as it can wipe out huge amounts of accumulated debt without any longer needing the financial markets to fund current expenditures. If faced with the choice between paying Greek debts and letting Greece default, its northern neighbors may, once their banks are on more solid footing, find it more attractive simply to let Greece default. This is the story line that the markets are now pricing into government bond spreads.

Oh dear.

Bond yields fall below 6%

Irish bond yields hovered below 6 per cent as the Government announced it would split Anglo Irish Bank into two separate entities.

The interest rate or yield on Government 10-year bonds fell back after the Government said Anglo would be divided into a funding bank and an asset recovery unit, which would be wound down over time.

At close, the yield on Irish bonds was 5.991 per cent, down from an earlier high of 6.047 per cent.

Earlier, credit-default swaps on Ireland rose 21 basis points to 402.5, surpassing a previous closing high of 396 in February 2009, according to data provider CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Shares in Irish banks were also hit this afternoon, with Bank of Ireland closing at 70 cent, down about 3 per cent, having been off almost 7 per cent earlier in the session. AIB closed at 75.5 cent, down less than one cent.

Irish Life and Permanent fell 3.66 per cent to close at €1.63.

Credit-default swaps on the nation's banks also soared, with contracts on Anglo Irish Bank climbing 58.5 basis points to 774.5, the highest level since March 2009. AIB jumped 29.5 basis points to 521.5 and Bank of Ireland increased 21 basis points to 409, CMA prices show.

A basis point on a credit-default swap contract protecting €10 million of debt from default for five years is equivalent to €1,000 a year.

Minister for Finance Brian Lenihan and Taoiseach Brian Cowen have insisted the cost of dealing with the problems in Irish banks are manageable because they are spreading the costs out over 15 years and the State has no immediate funding requirements.

But analysts said they need to be more specific.

"They will have to put clarity on the language and clarity on the numbers. This business of saying it's manageable is not going to wash with the markets," said Alan McQuaid, economist with Bloxham Stockbrokers in Dublin.

"The market is saying, 'You are trying to juggle too many balls, you're weighed down by Anglo and you are not going to be able to generate enough economic growth and implement fiscal austerity and meet budget targets by 2014, it's just impossible,' that's what the market is telling you."

A senior member of German chancellor Angela Merkel's party said today that Ireland, Portugal and Spain probably won't need support from the euro zone rescue fund.

The €440 billion European Financial Stability Facility, headed by former European Commission official Klaus Regling, was set up in May as the Greek debt crisis threatened to spill over to other euro states.

"I see - and Mr Regling stressed that as well in the past days - that the stabilisation fund is probably not going to be used," Leo Dautzenberg, parliamentary Finance Committee spokesman for Ms Merkel's Christian Democratic Union, said today in an interview.

In a speech in Riga, Ms Merkel said that debt-laden governments must stick to their deficit- cutting programs because Germany won't agree to have the euro fund turned into a permanent facility to provide aid.

"The crisis mechanisms now in place are temporary," she said in the Latvian capital. "Germany won't agree to an indefinite prolongation. Otherwise, people would say 'we've got such a nice rescue package in place that this can go on forever.'"

New and Things

2010-09-08T22:42:00.000-07:00

Fall in German exports signals slower growth
By Ralph Atkins

http://www.ft.com/cms/s/0/e6a6e508-bb1a-11df-b3f4-00144feab49a.html

Published: September 8 2010 09:32 | Last updated: September 8 2010 09:32

German exports fell in July in the latest sign that growth in Europe’s largest economy is slowing.

News of the 1.5 per cent decline on the previous month, reported by the German statistical office, followed figures earlier this week that showed growth in industrial orders had also cooled more than expected in July.

They added to evidence that after a strong growth spurt in the three months to June, the pace of expansion would moderate over the rest of the year.

Exports powered Germany’s climb out of last year’s deep recession, buoyed especially by demand from China, for instance for luxury German-made cars. Despite the latest month-on-month decline, German exports in July were almost 19 per cent higher than a year before.

Even if German growth slows over the rest of the year, economists generally do not expect a double-dip back into recession. Although worries have grown about the outlook for the US economy, demand for German exports from Asia is expected to remain robust.

Germany’s recovery had also broadened beyond exports. The figures showed imports had risen faster over the past year. In July, imports were almost 25 per cent higher than a year before, although compared with the month before they were down 2.2 per cent. The year-on-year increase was probably the result of a surge in goods and materials imported to manufacture products that were then exported, but it could also have reflected a pick-up in domestic demand.

Germany’s economy will feel the impact of fiscal austerity programmes across the eurozone, compounded by the weakness of the southern European economies worst hit by this year’s crisis over public finances.

But Carsten Brzeski, economist at ING in Brussels, pointed out that Spain, Portugal, Greece and Ireland accounted for only about 5 per cent of German exports in the first half of this year. “German exports are now normalising,” he said, but “even at a slower pace, the export sector should remain an important growth driver”.

ECB steps up eurozone bond buying
By David Oakley and Jennifer Hughes in London and Kerin Hope in Athens

Published: September 8 2010 19:30 | Last updated: September 8 2010 19:30

The European Central Bank has stepped in to shore up the eurozone government bond markets in what appears to be its biggest such intervention since early July. The ECB has bought between €100m and €300m of Greek, Irish and Portuguese bonds so far this week, traders said on Wednesday, as worries over the health of some highly indebted eurozone economies resurfaced.

Yields on Greek bonds rose to levels last seen before the €750bn emergency rescue package was launched to avert the collapse of the eurozone bond markets in May.

Although the amount of bonds bought by the ECB this week has been small, some strategists said the purchases were a sign that the European sovereign debt crisis was not over.

The ECB has bought €61bn in government bonds – mostly of the weaker eurozone economies of Greece, Ireland and Portugal – since it launched its intervention programme on May 10 as part of the multibillion-euro international bailout.

It bought €16.5bn in bonds in the first week of the programme but has since scaled back its buying. In recent weeks, as the eurozone crisis appears to have eased, it has bought only very small amounts of government debt.

The so-called peripheral bond markets of Greece, Ireland and Portugal have come under pressure as doubts over their economies and banks have deepened.

Greek yields for two-year bonds jumped nearly a quarter of a point on Wednesday to 10.33 per cent, while Irish yields edged slightly higher to 3.21 per cent. Portuguese two-year yields were flat at 3.28 per cent.

Portuguese auctions of three-year and 11-year bonds were well subscribed, although traders said the government had to pay high yields to attract investors.

Market confidence in Greece was hit by numbers showing that the country sank deeper into recession in the second quarter and fears that street protests were about to resume.

Domenico Crapanzano, head of euro rates sales and trading at Jefferies, said: “Hopes that the eurozone debt crisis had seen the worst are premature. It is far from over.”

Steven Major, head of global fixed-income research at HSBC, said: “Many investors are still reluctant to buy the bonds of the weaker eurozone economies, even at very high yields.” Across the eurozone as a whole, one of the biggest concerns has been the state of the European banking sector, in Germany as well as in the weaker economies.

The Basel Committee on Banking Supervision and the Group of Governors and Heads of Supervision, are set to finalise on Sunday banks’ minimum level of so-called tier one capital.

ECB: Bank Rules Will Be Eased In

http://online.wsj.com/article/SB10001424052748703453804575479040076363192.html?mod=WSJEUROPE_hpp_LEFTTopWhatNews

FRANKFURT—Tighter standards for banks' capital and liquidity won't hurt the economy, European Central Bank governing council member Axel Weber said Wednesday.

Mr. Weber told a banking conference the lengthy transition phase foreseen by international regulators working on the new requirements, known as Basel III, will help to ensure that banks don't find themselves too overburdened and unable to lend.

"The real challenge lies in bringing harmonized international rules into line with differing national circumstances," Mr. Weber said.

He said the aim of greater systemic stability wasn't an end in itself, and that the economic costs of the 2007 to 2008 banking crisis had been immense.

German regulators had expressed reservations about the preliminary agreement reached by international regulators in July on new standards for bank capital and liquidity. The Bank for International Settlements' committee of Governors and Heads of Supervision intends to agree a more detailed version of the requirements next week.

Europe's Bank Stress Tests Minimized Debt Risk

http://online.wsj.com/article/SB10001424052748704392104575475520949440394.html

LONDON—Europe's recent "stress tests" of the strength of major banks understated some lenders' holdings of potentially risky government debt, a Wall Street Journal analysis shows.

As part of the tests, 91 of Europe's largest banks were required to reveal how much government debt from European countries they held on their balance sheets. Regulators said the figures showed banks' total holdings of that debt as of March 31.

At the time, worries about banks' government-debt holdings were fanning fears about the health of Europe's banking system as a whole. Release of the bank data was considered the main benefit of the stress tests, which were widely criticized as being lenient overall.

An examination of the banks' disclosures indicates that some banks didn't provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for "short" positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July.

Because of the limited nature of most banks' disclosures, it is impossible to gauge the number of banks that excluded portions of their sovereign portfolios from their disclosures, or the overall effect of that practice.

But the exposure to government debt of at least some banks, such as Barclays PLC and Crédit Agricole SA, was reduced by a significant amount, according to industry officials and financial filings made by the banks. Adding to the haziness, the stress tests' reported sovereign-debt levels differed, sometimes widely, from other international tallies and from some banks' own financial statements.

The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe's financial system. "That would certainly be unhelpful to people's perceptions" of the tests' credibility, said UBS banking analyst Alastair Ryan. Reducing banks' reported holdings of government debt "was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there's not a problem."

Representatives of several banks said they were simply following the guidance provided by the Committee of European Banking Supervisors, the London-based group that coordinated the tests. A CEBS spokeswoman declined to comment.

The stress tests' upbeat results—only seven banks flunked, and were deemed short of just €3.5 billion ($4.51 billion) of capital—initially soothed markets. But fears have flared up again as heavily indebted countries like Ireland and Greece continue to struggle. Among other warning signs, the costs of insuring many bank and government bonds against default in countries such as Portugal, Ireland, Greece and Italy have jumped above their pre-stress-test levels.

There's no established protocol for how banks should report these holdings. Until recently, investors generally didn't worry about government-debt holdings, viewing them as essentially risk-free. So most banks simply lumped the holdings into broader asset categories on balance sheets.

Things changed last spring as fears of government defaults intensified. Greece for a time appeared poised to default on its public debts, until a massive European Union bailout defused that crisis.

The banks based their stress-test disclosures on a template provided by CEBS. The template asked for banks to disclose their "gross" and "net" exposures to sovereign risk in each E.U. country. Most banks' disclosures didn't define "gross" and "net" beyond saying that the latter were "net of collateral held and hedges."

The implication was that the disclosures—particularly the gross exposure figures—were all-encompassing. In a document it published along with the test results, CEBS said "the disclosure of total exposures to sovereign debt by individual banks allows for a full assessment of their respective capital positions."

But some banks' figures didn't represent their total holdings. Barclays, for example, excluded some government bonds it was holding for trading purposes. The rationale, according to Barclays officials, was that the bonds were directly related to transactions the big U.K. bank was performing for corporate or government clients, and that the holdings vary widely from day to day. Barclays didn't disclose that it wasn't listing its full holdings.

Excluding the bonds reduced Barclays' portfolio of Italian sovereign debt—which the bank said was £787 million ($1.22 billion)—by about £4.7 billion, Barclays officials said. The bank's holdings of Spanish government bonds, listed at £4.4 billion, shrank by about £1.6 billion.

Barclays said it excluded the holdings based on guidance from CEBS, which was communicated to the bank via the U.K.'s Financial Services Authority. "We've done exactly what CEBS told us," a Barclays spokesman said.

An FSA spokeswoman declined to comment.

The Barclays officials said they believe other big European banks also excluded significant slices of their trading portfolios from stress-test disclosures.

In its midyear results last month, Barclays reported its sovereign-bond portfolios based on a broader definition than the stress tests used. As a result, Barclays' reported holdings of debt issued by the Italian, Spanish and Irish governments swelled.

Other banking companies excluded bonds held by subsidiaries. France's Crédit Agricole didn't count sovereign debt held by its insurance unit. A Crédit Agricole spokeswoman said the company followed guidance from regulators.

Some banks' figures also were whittled down by accounting for "short" positions they held in various countries' debt. For example, if a bank held €100 million of Greek debt and €25 million of short positions in Greek debt, the gross figure was listed as €75 million.

CEBS didn't disclose that the banks were calculating the figures in that way.

It was unclear how much that practice reduced the gross exposures that banks reported. A few banks, including Barclays, opted to provide investors with more comprehensive figures—in which short positions were not netted out—as part of their midyear results.

There are other signs that banks' disclosures understated the actual government-debt exposure in the European banking system. Jacques Cailloux, chief European economist at Royal Bank of Scotland, compared banks' stress-test disclosures with figures compiled by the Bank for International Settlements. His conclusion: The BIS data shows banks in some countries holding far more sovereign debt than was picked up in the stress tests.

BIS data from March 31 indicates that French banks were holding about €20 billion of Greek sovereign debt and €35 billion of Spanish sovereign debt. In the stress tests, four French banks, which represent nearly 80% of the assets in France's banking system, reported holding a total of €11.6 billion of Greek government debt and €6.6 billion of Spanish debt.

Spanish Bonds

Investors are putting European governments under renewed scrutiny. The extra yield that investors demand to hold Spanish 10-year debt over German bunds has surged 36 basis points since July 27, touching 185 points yesterday. It hit a euro-era high of 221 points on June 16.

The spreads on Irish and Portuguese debt this week climbed to 373 basis points and 354 basis points respectively, the highest since at least 1997. In Belgium, which still doesn’t have a government 2 1/2 months after inconclusive elections, the spread on its 10-year bonds was the highest since July.

On the budget, Zapatero’s room for maneuver has narrowed since August, when borrowing costs were falling so fast that he said the government could reverse some spending cuts. The spread widened 35 basis points in the four days after his comments.

Portugal's borrowing costs jump in bond sale
By BARRY HATTON

http://www.businessweek.com/ap/financialnews/D9I3N4VO0.htm

LISBON, Portugal

Portugal raised euro1.04 billion ($1.3 billion) in a debt auction Wednesday that drew strong investor interest, but the sharply higher borrowing cost reflected market concerns that Europe's debt crisis may be flaring up again.

Portugal, which in recent years has generated little wealth and piled up heavy debts, is regarded as one of the most financially vulnerable countries in the 16-nation eurozone.

Portugal's Public Debt Management Agency said it sold euro378 million in 11-year bonds and euro661 million in 3-year bonds. However, the average interest yield on the longer bonds was 5.973 percent, up from 5.312 percent on 10-year bonds at an auction last month. The 3-year bond yield was 4.086 percent, up from 3.62 percent in a 4-year bond auction in July.

"Portugal is seen to some extent as the eurozone's weakest link" after Greece and Ireland, said Filipe Silva, a debt manager at Banco Carregosa in Porto, Portugal. "Investors are ready to take a risk but they will only do it at a higher price."

Portugal's financial difficulties could aggravate international fears about the continent's broader financial problems.

The Wall Street Journal reported on Tuesday that EU stress tests of 91 banks in July understated some of their holdings of potentially risky debt. That fueled market concerns about underlying weaknesses in the bloc and wider fears about the strength of the global economic recovery.

Despite its fragile economy Portugal has had no difficulty raising funds on international markets this year, and the agency said there was demand for more than twice the amount available. But the success has come at the price of steadily rising borrowing costs.

Moody's Investor Service in July downgraded Portuguese bonds to A1 from Aa2, citing sluggish growth prospects.

Portugal, along with Spain and Ireland, is widely seen as a potential candidate for a bailout like the one provided to Greece to keep it from defaulting on its debts.

That has pushed up the government's borrowing costs just as it is trying to cut spending.

The center-left Socialist government has adopted an austerity plan which seeks to reduce to budget deficit to 7.3 percent this year from 9.3 percent in 2009.

Its record has been patchy so far. The Finance Ministry reported last month that although tax revenue this year was up almost 6 percent through July, primary current spending also jumped 5.7 percent. The increase stemmed from larger welfare payouts amid a jobless rate that has risen to 11 percent, according to EU figures.

Ireland, Portugal Probably Won't Tap EU Fund, Coalition's Dautzenberg Says

http://www.bloomberg.com/news/2010-09-08/ireland-portugal-probably-won-t-tap-eu-fund-coalition-s-dautzenberg-says.html

Portugal, Spain and Ireland, all of which saw their bond-yield spreads over Germany rise this week, probably won’t need support from the euro-region rescue fund, a senior lawmaker from Chancellor Angela Merkel’s party said.

The Luxembourg-based 440 billion-euro ($558 billion) European Financial Stability Facility, headed by former European Commission official Klaus Regling, was set up in May as the Greek debt crisis threatened to spill over to other euro states.

“I see -- and Mr. Regling stressed that as well in the past days -- that the stabilization fund is probably not going to be used,” Leo Dautzenberg, parliamentary Finance Committee spokesman for Merkel’s Christian Democratic Union, said today in an interview.

Irish and Portuguese government bonds fell yesterday, pushing the yields on 10-year securities to records versus benchmark German bunds. In a speech in Riga the same day, Merkel said that debt-laden governments must stick to their deficit- cutting programs because Germany won’t agree to have the euro fund turned into a permanent facility to provide aid.

“The crisis mechanisms now in place are temporary,” Merkel said in the Latvian capital. “Germany won’t agree to an indefinite prolongation. Otherwise, people would say ‘we’ve got such a nice rescue package in place that this can go on forever.’”

European central banks bought Greek, Irish and Portuguese bonds today, according to a trader involved in the transactions, as the securities’ premiums to German debt surged for a third day.

The Portuguese-German 10-year bond spread widened as much as 18 basis points to 372 basis points today, and was at 363 points as of 12:23 p.m. in London. The Irish-German spread was 8 basis points wider at 381 basis points.

The rescue fund, which is limited to three years, is the main part of a 750 billion-euro aid package hammered out by European Union finance ministers to combat a sovereign debt crisis. Another 60 billion euros will come from the commission - - the EU’s executive arm -- and 250 billion euros from the International Monetary Fund.

ECB chief needs to be much bolder

http://www.irishtimes.com/newspaper/finance/2010/0908/1224278447559.html

ANALYSIS : Trichet has the power to calm market fears – he should exercise it, writes DAN O'BRIEN, Economics Editor

IF THE massive rescue package agreed by the European countries in early May was about calming market fears, it is clearly not working.

Yesterday’s developments in the government debt market saw yields on Irish government bonds soar past the peaks reached at the height of the crisis in late April and early May. Other peripheral countries also experienced big increases. This is alarming.

The EU rescue package brought the situation back from the brink in May, but within weeks, yields on the weaker countries’ debt began to rise, sometime in leaps, sometimes in baby steps, but almost always in a ratchet-like fashion.

Apart from Greece, Ireland and Portugal have been the most seriously affected. Spain is in the firing line, but to a lesser extent.

The latest ratcheting up of yields for the peripheral euro-area countries appears to have been caused by a number of factors, including a continued weakening of sentiment towards Ireland. Negative comments on European banks in the Wall Street Journal and a downgrading of AIB and Bank of Ireland by Dublin stockbrokers Davys added to fears yesterday.

The euro area can be likened to 16 climbers roped together on a mountain in appalling weather conditions. Greece has gone over the edge. The other 15 can easily take the strain of keeping the Greeks dangling, however uncomfortable it may be for them. Ireland is now closest to the edge, and moved even closer yesterday. Just behind it is Portugal, and a good bit further back is Spain. If all three go over, 12 countries will be supporting four, something that the May bailout package anticipates as a worst-case scenario.

Thankfully, the mountaineering metaphor is less applicable since the European Central Bank was given new powers as part of the rescue package in May. These powers allow it to go into the market where government bonds are traded and, using the money it prints, buy up bonds.

There is, in theory, no limit to the amount it can print. This means there is no limit to the amount it can buy. This is a formidable weapon. It has been timid in deploying it.

Whereas it bought tens of billions worth of bonds in the weeks after it was first given this power, in July and August it effectively ceased doing so. Over the past three weeks, it has been more active, buying more than €650 million worth. But this is a small amount relative to the size of the market, and it has clearly not stemmed the panic.

The future of the euro is not in question yet, but if the slide is allowed to continue, it could be.

This is now the European sovereign debt crisis, Mark II. Jean Claude Trichet needs to be much bolder. He has the power to calm the panic. He should exercise it.

Also.....

Credit default swaps (CDS) for Portugal, Spain, Italy, and Belgium have all surged this week. Markit's stress gauge for the group is now higher than during the debt crisis, when the EU launched its €440bn bail-out fund and the European Central Bank began buying eurozone bonds.

Joachim Fels, chief global economist at Morgan Stanley, said strains had reached a point where "one or several governments" may soon have to tap soon the rescue mechanism.

"Neither the European sovereign debt crisis nor the banking sector crisis has been resolved and both continue to mutually reinforce each other," he said, adding that the EU's stress tests for banks had failed to restore confidence.

Investors are bracing for a flood of fresh bond issuance, while concern is mounting that austerity measures in Ireland, Greece, and Spain have left these countries trapped in a downward spiral.

Charting The Way

2010-08-30T12:48:00.001-07:00

Polish Trade

2010-08-30T05:57:00.000-07:00

The Odd Couple

2010-08-22T06:56:00.001-07:00

The modern world moves at a breathtaking pace, even when most of us find ourselves on holiday. No sooner do we receive, read and start to digest one set of economic data than we find ourselves pushed to think about what the next set will look like. The clearest recent illustration of this undoubted reality is to be found in peculiar twist of events which meant that just as the news reached us that the German economy had expanded at a record rate in the second quarter, at almost the very same moment Federal Reserve officials meeting in Washington decided to significantly downgrade their economic outlook for the United States, saying the “pace of recovery in output and employment had slowed in recent months” and was likely to be “more modest” than anticipated in the near term. But this followed a month of May when it seemed Europe's economies were on the brink of disaster, while over in the United States some sort of recovery was on the cards.

So what is going on here, does the earth switch it’s magnetic pole every six months, with what went up last time round now going down? Or could it possibly be some kind of common thread here, one common factor which unites the unprecedented expansion we have just seen in Germany, and the fears of renewed recession in the United States. Well, as it happens, indeed there could, and it has a name - the Greek debt crisis.

Structural Problems In The Currency Architecture?

So what is the link? Well, the fact of the matter is that we live in a bi-polar world, at least as far as currencies are concerned. Until our current global financial architecture evolves into something more sophistocated, we have two main currencies which rival one another for pride of place in central bank reserves and investment portfolios: the euro and the dollar, and when one of these goes up, the other must come down, and vice versa. It is as simple, and as complicated, as that.

Prior to February, and the outbreak of the European Sovereign Debt Crisis the US economy was seen as the weaker partner, and the euro was priced at a relatively high level. Then the euro slumped (falling at one point from around 135 to 120 to the US dollar in a matter of weeks) as attention focused on what appeared to be significant weaknesses in the Eurozone infrastructure. As a result of the change German exports boomed, while the US economic recovery steadily started to grind to a halt.

And with the rise of the dollar the global economy started to fall back into dangerous - pre crisis – habits. The US trade deficit started to open up again, and one exporting nation after another started to see yet one more time the US market as the global economy's consumer of last resort. Indeed the US June trade statistics reveal the extent to which American consumers are once more sucking in large quantities of imports as their spending power recovers, while weak demand in the rest of the world coupled with the comparatively high dollar has been keeping a brake on American exports.

As the New York Times put it in an editorial, "China is mopping up demand everywhere you look with its artificially cheap supply of goods, while Germany, the world’s other exporting power, is cutting its budget and relying on foreign demand to drive its economic rebound. This isn’t sustainable".

And the numbers prove the point. The United States trade deficit ballooned to $49.9 billion in June, the biggest since October 2008. In July, one month later, China recorded a $28.7 billion trade surplus, the biggest since January 2009. In the first five months of the year, Germany’s trade surplus, driven in large part by demand for machine tools in recovering Asian economies (many of them busily sending exports to the US), rose 30 percent compared with 2009.

And this impression is only confirmed when we come to look at the latest revision for US GDP in the second quarter. According to the revised data, US GDP increased at an annualised 1.6% rate (as compared with the 9% annual rate in Germany), after registering a 3.7% rate in the first quarter, according to the Bureau of Economic Analysis (BEA) today. The second-quarter growth rate was revised down by 0.8 percentage point from the “advance” estimate (of 2.4%), in part as a result of the new data on imports for June. The US Bureau of Economic Analysis report stated that slower GDP growth primarily reflected a surge in imports compared with the previous quarter and a slowdown in inventory investment. In fact, real exports of goods and services increased at a 9.1% rate in the second quarter, compared with an increase of 11.4% in the first, while real imports of goods and services increased by 32.4%, compared with an increase of 11.2% in Q1.

Effectively the American economy is simply too weak to carry this additional load, and is now showing signs of heading back towards recession, forcing the Federal reserve, which only a few months ago was moving towards a tightening in monetary policy to fend off inflation to now re-assert its policy of quantitative easing to avoid any posssibility of a drift towards deflation.

Meanwhile the German economy turns in a 2.2 per cent quarterly growth spurt, unified Germany’s best-ever performance. The annualised 9 per cent growth rate, is, as the Financial Times noted, virtually unprecedented in developed economy terms. Such dramatic changes, rather than reassuring us that all is well, only lead to even more doubts. Is it really desireable for an economy to shoot forward so dramatically, only to fall back again in the second half, which is what almost everyone (Monsieur Trichet included) expects to happen?

Not only does the German performance seem exaggeratedly large, at the other end, on Europe's periphery, the result was lamentably small. Greece naturally exceeded everyone's expectations, on the downside, with a 1.5 per cent quarterly contraction (a 6 per cent annual rate), but Spain remained at the bottom end of the range, with a 0.2 per cent expansion, as did Portugal. Undoubtedly the Greek contraction will slow as the year advances, but the outlook there continues to be preoccupying. Only today the Greek manufacturing PMI, which showed the contraction in Greece's industrial sector accelerated again in August, has reminded us of just how difficult it is going to be for the country to return to growth, and especially if the external environment now starts to deteriorate.

As the FT's David Oakley said yesterday, in many ways Germany could be said to have had a "good crisis", since the Greek issue pushed the Euro down and German exports up, while the current flight to safety is driving down the yield on German bunds to record lows even as it pushes up the spreads for peripheral Europe sovereigns. Among other imapcts this gives German companies an even greater competitive advantage as their capital costs come down even while those for their competitors go up.

Spreads – which are the additional borrowing premiums countries have to pay over benchmark Bunds – hit a fresh record of 357 basis points in Ireland this week, following problems in Allied Irish bank and a Standard & Poor's downgrade. In Portugal and Spain, spreads have been creeping back up, and are now once more close to their all-time highs. Spain’s 10-year bonds are trading at about 192 basis points above Germany, compared with 57 at the start of the year while Portugal is trading at 333 basis points, compared with 67bp on January 1.

All three economies are experiencing extremely weak growth and Ireland is even flirting with deflation. Higher government borrowing costs can harm economies in a number of ways, from higher borrowing costs for companies to added pressure on a country’s public finances as more is eaten up in interest charges, leaving less for public services and stimulus. Effectively the presence of a large spread differential means that monetary policy is applied unevenly across the Euro Area, despite the "one size for all" objective of the ECB. And doubly so with a credit crunch which means some banks struggle to finance as a backdrop.

And as if all of this wasn't enough, Germany's main competitor in Asia (where German exports have been clocking up large increases) has been effectively KO'd by the flight to safety produced by the Sovereign Debt Crisis. Japan's exchange rate against the USD dollar is now hovering around a 15 year high.

The consequence of this is not hard to predict, while Germany clocks up record exports to China and other parts of the continent, the Japanese "recovery" is gradually grinding to a halt, as the latest manufacturing PMI report only confirms.

We Need To Seriously Address The Imbalances

At the end of the day it is hard to avoid the conclusion that we continue to live in a very unbalanced and essentially economically unstable world, where currency valuations and economic growth rates fluctuate with unnerving rapidity. Not only that, the recent Federal Reserve meeting seems to have constituted some sort of defining moment, the point when everyone finally recognises that the long promised recovery was no longer simply weeks or months away, and that emerging from the trough in which the developed economies find themselves is going to involve a long period of slow and painful effort, one where we will also need time to clean up the mess we have made in cleaning up the original mess, assuming that is that we have the dynamism and energy to do so.

On thing is clear, the old habits won't work any better now than they did before 2007, and external deficits which were not sustainable then will not be sustainable now. So we need a new model, a model in which the emerging markets will have a much larger role to play than ever before. And if we are to move towards a more sustainable future, then we need to move beyond those simplistic headlines stressing the virile nature of Germany's export prowess. There is no doubting the efficacy and competitiveness of many German companies, but for that very reason that country needs to shoulder more of the responsibility for sharing the burden which is involved in finding solutions. Here in Europe we don't only need sacrifices in the South, some of them also need to be made in the north. German industry is enjoying real and tangible benefits (via artificially low interest rates and an undervalued currency) from the mess that the Greeks created for themselves, but in the interest of all European some of those benefits need to be plowed back in again, since if Greece is allowed to fail, no one will be the winner.

Looking farther afield we need to think about how to best aid and abet the emerging economies in their quest for growth and better living standards. Earlier in the crisis I asked Nobel Economist Paul Krugman a question which is very much to the point. “At a time when the financial crisis is generalised across all developed economies - whether because those who borrowed the money now have difficulty paying back, or those who leant it now struggle to recover the money owed them - to which new planet are we all going to export?”

My response to him back in January was that maybe we don't need to look so far afield. Many developing economies badly need cheap and responsible credit lines, and access to state-of-the-art technologies, so why not accept the world is changing, and go for some sort of New Marshall Plan, one capable of generating a win-win dynamic which would be in all our interests? At the time the proposal seemed totally unrealistic and unobtainable. Now, with every day which passes it starts to look essential. And who knows, maybe the rise of a number of other major economic powers would help solve that bipolar currency problem which is currently causing our policymakers so many headaches.

Bulgarian Things

2010-08-20T07:49:00.000-07:00

As the IMF say in their most recent staff report, the present economic crisis raises the question of whether potential output growth in Bulgaria in the years to come is going to be markedly lower than it was during the boom years. As the IMF point out, the current recession was preceded by an investment boom in construction, real estate and the associated financial sectors. Now that the boom (which was always unsustainable, Bulgaria's current account deficit in 2007 hit almost 27% of GDP) is well and truly over in these sectors, the strong associated decline in investment could have large negative effects on output. Moreover, it will take considerable time for the excess labor and resources to be absorbed by other sectors, which suggests that the rate of unemployment may rise and remain higher. Not a uniquely Bulgarian story, but none the less preoccupying for that.

After several years of strong increases (around 6% a year) Bulgarian growth declined sharply in 2009 after the economy was hit hard by the global economic and financial crisis.

Capital inflows, which had been keeping the current account deficit afloat, dropped from a peak of 44 percent of GDP in 2007 to less than 10 percent of GDP in 2009. As a result, investment fell by nearly 30 percent, after rising more than 20 percent annually during the previous two years.

Employment also started to fall, while the unemployment rate rose rapidly, hitting a seasonally adjusted 9% in March and April this year, according to Eurostat seasonally adjusted data.

The question the IMF ask, about whether Bulgaria will be able to return to the high growth rates of 2001–08 is no idle one, since with a shrinking and ageing population, and an external debt which stands at around 110% of GDP, sustainability in the medium term means finding a level of growth which can enable to country to pay down its debt and support its pension and health systems.

Apart from the obvious demographic impediments the country faces, there are other reasons to think that getting back to moderate sustainable growth may be more difficult that it initially appears. In the first place, Bulgaria operates a currency peg with the euro, yet during the boom years the country had very high inflation rates.

As a result a sharp loss in competitiveness occured, a loss which, as the IMF point out, was not accompanied by any substantial corresponding productivity gain.

The other evident consequence of this loss of competitiveness was that the country developed a trade deficit, a deficit which though it has reduced following the collapse of imports still exists. In order to return to sustainable (export lead) growth, this deficit needs to become a surplus.

Growth during the boom years was driven by large capital inflows that fueled strong growth in the non-tradable sector. As capital inflows are likely to stabilize at a level well below that of the boom years, and growth in the non-tradable sector is likely to remain weak at best, growth would only be high if the tradable sector takes over as an engine of growth. And with lower investment, the robust employment growth the country saw during the years 2001–08 will be difficult to reproduce. Much of the strong employment growth was driven by strong growth in the non-tradable sector. Total employment rose by 20 percent during this period, of which 15 percent was the contribution from the construction, real estate, wholesales and financial service sectors.

So the country (like so many others in the East and South of Europe) must now make a major shift from non-tradeables to tradeables, and this in the context of a currency peg (and a significant level of external indebtedness) is not going to be an easy task.

Signs of Recovery

Bulgaria does not publish seasonally adjusted quarter-on-quarter growth numbers, but given that the economy only shrank by 1.5% year-on-year (according to the flash estimate published by the statistics office on August 13), which was the lowest figure recorded since the country entered a recession in the first quarter of 2009 (and down from an annual drop of 5.9% in Q4 2009), the economy does at least seem to have stabilised.

As for the details agriculture contributed to the improvement, with an increase of 1.6 per cent year-on-year, while the services and industrial sectors only declined by 1.7 per cent and 0.3 per cent, respectively. Private consumption, which was one of the main drivers of economic growth in earlier years, was down an annual 7.6 per cent for the quarter, while investment was 1.4 per cent lower. So there has been no real improvement in private consumption, nor should we expect to see any in the near term.

Retail sales seem set on a long steady downward path (similar to that seen in other countries in the region with declining populations) and again, this is unlikely to turn around in any sustained way.

Domestic demand is likely to remain flat to downwards for some considerable time, as the numbers for household and corporate borrowing (which are not moving upwards at all) tend to confirm.

Despite an increase in exports and continued decline of imports, the trade gap for the second quarter was expected to be 4.2 per cent of GDP.

Long Term Growth Trend Headed Way Down

As the IMF stress, potential growth in Bulgaria is surely set to decline further in the longer term. Bulgaria faces a serious problem of aging population. The median age is now through the critical 40 barrier, and headed on up towards the 45 range, in a country where male life expectancy is some 10 years below the West European average.

Bulgaria's population has been falling for a decade now, and is projected to decline by a further 28 percent between 2008 and 2060, while the old age dependency ratio would exceed 60 percent in 2060.

This population drop is already affecting the working age population, which is already in decline, and is forecast to fall by an additional 25 percent over the
next 50 years.

As a result, the EU 2009–12 Convergence Programme is forecasting a steady decline in potential growth to 0.3 percent in 2050, and this even with a totally unrealistic (in what will then be such an old population) labor participation rate of 70 percent. Personally, I think these numbers are way, way to optimistic, and all of this is badly in need of calibration based on what is already happening in ageing societies like Germany and Japan.

And Bulgaria has another handicap: the large number of Bulgarians who now live and work abroad. The worrying thing is that we don't know how many such workers there are, since the migration data from Bulgarian statistics hardly acknowledges they exist (same situation in Latvia, see this study), using the argument that only those who officially inform them they are emigrating count as migrants.

So how do we know they exist, because these migrants send home remitances, and the World Bank attempts to track them. According to World Bank data (and my calculations), migrants sent home remittances to the order of an estimated 5.3% of GDP in 2009. Not small beer this at all.

But what, you may ask is a country with rising external debt (the IMF is assuming the CA deficit continues to 2015, at least)and falling and ageing population doing exporting its workforce? A good question. And why is no one seemingly concerned about this issue? Another good question. And why are neither the EU Commission and the IMF raising the problem in the studies of the country. Oh, there are no shortage of questions here.

So, Bulgaria as a country is certainly not short of problems. What with the evident demographic ones, and the limitations of the currency peg, it is hard to see how they are soluable. To put it bluntly, Bulgarian industry only accounts for some 18% of GDP (in value added terms). If we assume as a rule of thumb that about 50% is geered to the domestic market, then this means that Bulgarian GDP is going to have to leverage itself forward through growth in about 10% of its output, while other sections shrink. A difficult, if not impossible task.

And there are more problems. As the IMF point out, Bulgaria’s fiscal situation is challenging, since the earlier revenue boom has come to an end, while expenditure pressures are considerable. The pre-crisis revenue boom, was fuelled by higher receipts on goods and services on the back of Bulgaria’s rapid domestic demand growth, but returning to pre-crisis revenue levels will be a major challenge, not only because the economy is expected to recover slowly but also because the growth pattern will need to shift, with less contribution from domestic demand and more contribution from the external sector, which will result in lower tax revenues. And since Bulgaria's treasury is stongly dependent on VAT, and exports evidently don't attract VAT, the situation becomes even more difficult.

In the short term the debt to GDP ratio is pretty low (15% only in 2009), but any faltering in the peg at some point, and that could change quickly.

Spain's National "Dinero B"

2010-08-16T12:25:00.000-07:00

Well, before we go any further, I would like to make clear that what we are talking about here is not anything illegal, or even irregular (things like this must be going on in almost all Euro Area countries even as I write). Bending of the rules? Perhaps. Taking them to their limit? Certainly.

What Spain's central, local and regional government does is take advantage of loopholes in Eurostat accounting regulations to generate debt that really is debt, but is not classified as such according to the Eurostat excess deficit criteria. Areas in volved are debts on the balance sheets of state (or regionally, or locally) owned companies, overdue payments for receivables (very common practice in Spain), and public private partnership type leaseback arrangements. None of these are (typically) classified as debt, though they do all have to be paid at some point, which means there is a stream of revenue (flow) impact rather than a debt stock one (unless and until Eurostat changes the rules). Which means that while they do not impact that critical debt to GDP number, servicing these liabilities does exaccerbate the annual fiscal deficit one. Which is why ultimately bringing Spain's fiscal deficit under control will almost certainly prove to be much harder work than it seems.

We are able to make this comparison since the Bank of Spain effectively maintains a double entry book keeping system, whereby it keeps one record under the National Financial Accounts of the total debt , while at the same time keeping a separate record of debt as classified for the EU Excess Deficit Procedure.

As we can see in the chart below, total gross government debt in Spain as classified in the Financial Accounts was some 751 billion euros (or around 75% of GDP), as compared with the 585 billion (or around 58% of GDP) in gross debt recognised under the EU excess deficit procedure classification.

Now if we look at the chart below, we will see that the proportion of Spanish national debt which remains outside the Eurostat classification system has risen since the introduction of the euro - from 14 to around 23 per cent - but most of the increase actually took place in the run up to the crisis. So as Spains funding problem has deteriorated, there does not seem to be any direct evidence that this has impacted the level of "non-accounted" debt, it has simply remained the same (in % terms). Of course, as the debt itself has balooned, so too has the "dinero B" part.

In the case of the regions (Spain's Autonomous Communities) the position is not that different - the % has increased from 12% in 2000 to around 25% at the present time - even if there is rather more evidence of "stress" on their finances after the start of 2008 (see chart).

The position of Spain's local authorities is also similar - with the proportion of "non-accounted" debt rising from 14 to about 23% - although again, there is even more evidence of post-crisis financial stress if we look at the gap between the two lines, and how it widens, which is none too surprising when you consider that it is the local authorities who lost the biggest chunk of the financing in the collapse of the construction boom. Indeed, it is my impression that in this case the gap only hasn't widened further due to the fact that very few people are now willing to give any sort of credit to Spain's local authorities.

As I indicate, one of the key forms of kicking the can down the road in terms of public finances, is to delay payment on receiveables (if you are not sure what receivables are, check this wikipedia entry), and the following charts show the relentless use of this procedure in Spain, despite the promise of Spain's government to bring short term credit under control by 2013, there is no sign of this happening to date.

The other big area of "non-accounted" debt, is that accumulated by governmentally owned or "satellite" agencies (who may for example run public transport, or outsourced cleaning services for local authorities). As can be seen from the charts below, this has increased massively since the crisis started.

As I say at the start, none of this debt is hidden, nor is it illegal under Eurostat regulations, so there is nothing (in principle) out of order here. This fact doesn't make the situation any less preoccupying, since one way or another all this debt will have to be paid. What it does, I think, indicate, is a certain "laissez faire" attitude towards fiscal targets on the part of the EU Commission and indeed the IMF (as I argue in this post, it is hard to understand the IMFs own Spain growth forecasts and CA deficit levels if they are not assuming a rather higher level of indebtedness into the future than anyone is prepared to admit right now) . The May measures are deemed to have worked. Europe's Soveregin Debt Crisis is, if not over, at least in abeyance.

Only last week José Luis Rodríguez Zapatero, the Spanish prime minister, raised the possibility of reversing some of the spending cuts announced in May. In a cautious announcement, which the FTs Victor Mallet reports was apparently aimed at testing the mood of financial markets, Mr Zapatero said the government expected to restore some suspended infrastructure investments if – as the government anticipated – renewed financial stability left room for manoeuvre in the 2011 budget.

“In 10 to 15 days we will be able to give some positive news in relation to restoring investment activity in infrastructure, which will affect most regions and would provide relief, an important boost, to construction companies,” he told a news conference in Mallorca after meeting King Juan Carlos at the monarch’s summer residence.

A €6bn cut in public sector investment was among the biggest austerity measures announced by Mr Zapatero in May to coincide with the EU and IMF announcement of a €750bn financing facility for the eurozone.

Despite the fact that among the evident losers in what was effectively a "U turn" at the ECB in May were the monetary hard-liners like Jürgen Stark and Axel Weber, you obviosuly can't keep a good man down, and European Central Bank Executive Board member Juergen Stark was out again on Monday, warning in the columns of the Financial Times that Europe is set to ramp up economic surveillance to prevent a repeat of the region's recent debt crisis. "A new framework for macroeconomic surveillance will monitor whether national trends are compatible with those that are appropriate for the Union as a whole", he said. "This framework will allow both targeted peer pressure and differentiated and more binding recommendations on follow-up action at the national level."

All I can say looking at the above numbers is, there isn't much sign of any of this being operational yet, but then, as I say, the Jürgen Starks of this world have rather had their noses pushed out of joint in recent weeks.

Isabel Presentation

2010-08-12T06:10:00.000-07:00

WORKING TITLE: Running Out Of Money - Spain's Economy Hits A Ditch In The Road
GENRE: 50 min TV Documentary
FORMAT: HD 16:9
IDEA, SCRIPT AND DIRECTED BY: Edward Hugh (just decide the content - you direct) and Isabel Andrés

ORIGINS OF THE PROJECT…

The idea of making a documentary about the Spanish economic crisis goes back to a sunny Sunday morning spent at the top of Barcelona's Putxet Park, as macroeconomist and blogger Edward Hugh (61), and documentary maker and producer Isabel Andrés (35), were idling away the morning chatting about their mutual interests in film and economics, looking down over the breathtaking panorama of Barcelona that lay at their feet (see taster).

That was back in 2008, the crisis was still really in its early days, the government were still denying there was even going to be a recession, and while it was obvious to them that the Spanish crisis was going to be one of the major focal points of what later came to be known as the "Great Global Recession", both were, in their differing ways far too busy at the time to put any of the ideas they were discussing into practical form as a feasible "to do" project. Edward was too busy spending long hours work analysing and writing about the crisis as it developed, while Isabel was working away on a documentary for Spanish television about a XIX century revolutionary.

Meanwhile the crisis went from bad to worse, and then from worse to even worse with the result that Edward became an increasingly well-known and respected economist as many of the initial predictions he made about the crisis, turned themselves little by little into reality. In particular, a forecast he made in November 2008 that the Dubai debt problem would rapidly become a European Sovereign funding one in Greece, was not slow in fulfilling itself, as that country became engulfed in a major international crisis in January 2010.

As a result of such analyses, and of his long standing expectation that weaknesses in the way the Euro was set up institutionally would eventually result in a generalised coordination and debt problem Edward moved from being a lowly and humble blogger to become an internationally respected analyst, who's opinions were sought by aspiring national leaders, and by the likes of the IMF. Edward's analyses suddenly became fashionable, and he is now frequently consulted by media and by economic analysts from around the world. In fact, he has suddenly become something of a media personality following the publication of a full page story about his work in the pages of the New York Times.

Meanwhile Isabel found herself having to move to Rome, since while Edward flourished on the back of the crisis, Isabel became one of its early victims, as funding in Spain suddenly started to dry up, leading to serious cut backs in the media industry. New films and documentaries were especially hard hit, leaving lots of highly skilled professionals forced to look for work elsewhere. So off she moved to Italy where she worked in a film school while continuing to work on scripts and other film projects.

Fast forward two years, the crisis is still far from over and as Spain continues to lurch from one new problem to the next, many people many asking themselves will this never end?

Isabel is back in Barcelona again, working on a TV documentary she has written and is directing about trade union opposition to the Franco regime in the 1970s, while Edward is busy organising an international conference about the differing ways in which the countries on Europe's peripery are confronting the crisis.

So both of them are, if anything, even busier than before, but then a random event brought them back together again: a film team from the US PBS news programme Making Sense contacted Edward, and asked him to help them prepare some news reportage about what was happening in Spain. So Edward, remembering his earlier conversations with Isabel, picked up his mobile phone, and rang her. She answered, and it turned out that she was back in town again. They met and decided to use the opportunity to start to really go to work on that project they had once talked of doing. They offered themselves as production consultants to Paul Salman and his team, and during three days they accompanied them round Barcelona in a van, meeting people, interviewing, shooting locations, and generally trying to give people in the United States an idea of what life in Barcelona has become today.

And naturally, they took them back to the park where the whole idea was born.

As is evident, the crisis changed their lives, and now they hope that watching the documentary that results from this process will help change yours, or at least your perception of what it is that is so different about this crisis we all find ourselves living through, taking the Spanish case as one example.

SYNOPSIS / OUTLINE:

When the crisis first hit Spain, people had the impression it was just another link in chain of the domino-effect which was set off by the US sub prime crisis. Few were aware in that fateful summer of 2007 of the significance of the fact that Spain's banks , along with those of Kazakhstan, now found themselves almost entirely excluded from Europe's wholesale money markets.

Even if they had been aware of this, they would have had no idea of the potential significance of that fact, nor of why it was that these two countries were classed together in the eyes of the financial markets. They had no idea of what Cedulas Hipotecarias, or indeed any of the other other exotic-sounding financial products Spain's banks had created to meet there funding needs, actually were, or what impact the invention of such "financial products" would have on their lives. Nor were they aware that they might eventually come to rue the day such instruments were invented to be used to finance those very mortgages they themselves needed to help them buy their homes. They had no idea their country was about to become a toxic danger-zone just as the unfortunate inhabitants of Chernobyl were only to learn later about the potential perills that lay in that large building they could see on their daily skyline, which provided work to so many of their friends.

In short, they had no idea just what significance having banks which were "dependent on external funding" really had, nor did they know just what it was about to do to their lives.

Three years later, the consequences for this Southern European country have been little short of devastating. With a level of unemployment which is currently running at around 20% the impact of the crisis has been far worse than that to be found in most other countries in Western and Southern Europe. And while most Spaniards are now resigned to the fact that even as most of their neigbours steadily emerge from recession theirs is still hovering on the brink, they are by-and-large still unaware of the fact that their country now faces many long years of what will at best be economic stagnation, with little prospect of those horrifying unemployment numbers being significantly reduced for half a decade or more.

So just what is it that makes Spain different? Like the United States the country had a large housing bubble, and it accumulated international debts by running a sizeable external trade deficit for far too many years. But difficult as the problems which face the United States are, those in Spain have a different feel about them, so why is this?

Basically, there are many similarities and many differences between Spain, the United States, and the United Kindom. In all three cases, during the good times they were funded by the global financial markets who were tolerant of their large international borrowing needs. Now that the "bad times" are here, these markets are not tolerant at all, and often show great reluctance to lend them money. However there is one very important difference between them, and it is the one we want we want to highlight here - Spain no longer has its own national money, its own currency. It belongs to a currency union, which means that unlike the United States, or the United Kingdom, it cannot print its own banknotes, nor can the Spanish central bank increase the money supply. Spain is thus dependent on the good will of other countries - its partners in the currency union - to finance itself. Indeed, given the rules of the club Spain belongs to, it cannot even set its own fiscal deficit targets.

The problem is not that Europe's monetary union is a bad thing, but simply that, when the common currency was set up, few really saw the kind of problems that might arise, and so their was little done to try to prevent them happening. As Federal Reserve Chairman Ben Bernanke said, "the Euro is a great experiment", unfortunately it was never made adequately clear to Spain's citizens that they were among the guinea pigs.

So no common treasury was established to help those countries who got into difficulties, a failing which was rectified in May 2010 with the establishment European Stability Fund. Nor was the central bank authorised to intervene in the bond markets to keep the cost of borrowing down for member governments, until that is, the policy was changed under the impact of the Sovereign Debt Crisis.

Most importantly, the economic supervisory role of the EU Commission lacked real teeth, since no one was really willing to give up much of their national soverignty, and while much attention was paid to the size of member state fiscal deficits, none was paid to national trade imbalances between participating countries, until again the crisis hit, and those who had been running large external deficits found they could only continue to fund them by running into the welcoming arms of the ECB.

As a result of this neglect, Spain's economy has now become completely distorted, and rather uncompetitive in relation to its more efficient Euro Area partners. Spain's economy is stuck, and scarcely able to grow. More importantly it cannot export sufficent to pay for its imports, so slowly but surely Spain is running out of money.

Every month either some 5 billion euros (0.5% GDP) has to leave the country (the current account deficit), or someone somewhere has to borrow the money to plug the gap. This financial leakage gives the feeling the money is disappearing from Spain, giving rise to questions like "where is it going?" (under people's beds for example), questions which really don't need new urban legends to answer them, since the answer is fairly straightforward and obvious, even if complex and hard to understand.

One of the key objectives of this film is to try and make the technical explanation for Spain's situation more accessible to an audience who would normally find economic topics "difficult".

So our objective is to try to convey in a clear and straightforward way what is ultimately an extremely complex problem. Hopefully our highly visual, and rather unorthodox, approach will make it easier for people to approach what otherwise seems a rather boring and dreary subject matter.

The filmakers are completely independent, with neither institutional nor party affiliation, and totally non-ideological. What they hope to do identify a problem, putting an end in the process to a long-standing public denial that it even exists, in the hope that drawing attention to Spain's situation will provoke the kind of public debate which is essential if adequate responses are to be found, and if we are to avoid such situations being reproduced in the future, whether in Spain or elsewhere.

In order to make this possible, Edward Hugh, Europe's so called "Doctor Doom", will guide the viewer on a journey that with the background to the crisis, show what has brought us here and where are we now, at the present time, and then finally end up by opening some doors to try to throw some light on what can we do about it all…

Edward will chat/ have informal conversations with Spanish a number of economic analysts, representatives of major banks, real estate developers, and other key players - many of them Edward’s friends, or people he has gotten to know during the course of the crisis - all with the aim of trying to help people understand why money is not circulating here the way it was, why there are so many empty houses in Spain, why unemployment remains stubbornly high and what could be done to put the situation straight…

At the same time, we’ll get to see and feel the crisis through the eyes and day-to-day lives of a few, very well selected characters, people who are in this at the sharp end, and experiencing the direct consequences. People who will talk to us directly and openly about how their lives have changed, about what has happened to their dreams, about what their expectations for the future are, in a way which will enable the viewer to get "close up and personal" with how seemingly abstract, impersonal processes end up impacting on the day to day reality of those who always felt themselves far removed from the world of finance and economic policy.

Take, for instance, Carles (30) and Maria (26), a young couple with two children who have moved-in and "occupied" a flat in an (empty) municipal housing block. Carles and Maria don't belong to any radical "okupa" movement, they simply lost their home after they both lost their jobs, and since Spain lacks any adequate public housing programme for those in need, and since the flats were empty (like nearly a million and a half other private sectors houses) they decided to take the law in their own hands.

Or Javier (45) , an unnemployed Latin american immigrant, whose marriage broke up as the family got into increasing economic difficulty. Javier has been left by his wife, and now finds himself forced to take care of 4 kids and a grandson on his own, and is just left waiting for the eviction notice to arrive, or Marc (31) who is studying French to emigrate to Canada or Pau (28) who has moved to Brasil to be able to work on what he studied, Media and Film degree…

At the same time the crisis is changing Spain, young people have started to talk about debt in another way - as something they don't really want. People are becoming aware they have been living beyond their means, and that their lifestyles will have to change. So people have started to look for their own solutions.

Those who have run out of unemployment benefit have started to wait around outside supermarkets for the daily "throw away" - a more or less rountine sight now in contemporary Spain. Others line up outside churches to receive food, or a free meal.

And since the real difficulty is financing the cash economy, other forms of activity have started to come into existence, such as the "Banc de Temps" (Time Bank) in Barcelona, where those who don't have jobs can still raise their living standards by exchanging what they do have, time, by providing all kinds of services on a time swap and not a cash basis.

Other groups of young people have gone to live live in the countryside, growing their own vegetables and trying to be as much independent they can from the system, trying to depend on money as less as they can… All kind of proposals that come up from people that has taken action and does not want to depend on the system or the politicians…

While others now talk openly about emigrating, frustrated by the seeming impossibility of finding a job, or better put, a job commensurate with their qualifications. Like Jordi Molins, a financial analyst, who moved back to his native Catalonia to go and work in local Barcelona bank, only to find himself unemployed. Jordi announced his disappointment on his blog, declaring he felt himself condemned to a "new exile", and has now left to take up a position in London. How many more "Jordi's" out there. A lot, but no-one is officially keeping count.

Then there are the "new Spanish", the five million or so migrants who came to Spain during the construction boom, but who now find themselves without work, and with little prospect of finding them. Worse, they are far from home, and lack the family support networks that help many native Spaniards survive. Like Diego, a construction worker from the Dominican Republic, who is just about to hit the last of his 420 euro unemployment payments, and will explain how, difficult as the situation in his country is, life in Spain is becoming unbearable.

The journey through the crisis in Spain following such an easy concept to understand for everybody as “running out of money” will end up with the inauguration of the conference where experts from all around the world will put lots of questions: Things can get worse? Can be Spain an example of what other countries shouldn’t do? But maybe at this point a new door is being opened: Will they find a way to get out of here? Is this the begining of a new social era? What will it change?

Some graphics and representative photographs will be used to complete our story and make it direct, understandable and at the same time entertaining.

VISUAL TREATMENT (need to be described)

INTERVIEWEES (need to write a short bio/description of eachone)

Edward Hugh

Macro economist who has lived in Barcelona for 20 years.

Salva García

Economist employed in one of Spain's well known Cajas.

David Rodriguez

Economist concerned with the social dimension of economic changes. Universitat Pompeu Fabra.

Mark Stucklin - Property specialist who lives in Barcelona. Spanish Property Doctor for the Sunday Times and author of Spain Property Insight blog.

Miquel Baró - property developer whose business is effectively bankrupt.

Joan Carles Gallego CCOO - Union Leader

Jordi Gual - Chief Economist with La Caixa

Fernando Fernandez - Professor at Spain's IE business school, former chief economist with Banco Santander

Juan Carlos Ureta - President of Renta4 - Spain's largest independent stock trading company.

Manuel Conthe - Es licenciado en Derecho por la Universidad Autónoma de Madrid (1976) y técnico comercial y economista del Estado (1979). Dentro de sus actividades profesionales, ha sido director general del Tesoro (1988 a 1995) y secretario de Estado de Economía (1995-1996), entre otras. Entre 1999 y 2002 se desempeñó como Vicepresidente para el Sector Financiero, en el Banco Mundial en Washington y posteriormente como Socio de la consultora AFI.

Fue habitual columnista en diarios como Expansión o El País, analizando desde temas de la vida cotidiana a los más complejos asuntos de la política y la economía española, en que sagazmente mezcla conceptos de ciencias sociales, económicos y teoría de juegos con agudeza intelectual y amplia cultura, hasta su nombramiento como presidente de la Comisión Nacional del Mercado de Valores de España en 2004;

Alfredo Pastor: Alfredo Pastor is professor in the Economics Department of IESE Business School. His main specialties include the European Union, Spanish economic policy, the role of the state in the market economy and the Chinese economic system.

From 1981 to ‘83 he served as a Country Economist at the World Bank, and from 1983 to ‘85 he held senior posts at the National Institute of Industry, first as director of planning and then as director general.

Following that, he ran the company Enher for five years. Two years later, he became director of the Family Business Institute, a post he left to work as Spain’s Secretary of State for the Economy until 1995.

CHARACTERS

Javier: unnemployed latin american immigrant

Jordi Molins, financial analyst, moving to London. Jordi first announced his decision to emigrate on his blog, when he became disappointed with the response of Spain's financial sector to the economic crisis.

Marc, unemployed graphic designer. Currently studying French to emigrate to Quebec.

Esteve Jané -Young businessman, struggling to maintain momentum in his business

Carles and Maria - a young unemployed couple who have gone to live in an empty block of new social housing units.

INICIATIVES THAT MAKE A DIFFERENCE…

Banc de Temps…

Comunitats autosuficients…

CREW:

Idea and Script: Edward Hugh and Isabel Andrés

Director: Isabel Andrés and Ed?

Cinematographer: Simone or other (still to choose Neus Ollé, Hermes Palalluelo, …?)

2on Camera Operator: Simone Belisario (if there is budget for a second one, but we’ll see if needed)

Editor: Simone Belisario

Musician: If we don’t know yet we don’t put or we put a provisional one…

CVs of Writers and directors: (A description of half page each) and a photo.

PROJECT STATUS: in financial terms if we have something to put, otherwise we don’t put anything.

PRODUCTION COMPANY:

Normally in here there is a CV of the company and their editorial line.

Maybe although we haven’t created it yet, we could invent a name of our company and write a few lines of our editorial criteria… and maybe add a couple of videos I made myself to show we have some experience producing. In any case we’ll need to get somebody to do it, I mean a Production Manager who will organise the shoot, the working plan together with us, and will distribute the money to do the film trying to get better deals from camera rent, restaurants, etc…

Hungary - Save The Last Waltz For Me

2010-08-08T03:48:00.001-07:00

"We must pay the debt precisely and punctually, even if we destroy the economy in so doing".
Katalin Botos, Secretary of State in the Hungarian Finance Ministry during the government of József Antall (1990 - 1993).

Background: On November 6, 2008 Hungary received IMF approval for a 17-month Stand-by Arrangement to the value of €12.5 billion (a figure which represents 1015 percent of the country's estabilshed IMF quota) and in the process became the first EU nation to enter a conditional program with the IMF. The European Union also agreed to provide a loan of €6.5 billion (funded via the issuance of EU bonds) of which some €5.5 billion have so far been disbursed. The World Bank also agreed to provide an additional €1 billion.

Access to the loan was front loaded, with €5 billion becoming available on the approval date, €2.5 billion at the time of the First Review (March 2009), and €1.55 billion at the time of the Second Review (June 2009). During the Second Review the arrangement was extended for a further six months (new expiry date October 6, 2010), and the undisbursed amounts were re-phased over the remainder of the arrangement. A fourth installment of €60 million was paid at the time of the Third Review (September 2009).

Judging the economic and financial situation of the Hungarian economy to be improving steadily, the authorities chose not to draw the €865 million which became available to them on completion of the Fourth Review (December 2009). During the program period the European Union has also disbursed €5½ billion of the €6½ billion that were initially approved. The World Bank loan was approved by their board of directors in September 2009, but the loan documents have still to be signed by the parties to the agreement.

Subsequently, feeling again reassured by what seemed to be a positive improvement in external financing conditions, the government did not draw on either the IMF or EU resources that became available at the completion of the fifth review (March 2010). At the time gross international reserves had almost doubled from the pre-program level of €17.4 billion in September 2008 to €35.2 billion in June 2010. Parent banks continue to maintained their exposure to their Hungarian subsidiaries, in line with their European Bank Coordination Initiative (EBCI) commitments, and rollover rates of bank liabilities are running close to 100 percent.

But behind this apparenty "poster boy" type success story, a rather more compex chemistry has been at work, since a Hungarian citizenry who have been living under the weight of one "austerity program" after another since the June 2006 run on the forint (a prelude to, and foresadowing of the November 2009 Greek crisis) which followed the then Prime Minister Ferenc Gyurcsány's post election victory admission that the fiscal deficit was far larger than had been acknowledged, has now visibly grown sick and tired of the whole situation. As Gyurcsány said at the time, "We lied to them in the morning, we lied to them in the evening."

So when the IMF announced in June that it would conclude its mission without having agreement with the newly elected government of Viktor Orban, few should really have been surprised, since the ground had already been being prepared following the decision not to draw on the November tranche. As both parties prepared for the April elections they knew only too well that the tolerance in Hungary for further IMF-type programs was wearing thin.

As a result it appears that market participants are seriously under-appreciating the potential for events in Hungary to take a nasty turn, since despite all the years of austerity programmes the underlying macro position is not as sound as many think. Hungary’s economy is now almost totally dependent on export surpluses for economic growth, and thus it is very sensitive to movements in demand elsewhere in the EU. That is to say, if the Eurozone economy does catch a cold in the second half of the year, Hungary will be among the first to sneeze.

At the same time, the high level of external debt means that the economy is very vulnerable to externally induced contagion, and while financing this year's debt may well not pose excessive problems for the authorities, with rating reviews looming from two of the major ratings agencies, and external debt to GDP dynamics highly sensitive to movements in the forint, the risk of adverse developments in 2011 is far from negligible, especially if, as Prime Minister Orban is already suggesting, the government does decide to go ahead with a fiscal deficit significantly over the 3% EU Stability and Growth Pact target.

Economic Profile

After several years of above-par (and more than likely above capacity) performance, Hungary's GDP growth started to weaken in the third quarter of 2006. Since Q2 2008 the economy has only seen one period of quarterly growth (in Q1 2010). That is to say there were seven consecutive quarters of economic contraction. Even more significantly first quarter growth was not sustained, and in Q2 2010 the economy essentially trod water (0% growth q-o-q), despite a seeing a sharp surge in exports, and a considerable trade surplus. The fact of the matter is that Hungary's export oriented industrial sector is just not large enough to pull the whole economy forward in the face of a significant and sustained decline in domestic demand. It is thus not improbable that we will see more quarter-on-quarter contactions during the coming twelve months.

Hungarian GDP declined by 6.3 percent in 2009, which was, in fact, slightly less than had been expected. The pace of economic contraction started to ease back in Q4 2009, with real GDP falling by 4.0% (y-o-y), down from the 7.1% peak in 2009Q3. Many observers and analysts have been surprised by the way the economy rebounded strongly in Q1 2010 - as the positive contribution from net exports began to offset weak domestic demand - but it is important to avoid overly simplistic and optimistic interprepations of this phenomenon. In fact, the economy grew by a seasonally adjusted 0.6% over the previous quarter, largely due to a resurgence in export demand (driven partly by the strong German performance - Hungarian exports are strongly inter-linked with the German industrial machine). However all the old doubts about long term sustainability remain, as witnessed by the fact that even though GDP in Q2 2010 was up 0.8% over the level of Q2 2009, private consumption continues to decline, the unemployment rate remains very high by Hungarian standards (10.4 % in June) while private sector credit continues to stagnate.

On the credit front, loans to households have remained broadly stable during 2009 and the first half of 2010, and although the emphasis in new lending to households has now shifted from foreign to domestic currency, revaluation effects from the downward movement in the vale of the forint vis a vis the CHF mean that the forex mortgage stock remains relatively constant (at around 75%) as a proportion of the total. Indeed there is a slight uptick in the outstanding value of household debt in June and July which is almost certainly a simple reflection of revaluation effects.

While a great deal of emphasis has been placed on household forex borrowing, the situation regarding corporate and government borrowing is not materially different. Corporate borrowing reached a high point in Q1 2009 (and by March this year it had fallen by around 13% from the peak), while at the same time the level of forex borrowing also peaked - at around 63% of total copporate debt.

Given the evident lack of vibrance in the private credit market, it is hardly surprising that domestic consumption continues to decline. Indeed, retail sales have now been in constant (almost terminal) decline since the summer of 2006.

The construction sector has likewise been in freefall.

If we look at new building permits, which have collapsed since mid 2009, it would seem that there is little likelihood of a turnround in the secular decline in construction activity anytime soon. Indeed, recent government proposals for infrastructure projects could be read as an attempt to breathe some life back into this beleagured sector.

The underlying constraints in the credit market (which are largely a by-product of the country's high level of external indebtedness), when placed alongside the fact the country has an ageing and declining population give us the key to understanding why private consumption in Hungary has remained flat to negative for so long now, and will, it appears, continue to do so.

Little Job Creation In The Private Sector

When we come to the labour market, while the unemployment rate peaked in March at 11.2%, by June it was still only down to 10.4% (Eurostat EU harmonised - seasonally adjusted - rate).

And if we come to look at employment, it is not hard to see (from the accompanying chart) that total Hungarian employment (despite some seasonal fluctuation) has been trending steadily down since 2006.

Even more importantly, one of the explicit aims of the austerity program that was introduced in the summer of 2006 was to shift the balance of employment away from the country's public sector, and this it has manifestly failed to do, since despite some initial success in reducing the public sector workforce, following the introduction of rural employment creation schemes, the current proportion of the total workforce who are employed in the public sector (29%) is virtually identical to what it was at its earlier peak in May 2006 - before the adjustment process started.

The reason for this secular downward drift in Hungarian employment is not hard to locate, since it has its roots in the fact that the working age population is both declining and ageing, a factor, in our opinion, which needs to be kept closely in mind when assessing the sustainability of the country's accumulated external debt in the longer term.

Given this context, much of the thrust of the recent structural reform process has been oriented towards trying to increase the labour market participation rate, although with little evident success to date, since apart from normal seasonal fluctuations the level has remained reasonably constant at just under 62% since the start of the adjustment process.

Improved Current Account Balance

The Hungarian current account was in surplus in 2009 for the first time in over 15 years (by 0.4% of GDP).

The reason for the improvement was the significant increase in the trade balance as the fall in domestic demand led to a more rapid decline in imports than exports. Now the process is reversing, as imports rise more slowly than exports, given that domestic demand is weak to negative. But the net result is the same - a positive impact on the trade balance and on GDP growth.

Along with the trade balance the income one also improved as profits fell, with the result that the current account adjusted by over 7.5 percentage points of GDP, a not unimpressive achievement. However, since what comes down also goes back up, the current account balance may well deteriorate slightly in 2010 as profits increase the income account will again deteriorate, and there may also be a small reduction in current transfers. At the same time EU capital transfers will probably more than offset the shortfall.

The problem here is the very large negative external position (especially loans and equities) that Hungary has accumulated over the years, and the ongoing cost of servicing this, which very nearly mirrors the size of the trade surplus.

This means that, in order to see "daylight" and start to seriously reduce the size of the long term external debt Hungary needs to produce a much larger trade surplus than the one the country is currently generating. Given that manufacturing industry only accounts for some 19% of total value added this is not going to be easy. Thus, while externally driven industrial output has rebounded reasonably strongly in recent months, on the back of Europe wide demand, GDP has in fact stagnated.

In fact, while aggregate output shows some significant improvement, this total is the sum of output from two fundamentally different sectors, the export oriented one (which has been growing strongly) and the one which depends on internal demand - which is steadily declining as retail sales etc continue their fall.

Since export oriented output now constitutes about 55% of Hungarian IP (in value added terms) this means that the whole economy is trying to leverage itself on about 10% of national capacity, a very difficult job indeed, and especially with the current value of the HUF.

Devaluation The Nub Of The Problem

Evidently the most intelligent policy move in a situation like the one Hungary finds itself in would be to devalue the currency sharply, but for a variety of reasons (principally the large external debt and consequent forex loan exposure) this road has not been considered viable (see, for example, the quote from the Finance Ministry official cited at the start of this report, which characterises exactly the ongoing mentality: never mind the impact on the economy, the debt must be paid, and to pay the debt the forint must stay - more or less - where it is). As a result Hungarian monetary policy has been more a question of protecting the currency than stimulating the economy, which is one of the reasons the National Bank of Hungary currently has the highest policy rate in the European Union (5.5%).

The enormous disadvantage of this road is that it discourages credit, and at the same time makes contracting yet more forex loans an attractive proposition. Notwithstanding this extremely tight monetary policy stance (in an economy which contracted 6.3% in 2009) inflation was still running at 4% in July. This figure (which is down from the 5.3% registered in June, following the base effect of last year's VAT increase dropping out) is still extraordinarily high for a country which effectively attempting to peg its currency & drive economic growth via export sales.

The longer run price rigidities to which the Hungarian economy is subject are evident, and even by years end we could be looking at annual inflation rate of something like 3%. Real wages in the private sector have started to fall since last summer (which will also further depress domestic demand), but they are still up around 2% in nominal terms, and the only really, really surprising thing here is that policymakers can be so complacent about the situation.

Declining And Ageing Population Create Debt Sustainability Problems

It is no secret that Hungary's population is now in long term decline, and that its working age population is declining and getting older even as the elderly dependency ratio (which is a good indicator of health and pension liabilities) rises and rises.

This problem only adds to the doubts about the sustainability of Hungary's heavy external debt, which is currently hovering around 150% of GDP (gross debt). As the IMF themselves recognise in their March sba review:

"The current account adjustment and projected pick-up in growth over the medium term should place the high external debt on a declining path. Having increased sharply over the past two years, external debt is projected to have peaked at 137 percent of GDP in 2009 and is expected to decline to 113 percent of GDP by 2015. These projections, however, are particularly sensitive to the exchange rate."

This last paragraph effectively hits the nail on the head, since the recent forint weakening (plus some early bond sales) have meant that gross external debt was more like 140% of GDP at the end of Q2 2010. If the forint declines the debt rises for revaluation reasons, and if it isn't devalued then the economy is effectively "destroyed" in the words of that Finance Ministry official.

It is for these reasons that we consider the Hungarian economy to be extremely vulnerable, perhaps the most vulnerable of the EU's Eastern contingent at this moment. As finance scholar Michael Pettis puts it in his article "Do Sovereign Debt Ratios Matter?" the structure of the balance sheet really does matter:

"The structure of the balance sheet matters, and this may be much more important than the actual level of debt. In my book I distinguished between “inverted” debt and hedged debt. With inverted debt, the value of liabilities is positively correlated with the value of assets, so that the debt burden and servicing costs decline in good times (when asset prices and earnings rise) and rise in bad times. With hedged debt, they are negatively correlated."

"Foreign currency and short-term borrowings are examples of inverted debt, because the servicing costs decline when confidence and asset prices rise, and rise when confidence and asset prices decline. This makes the good times better, and the bad times worse."

"Long-term fixed-rate local-currency borrowing is an example of hedged debt. During an inflation or currency crisis, the cost of servicing the debt actually declines in real terms, providing the borrower with some automatic relief, and this relief increases the worse conditions become."

"Inverted debt structures leave a country extremely vulnerable to debt crises, while hedged debt helps dissipate external shocks. Highly inverted debt structures are very dangerous because they reinforce negative shocks and can cause events to spiral out of control, but unfortunately they are very popular because in good times, when debt levels typically rise, they magnify positive shocks."

Hungary's high external debt exposure is a classic example of what Professor Pettis calls inverted debt, and this makes the country deeply vulnerable to a combination of economic slowdown in Europe, and credit rating downgrades, both of which are entirely possible as we enter 2011. If you add to that a government which seems hell bent on defying both the IMF and the EU Commission, then you have all the ingredients for a very explosive cocktail.

Indeed, with the Hungarian government now set to pursue a more expansionary fiscal policy in 2011, the odds are growing that it will miss its deficit targets and expand the debt — already around 80 percent of gross domestic product. Slippage on fiscal targets in any kind of delicate moment could push Hungary into a Greek-style financial crisis early next year. We feel the comparative ease with which Hungary may meet its financing needs in 2010 may well lull both the government and many financial market participants to seriously underestimate the challenges which lie ahead. On the surface the external funding needs - some €3.3 billion are not galactic, but the danger for the economy would more likely come from a bond market sell off, a spike in spreads, and a run on the currency, which forced the central bank to hike sharply, sending the economy off into another significant recession, and the population out onto the streets (a serious possibility at this stage) in protest.

At present time the financial markets seem prepared to tolerate the stance of the Orban government. Perhaps they feel that the EU and the IMF have gone too far in the Hungarian case - especially given their agreement to a deficit target of over 6% in Romania, and that Hungary's budget deficit seems to be under control. Perhaps also they feel that the Orban government is simply posturing before the local elections, and once October has passed, Hungary will return to the fold. Also, the return of the Hungarian economy to growth in the first quarter may have produced overly optimistic expectations about the future path of GDP, expectations which may now be rather dampened by the Q2 reading.

The real question, then, is whether the market participants are being overly sanguine at this point, and they are, just how will they react when they do realise that this time it may well be different, and when they do react, just how will the Fidesz government respond.

Further, the budget deficit expectation is highly sensitive to movements in nominal GDP. If, as seems entirely possible, Europe's economies start to slow in the second half of this year then growth in 2011 may well be under 1.5%, and certainly nothing like the 3% that the government is predicting or the 3.2% that the central bank has forecast.

Then there are those government measures which evidently pose economic and political risks. The first of these is the bank tax. A tax whose revenues were allocated to either restructuring FX loans, or the creation of a fund to provide cheap long-term credit for SMEs would be one matter, but a tax whose sole objective is to fill a budget hole created by the decision to introduce a flat tax is only going to irk the entire banking sector, and risks inducing a mini-credit crunch, or, in the best of circumstances will simply produce an intensification of the current credit freeze, with negative consequences for both households and businesses.

Then there is the issue of the flat tax itself. Because – unlike its Slovak namesake – it removes the tax credits that guarantee a tax free income for those earning the equivalent of the monthly minimum wage, the 16% flat tax will mean a pretty sharp tax increase for most of the Hungarian population. Estimates suggest that some 55-60% of wage earners will pay more, while taxes will be substantially reduced for the top 20-25%. The longer term economic consequences of this move are hard to evaluate, but since the 55-60% of wage earners who will pay more are those who in principle have the highest marginal propensity to consume, while the 20-25% who gain will more than likely save a higher share, the net impact of this measure on the economy would seem to be to increase the imbalances and make the economy even more export dependent.

In any event, the impression that the government is persuing policies which are ideologically motivated, and for this reason is in conflict with the main multilateral institutions involved will more than likely weigh on investor sentiment in the longer term, as will the battle that is being waged against the Governor of the central bank.

We Were Left A "Heap Of Manure"!

Also market participants need to ask themselves just what sort of constraints Viktor Orban is under, how these may influence his scope for decision taking, and what implications all of this may have for other countries where IMF endorsed programs may come unstuck later on down the road.

Prime Minister Orban has cast himself as the socially-concerned, nationally purposeful leader and he is now seeking to re-invent this appeal in a way which does not completely destroy his credibility when it becomes clear to his voters just how restricted his freedom of manouver actually is. So it would seem to be the case that he just doesn't have the political option of choosing the route of the responsible national leader who bravely implements the IMFs prescriptions and retain his credibility. It is far more likely he will project himself as the national populist who defends his small country from powerful forces – and he will blame the negative market reactions on foreign, cosmopolitan intellectuals and investors. As his close companion and Chief of Staff Mihály Varga delicately put it recently "It will take months and years to clean up the heap of manure the previous administration left us". He was of course referring to the Bajnai government, and the IMF programme it implemented. He also stated that IMF "therapy" has never been effective and successful, and their "one-fits-all" recipe leads nowhere, and denied the EU had the right to tell the government what to do about private pension funds.

What such statements illustrate is just how easily the Hungarain prime minister and his aides could be drawn into a dynamic of radicalization in part due to his own volatile character, and partly because his voter base is constantly under pressure from the far-right Jobbik party. Investors need to ask themselves very carefully just how far down the "radicalisation" road this government could actually go. While the question is almost impossible to answer at this point, the very difficulty in answering it seems to be perhaps one of the most disconcerting features of all.

If there were to be an outright confrontation between the IMF/EU and the Orban government, the Hungarian population would effectively be caught in the middle, and it is hard to see how they would react. Most observers either believed or hoped that the new Orban government would simply be some sort of repeat of the 1998-2002 one, and and as a result didn't see the present situation coming. This, in itself, is a measure of the corroding impact of a three year adjustment process that simply hasn't worked, and there are surely lessons here for other countries in similar situations, for those who are able to hear them.

When the dust finally settles what will happen is surely highly uncertain - although it important that everyone is aware this is 2010, and not 2006, Hungary has just been through a difficult adjustment process, and is not simply about to enter one, which means that the dynamics of the situation are completely different. At the present time Viktor Orban's stance has neutralized the Jobbik threat, but his government faces another risk. If - as we expect - the general lack of confidence in the ability of his government to handle the situation produces a run on the currency, and the HUF falls sharply, then all those FX mortgage payers will start to believe that the FIDESZ government is playing politics with their homes, and that could well create a very dangerous political constellation which could have impredictable consequences.

Bottom Line Watch Out For Problems In 2011

While Hungary's primary budget deficit position is among the best in the EU, problems with the debt to GDP ratio potentially remain, especially given the likelihood that GDP growth will not be up to the government's optimistic forecasts, and the structural on-costs of population ageing and workforce decline, and it is only by keeping its current ultra-tight fiscal stance that Hungary can hope to stabilise its debt ratio in the region of 80% of GDP. Any loosening in posture now could easily drive the debt ratio much higher over the decade to come.

Also, the idea that Hungary does not need the IMF and can fund itself from the market without support is a dangerous one, and is only realistic under the best of scenarios, where emerging market inflows continue unabated and the general risk appetite stays were it is. Both of these are more than risky assumptions, especially in a country which seems virtually incapable of generating headline GDP growth, and where influential politicians describe IMF programes as generating "heaps of manure".

So, with credit ratings under review by both S&Ps and Moody’s, and downgrades likely in both cases, the potential for a sudden surge in the country risk premium is evident, especially if differences with both the IMF and the EU turn out to be more about substance than about detail. If this surge in risk premium is also accompanied by a weakening in external demand, then the recent slight improvement in the external debt dynamic could easily be reversed, with serious implications for the country’s capacity to finance itself.

It would also not be adviseable to remain complacent about the extent to which Hungary could become a source of contagion risk farther afield. Not only is the Orban government on trial at the present time, so too are the IMF programmes in Eastern Europe and Greece. After proclaiming a substantial underlying improvement in the country, should the reality turn out to be somewhat different, then evidently there will be clear implications for the Baltics, Romania, Bulgaria, and even Greece and Ukraine. Programmes which don’t work in one country will in all likelihood not work in others, and it would be foolish to imagine that markets won’t catch on to this at some point. Indeed, with a Spanish economy which has been stabilised still remaining far from recovery mode, and an opposition party which seems more focused on persuing internal political disputes than on reaching consensus with the other key actors over the difficult steps which will need to be taken to bring Spain back to "normality", could events in Budapest be offering us a warning signal of what might all too easily happen in 2012 in Madrid, if a substantial change in mindset doesn’t ocur in the meantime?

Just What Is The Economist Up To In It's Crusade Against Catalunya?

2010-08-02T00:34:00.000-07:00

Well, this is certainly not the first time I have had cause to complain about the quality of the journalism and economic reporting served up over at the Economist, and I'm damn sure it won't be the last. But this latest example of shoddy (I would almost even go so far as to use the word "gutter") journalism certainly takes the biscuit. Catalunya, the August magazine informs its readers is the "Land of the Ban" - "First the burqa, now the bullfight. What will Catalonia outlaw next?" Evidently the author of the article is entitled to his opinion, but having this practice of unsigned opinion pieces may now have somehow converted itself inadvertently into a rather cowardly way of expressing otherwise undefensible opinions behind the shield of anonymity. Or would our author really like to show us that valour is the better part of discretion, and enter the arena in persona in order to face the wrath of the bull.

“The bullfight is not a sport in the Anglo-Saxon sense of the word,” wrote Hemingway in his classic treatise Death in the Afternoon, “that is, it is not an equal contest, or an attempt at an equal contest between a bull and a man. Rather, it is a tragedy; the death of the bull, which is played, more or less well, by the bull and the man involved, and in which there is danger for the man, but certain death for the animal.”

One Bridge Too Far?

As I say, this is not the first occasion on which I have felt moved to take The Economist to task for the level and standard of its journalism. Central European Correspondent Edward Lucas's heartfelt stance in defence of the Estonian internal devaluation is not a justification for innacurate reporting of developments in the region I argued here (see The Economist Blog reply here), nor indeed is the India correspondent's taste for ever stronger versions of Vindaloo curry good grounds for revising upwards trend growth in India every two months (as I argued here, see also this excellent earlier piece by Nandan Desai debunking what appeared - at the time - to be inbuilt prejudices against recognising India's inherent growth potential). And then we have the case of their Science and Technology correspondent, who enthusiastically latched onto what in the cold light of day appears to have been a deeply methodologically flawed piece of research trying to show (contrary to conventional wisdom) that as the level of human well-being increased beyond a certain point, then fertility begins to rebound.

Normally, in fact what I have expressed reservations about in the Economist's way of looking at things, is their strong micro- (versus macro-) bias in terms of analysis, their preference for supply side rather than demand side considerations (how the hell are longer shopping hours in Germany really supposed to correct deep structural deficiencies in German domestic demand), and an underplaying of demographic factors in economic growth theory.

But as I say, all these are issues about which it is perfectly possible to have an ongoing debate. But quite how it is possible to have a debate about the following - Catalonia’s regional parliament outlawed bullfighting. It is a bit like a German state banning wurst or a French region condemning those pesky berets - it is hard for me to see, since it is not clear what the debate is intended to be about. As one (Female, Argentinian living in Italy) reader of my Facebook page commented:

"Bullfighting, burqa and Wurst, all in the same first paragraph? I cannot agree with this kind of oversimplification, either as a woman, as a European, as a mere reader with a bit of basic education. The article is unfortunately misleading. The complex debate on the burqa should not be instrumentalised as part of an argument against banning the killing of animals for the sole aim of entertainment. Spain as a whole is getting there, so please be fair to the Catalans and to the many Spaniards who consider the corrida a cruel relique of the past."

As I say, I am hard pressed reading the article to discover what the issue is, apart from an apparent distaste for Catalonia, and the Catalans. I had thought it might have been about the omnipresence of a "nanny state", but then I read in this very much more balanced New York Times piece, that:

"Reliant on state subsidies, bullfighting has suffered heavily from forced cuts in public financing".

So in fact, we learn that bullfighting is losing support across Spain, and only survives thanks to government support, and mightn't we have imagined that The Economist would be worrying itself about whether such spending is entirely justified in such troubled economic times as these. Not a word on that though.

Or maybe their correspondent is concerned about loss of tradition. Certainly, in his article of Bulls and Ballots - where our author tries to muddy the debate between bull fighting and popular ballots about self determination (a constant theme here I think) - he makes the incredible statement "Never mind that Catalonia’s own traditions involve similar torments for the hapless animals", which suggests it is this loss of tradition he is worried about. But then why not be really consistent, and campaign for the reintroduction from clandestinity of ancient English traditions like bare knuckle boxing:

or badger hunting:

At the same time it is hard not to notice that the correspondent does his best not to find too many positive things to say about Catalans. In an article back in July 2009 "All must have prizes", he also argues that one of the reasons for Mr Zapatero's continuing spending spree was to keep Catalan politicians happy, without mentioning - as the group of young professionals who for Collectiu Emma point out - that there is a net fiscal transfer annually from Catalunya to the rest of Spain of around 10% of GDP. Indeed trying to hold Catalonia responsible for Spain's economic woes makes about as much (and as little) sense as holding Germany responsible for the Greek economic mess. In fact, the comparison goes further, since it is reasonably clear that Catalonia has an external surplus with the rest of the world just like Germany does, which is why the Catalans share the same kind of reputation inside Spain for being thrifty and austere as their German counterparts on the European level.

Diversity Sensitivity Or Canaries In The Coalmine?

But moving rather further afield, it would seem that the US press in general have been rather more balanced in their assessment of the situation than their UK equivalents. I have already mentioned the New York Times, but there are also reasonable summaries in the LA Times, the Christian Science Monitor and the Wall Street Journal. CNN even published an Op-ed from Prou activist Jordi Casamitjana.

Indeed, as this piece in the LA Times highlights, "Catalonia is the second Spanish region to outlaw bullfights, which have long been decried as cruel by animal advocates. The Canary Islands banned the blood sport in 1991, but Catalonia is the first region on the Spanish mainland to do so".

In fact you have to go to Bloomberg (incredible isn't it) to learn that:

"The Canary Islands banned bullfighting in 1991 as part of a wider law that aimed to protect domestic animals, singling out a ban on dog fights and the phasing out of cock fights".

So in the Canary Island case it wasn't part of an effort to defend their regional identity, which is, incidentally, reasonably clearly established.

In comparison with their trans Atlantic colleagues the British contingent has fared notably worse. According to Robert Elms writing in the Independent, "End bullfighting and you give in to the neutering forces of accepted taste". since "Our squeamishness means that we prefer death which is mechanical and invisible, while the Spanish understand that it is part of a cycle". Personally, I have never read such tosh, and have no idea on which planet this person is currently living.

Or then there is Gerald Warner who writes in his Telegraph blog - in an article entitled "Decent British revulsion towards bullfighting, in the land of the lunchtime abortion" (a *must* read this post)- "Nevertheless, post-Blair Britain will never be rated the most hypocritical and materialist society on earth so long as there are Catalans to claim those laurels." Really you have to give it to Gerald, he has far more Spanish "cojones" than the Economist writer, since he is at least prepared to recognise that those "wishy washy" modern British are half way along the road to that Catalan end-state.

And then there is Giles Tremlett writing in the Guardian

"The local El Periódico newspaper reported that several nationalist deputies had decided to back the ban only after Spain's constitutional court struck down parts of the region's 2006 autonomy charter earlier this month. At least 430,000 people, or 6% of all Catalans, protested on 10 July in Barcelona against the court's decision ,which declared Catalonia was not legally a nation."

There we go again, this attempt to tie in people's feelings about animal sports, with the Catalan Statute argument (remember the Of Ballots and Bullets piece). Of course, this connection exists, but it is a little odd to base your argument on one small report in a (not unbiased) local newspaper. Which brings us to another interesting point. Is the Giles Tremlett who wrote the above referenced Guardian piece the same Giles Tremlett who regularly writes on Spanish political issues for the Economist? And did he actually write the Economist piece I am bitterly complaining about here - which would be strange to discover, since the Guardian piece is considerably less rabid)? Perhaps only Giles himself can tell us that.

Is It Closing Time In The Bullrings Of The West?

So what really is all the fuss about? The threat of Catalan secession from Spain (highly improbable at this point) or the danger that is posed to this highly subsidized form of entertainment from having two autonomous communities now refuse to accept it? Evidently many Spaniards now reject what many would foist upon them as their national heritage (more on this here).

"According to a poll published in the Spanish daily El Pais this weekend, "Most Spaniards do not like the centuries-old spectacle of bullfighting but also do not believe it should be banned.....In a poll of 500 people conducted by Metroscopia, 60 percent said they did not enjoy bullfighting though 57 percent said they disagreed with the move by the parliament of the northern Spanish region to ban it."

In fairness, not all the UK press was of one voice. There was an excellent piece by Colm Tóibín in the Guardian and maybe this would be a good point to end on:

"The crowd loved it. It was a useful experience learning that people in groups, without laws or limits ...set to govern their appetites, will have a great time watching some dumb and beautiful animal, who has no chance of escape, being cut open with swords and other sharp instruments. They can call it sport, they can call it tradition, they can write about its beauty, its poetry and its intricacy, they can invoke Hemingway and write about skill and ritual; for me that day the bullfight was a celebration of cruelty, of mob rule, of death, of picking on something weaker then you and amusing yourself at its expense. It was vile and it was disturbing."

Plagiarising the words of Brendan Behan, "the bells of hell go ting aling aling, for the Economist's Spain correspondent perhaps, but no more for the Catalan bull".

Latvian Population

2010-07-28T03:26:00.000-07:00

Spain Bank Borrowing From The ECB

2010-07-14T08:32:00.001-07:00

Donde Se Encuentra Graphs

2010-06-10T10:01:00.000-07:00

Spain Spreads

2010-06-04T05:24:00.000-07:00

From invertia: here it is.

CDS - here they are.

Euro External Demand

2010-06-01T22:22:00.000-07:00

Here is one link.

The Role of External Demand in the Eurozone
by Jacob Funk Kirkegaard | May 27th, 2010 | 03:20 pm

The argument is widely heard in Europe and elsewhere: If only Greece and other struggling eurozone countries could let their currency depreciate, as other collapsing economies have done when hit by debt crises—in Asia and Latin America, for example. Such a step would in theory boost demand for these countries’ exports, limit their imports, and make it easier to lower their debts.

Greece, Spain, Portugal, Italy, and other European countries wedded to the euro can’t take that step, of course, without suffering a major disruption. But the view that a currency devaluation would offer a way out for Greece or other countries is in any case based on a simple fallacy. Just because eurozone members share their currency, the euro, with their eurozone neighbors does not prevent them from benefiting from the increased external demand for their goods driven by a decline in the euro itself.

Here is another:

Challenges for the Euro Area, and the World Economy
Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECB
at “The Group of Thirty”, 63rd Plenary Session, Session I: The Crisis of the Eurosystem,
Rabat, 28 May 2010

It is a pleasure to be here today, in the Group of Thirty, to discuss the main challenges on the road to a sustained recovery. I actually ask myself whether the title of the first session – “Crisis of the Eurosystem” – adequately reflects what is happening in Europe and more generally in the global financial markets. My impression is that what we are now seeing primarily in the euro area reflects a broader phenomenon, namely the sustainability of public finances in advanced economies. To repeat a much used metaphor recently, we could say that euro area tensions are “the canary in the coal mine” of the challenges that policy-makers worldwide are going to face.

Let me elaborate by looking at the origin of the problem, i.e. the sustainability of public finances. In the aftermath of the Lehman failure, governments around the world seemed to rediscover Keynes. They injected huge amounts of borrowed money – public funds – to stabilise the economy after the shock of the Lehman failure. These policies worked, and averted a global depression. The success of those policies has led governments – encouraged by international organisations – to continue using expansionary fiscal policies to try pulling the economy out of the recession and getting it back to the pre-crisis level.

Here is another:

Germany vs. Europe (New York Times Editorial)
Published: May 26, 2010

Germany’s commitment to the European Union has been central to its postwar rehabilitation and its economic success. For years, Germany played the role in Europe that America so frequently plays globally — the locomotive whose dynamism and demand helps turn around recessions before they deepen into depressions.

Here is another:

The end of EMU: How Germany might leave

Julian D. A. Wiseman

Abstract: A country in the eurozone can, without being in breach of the Maastricht Treaty, create a new central bank controlling the monetary policy of a new currency. This loophole in the Maastricht Treaty is not widely known.

Here is another:

The PIGS’ external debt problem

Ricardo Cabral
8 May 2010

Markets are increasingly concerned that the Greek debt crisis could spread to other Eurozone countries including Portugal, Ireland, and Spain. This column notes that much of these countries' debt is held by non-residents meaning that the governments do not receive tax revenue on the interest paid, nor does the interest payment itself remain in the country. The solution lies with debt restructuring and rescheduling.

Financial markets are focused on the public finances of Portugal, Ireland, Greece, and Spain (the “PIGS”). The PIGS´ public profligacy is partly to blame for their current plight, but other factors are at play. Amid the hype, little attention is paid to the crucial difference between these nations’ public debt and their external debt.

* Debt held by a nation’s own citizens has less pernicious consequences (Scott 2010) – the interest paid is returned to the domestic economy.
* External debt, if used to finance non-productive expenditure, is a different matter. Non-residents receive the interest on such debt, making the nation poorer with every interest payment.

Rift in the ECB:

ECB FOCUS-Deepening rift hampers ECB public opinion battle

* Deepening split at ECB hampers efforts to sell bond buys

Bonds

* Weber opposition "like blaspheming in public"

* Conspiracy theories developing along national lines

By Krista Hughes, Chief ECB Correspondent

FRANKFURT, June 1 (Reuters) - A deepening split at the top of the European Central Bank is undermining efforts to convince the public of the merits of buying government bonds and could suck the ECB further into the murky waters of European politics.

Axel Weber, head of the German Bundesbank, has made no secret of his objections to a policy designed to calm nervous markets and help stabilise the euro, but which he contends could fuel inflation.

He went a step further on Monday by calling for a strict cap on the programme, so far open-ended, which entails buying debt of weaker south European economies such as Greece, Portugal, Spain and Italy on the secondary market. [ID:nLDE64U16A]

And one on Merkel's leadership:

German leader Merkel goes from glories to disgrace

BERLIN – It was only nine months ago that Forbes magazine named German Chancellor Angela Merkel the world's most powerful woman for the fourth year in a row.

She impressed Germans and foreigners alike with her ascent to power — an East German pastor's daughter who took control of the male-dominated conservative party and won elections in Europe's economic powerhouse, becoming Germany's first female chancellor in 2005.

She was lauded for hosting the world's top leaders at the G-8 summit in Heiligendamm in 2007 with ease and professionalism. She repaired relations with the United States that were strained over the Iraq war, and she positioned herself as a political heavyweight on the continent. It seemed that no major political and economic decision could be made in Europe without Merkel's approval.

Resignation of Köhler is blow to Merkel's fragile coalition
By Gerrit Wiesmann in Berlin
Published: June 1 2010 03:00 | Last updated: June 1 2010 03:00
Horst Köhler, Germany's president, added to the pressure on chancellor Angela Merkel yesterday when he resigned over his contentious remarks that the country's military effort in Afghanistan protected German commercial interests.

The resignation - the first of its kind in modern Germany - came after his comments drew widespread criticism in a largely pacifist country wary of the return of martial traits.

Although the presidency is a ceremonial role, the search for a replacement will test Ms Merkel, who is already fighting to keep her fractious coalition of Christian Democrats and Free Democrats on side over the euro rescue and austerity measures.

The task comes as her Christian Democrats wrestle to stay in power in the big state of North Rhine-Westphalia, and cast about for a new lion on the party's right flank after Hesse governor Roland Koch quit unexpectedly.

Ms Merkel conceded she had been "surprised" by Mr Köhler's decision. "He was an important counsellor," she said. "It is his counsel I will now miss."

Despite the slim majority for the ruling parties in the presidential electoral college, Ms Merkel said in an interview on ARD and ZDF television last night that her coalition would propose a new president, according to Bloomberg.

Ms Merkel's success in placing Mr Köhler in Germany's highest office six years ago was a harbinger of the political change that followed in late 2005, when she ousted the Social Democrat Gerhard Schröder as chancellor. The same symbolism will dog the vote in the electoral college in June - any alliance of Ms Merkel's Christian Democrats with the Social Democrats would be another blow.

Mr Köhler, once head of the International Monetary Fund, said he was resigning after "unfounded" criticism of his remarks about the need for German soldiers overseas undermined "the necessary respect for my office".

Opposition politicians last week attacked him unusually bluntly after he said the task of "stopping regional instabilities" was vital for Germany because it would bring "free trade routes" and "jobs and income through trade".

The circumstances of his departure served to remind that Mr Köhler was a head of state who had never found his role. A series of staff defections in past months had suggested all was not well in the president's office.

Mr Köhler lacked the warmth of some predecessors. He spent most of his career as a bureaucrat, rising to become deputy finance minister for international affairs under Helmut Kohl before being nominated by Mr Schröder, to take charge of the IMF.

Whither Spain – Towards Finland or Argentina?

2010-05-29T01:10:00.000-07:00

Well, here I am spending my last day in Sitges, attending the annual meeting of the Circulo de Economía (which is why I have been so silent). The annual meet up tends to attract many leading participants in Spanish economic and financial life. I have been here since Thursday, and gave a presentation on the need for som...e sort of internal devaluation. As Alfredo Pastor (who introduced me) said, what Edward was arguing six months ago seemed to be "catastrophist", now it has become the consensus.

Interestingly, Dani Roderik, who spoke yesterday, came to very similar conclusions: Spain's needs a 20 % internal devaluation (or in his opinion should leave the Eurozone - I don't agree with this part). Keeping ahead of the curve, I am now starting to argue - as previewed in my latest AFOE post - that either we move soon on this, or Germany will inevitably have to go back (temporarily) to the Mark. The system won't hold otherwise. Given that opinions have changed so radically here in Spain in just six months, nothing can be ruled out at this point.

Not even Zapatero stepping down. It is interesting to note that CiU gave him till the end of the year - he will not be able to pass a budget for 2011 - to do this, or there will be elections. So let's see if the leaders of PSOE are able to "factor in" what will inevitably happen, and take a decision now.

Spain does not need elections. Spain needs a change at the top, a consensus government supported by all the main parties, and a swift internal devaluation.

Interestingly a lot of people have spoken to me here over the last few days, and all the comments have been positive. Many of the people here seem to read me in La Vaguardia (Dinero supplement) on Sundays. I never realised I was so popular, in fact I had quite the opposite impression.

Below you will find the English version of my press release. I entitled my presentation "Spain - Finland or Argentina". I think the reason for this should be fairly clear. Back in the early 1990s, following an uncontrolled credit boom, Finland underwent a deep depression as its GDP dropped by around 14% and unemployment rose dramatically from 3 to almost 20%. Initially the Finish government refused to recognise the severity of the situation, and the economy failed to recover. Then they took the “bull by the horns”, carried out a series of deep structural reforms and as a result the country is now widely recognised as a model of flexibility and good practice.

The other path is to do very little, live in hope, and expect the worst. This is the road to ruin and decay. The Argentine path.

The Finnish case was of course a little different from the situation Spain now faces, since Finland had its own currency, and was thus able to restore competitiveness through a substantial devaluation, a devaluation which then required the creation of a bad bank to relieve lenders of toxic assets produced by the rapid rise in non perforing foreign currency loans.

To many in Spain this kind of radical price and wage adjustment proposal is simply unrealistic. But at this point there are few remaining alternatives. Spain is gradually replacing Greece as the focus of global investor concern, and while people in Spain may have little appetite for such drastic changes, they should never forget that across in Germany, where people are now being asked to authorise funding for substantial loans to be used on Europe’s periphery, support for proposals that the country return to the Deutsche Mark is growing by the day. As the IMF point out, any comprehensive strategy to move the Spansih train along the track which leads to the Finland station requires broad political and social support, while time is of the essence.

Spain - Finland or Argentina?

“Spain’s economy needs far-reaching and comprehensive reforms. The challenges are severe: a dysfunctional labor market, the deflating property bubble, a large fiscal deficit, heavy private sector and external indebtedness, anemic productivity growth, weak competitiveness, and a banking sector with pockets of weakness. Ambitious fiscal consolidation is underway, recently reinforced and front-loaded. This needs to be complemented with growth-enhancing structural reforms, building on the progress made on product markets and the housing sector, especially overhauling the labor market. A bold pension reform, along the lines proposed by the government, should be quickly adopted. Consolidation and reform of the banking system needs to be accelerated. Such a comprehensive strategy would be helped by broad political and social support, and time is of the essence”.
IMF 2010 Article IV Consultation Spain Mission Statement

Following a decade long housing “boom” Spain now has an enormous debt problem. The combined debt level of Spain’s households, companies and government now amounts to some 265% of GDP.

However, in contrast to the situation in countries like Greece and Italy, Spain’s endebtedness problem is not principally one of massive public sector debt. The main component of Spanish debt is private – between households and companies accumulated debt amounts to some 210% of GDP.

Spain is not, by a long stretch, the only country to suffer from such a high level of private indebtedness. There is, for instance, the example of the United States, where total indebtedness now significantly exceeds the 300% of GDP level, a threshold which many consider to be highly structurally significant. The sheer fact of knowing you share this problem with other larger, and richer, countries may be soothing, but it should also give an indication of the kinds of difficulty Spain may experience in interacting with the external environment, since solutions will need to be found which fit the needs not of one isolated country, but of various countries, all at one and the same time.

Stabilisation....But At A Price

After an extremely severe recession the Spanish economy has now been stabilised.

Industrial output has stopped falling, and retail sales have even started to rise slightly.

Output in the bloated construction sector, as was to be expected, continues to fall, as do house prices. Unemployment has stopped rising, although employment, and participation in the Social Security system continues to fall.

At the same time the previously large migration flows have now all but dried up.

But this stabilisation comes at a price, given that is the result of a dramatic surge in current government spending and a huge liquidity support operation for the financial system being supplied by the ECB.

Deficit and Debt Dynamics

As is by now well known, this increase in public spending has produced a further problem – one of a large government fiscal deficit – and this development has served to attract the attention of the international investors on whom Spain depends for its financing at precisely the time that the issue of sovereign debt in the ageing societies of the economically developed world is starting to become a cause for concern in the financial markets.

The principal difficulty facing the Spanish economy at the present time is that while the emergency measures have served to buy time, this time has not been wisely employed, and the measures have simply served to exaccerbate the underlying structural problems rather than resolve them.

According to the National Statistics Office (INE), the slight economic expansion that was achieved in the first quarter of 2010 (0.1% growth) was the combined result of an increase in internal demand and a worsening of the net impact of external demand – precisely the opposite of what you would want to achieve. In other words, while Spain’s exports did increase, the growth in domestic demand in conditions of limited international competitiveness meant that imports increased even more. On an interannual basis the negative impact of national demand reduced (from -5.3 percentage points to -2.5 percentage points – see chart below) while the positive impact of external demand fell (from 2.2 percentage points to 1.2 percentage points). To be clear, growth in the first quarter of 2010 was due to rising domestic demand, and not rising exports, which means the real impact of the increase in government spending and the liquidity measures applied by the ECB since June 2009 has been to reverse the positive trend in the goods trade deficit which had been seen in earlier quarters.

As the Spanish government stresses, the country’s share in world exports has remained more or less constant since the start of the century, but at the same time Spain’s share of world imports has increased. Put another way, thanks to the foreign funds which flowed in to finance the housing boom Spain became a major imports powerhouse, with the consequence that both the trade and the current account deficits deteriorated sharply, while a significant part of Spanish industry simple died. One of the major tasks of any recovery programme is to bring this industry back to life. In this sense what Spain’s economy needs is not rejuvenation but resurrection.

With a highly integrated global economy as the background, Spain’s seemingly insatiable demand to build and buy ever more housing units was satisfied via the massive entry of migrant labour (5 million immigrants in 10 years), and substantial ongoing capital inflows (a current account deficit of around 10% of GDP), which both served to raise the short term capacity of the economy, but lead to the consequence that Spain today is a highly over-indebted country – net external debt is around 90% of GDP – while a large part of the manufacturing base which would have facilitated paying down the debt now no longer exists.

As a result – and as Mr Zapatero repeatedly stresses – it is the case that the accumulated debt of the Spanish government is not (yet) inordinately large when compared to that of its peers, although as a share of GDP it has been increasing rapidly in recent quarters.

To reduce this debt burden the Spanish economy needs two things: inflation and growth, although it should be stressed that competitiveness can only be restored by some form of price and wage deflation.

In a modern, mature, economy growth in aggregate demand only comes either via an increase in the level of credit, or through an increase in exports. The problem that Spain faces is that, on the one hand all sectors of the economy (households, companies and government) are now heavily over-endebted and deleveraging as fast as they can, with the result that – on aggregate – they are demanding less (not more) credit. On the other hand, the Spanish economy is not sufficiently competitive to be able to grow simply by relying on exports.

In addition, systematic dependency on external financing is never a good thing, since your creditors can always impose conditions on you which may not be to your liking. Despite the fact that the commitment to reduce Spain’s fiscal deficit by 5% of GDP in 2 years is, in and of itself, a very strong one, the country actually has to make a far greater fiscal effort than it seems, due to the commitment contained in the recent Ley de Economía Sostenible to reduce substantially the quantity of unpaid receiveables on the public sector account books. Spain’s Autonomous Communities alone have some 30 billion (or around 3% of GDP ) in payments oustanding as of the last quarter of 2010 – which means there will need to be a reduction in spending of something like a additional 1% of GDP a year over the adjustment period under this heading alone.

The need to restore order to Spain’s public finances will mean that the adjustment will be even more painful than generally envisaged, and that the impact of the correction on the economy generally will be more severe. Thus, it is rather unlikely that the Spanish economy will grow in 2011 as many expect. Weighed down by a heavy fiscal correction, an unacceptably high level of unemployment, private demand in slight contraction and a weak growth rate in exports, it is probable that the economy will once more contract, possibly by between 1% and 2%.

To conclude, Spain stands at a crossroads, and important decisions need to be taken. A fiscal adjustment is necessary, but the country also needs a competitiveness adjustment in the form of a substantial reduction in the wage and price level (possibly by 20%). If this is not implemented the dynamic of Spain’s debt will surely become unsustainable. Spain has two – and only – choices at this point. It can follow Finland’s example in the 1990s, take the bull by the horns and use the present crisis as an opportunity to transform the Spanish economy into a new economic miracle, or it can remain in denial about the severity of the problem, let things drift until they can do so no longer, and then follow Argentina down the road of ruin and despair.

To cite the words of the latest IMF report: “Such a comprehensive strategy would be helped by broad political and social support, and time is of the essence.” Ladies and gentlemen, enough is enough. Nearly three years have now been wasted, and it is time to act.

Spain's Unemployment Problem Screenshots

2010-05-03T07:34:00.000-07:00

Please click on images for better viewing.

The links to the press release files are as follows:

March 2010

February 2010

January 2010

December 2009

November 2009

October 2009

September 2009

August 2009

July 2009

June 2009

May 2009

April 2009

March 2009

February 2009

January 2009

Forint Tanks

2010-04-28T09:20:00.001-07:00

Greek Worries

2010-04-20T03:25:00.000-07:00

Greek Debt Crisis Seen Getting Worse
Financial-Aid Needs Could Top $100 Billion, Bundesbank Chief Tells
German Lawmakers; Athens Readies T-Bill Offering

http://online.wsj.com/article/SB10001424052748704671904575193492072402292.html?mod=WSJ_WSJ_US_World

FRANKFURT—Greece may require financial assistance of as much as €80
billion ($107.92 billion) to escape its debt crisis and avoid default,
Bundesbank President Axel Weber told a group of German lawmakers
Monday, according to a person familiar with the matter.

The estimate, considerably more than the €45 billion that European
countries and the International Monetary Fund are currently prepared
to extend Greece this year if it needs a bailout, suggests that a
rescue of the country may come in several stages and reach beyond
2010.

Mr. Weber, a member of the European Central Bank's governing council
and a leading candidate to succeed Jean-Claude Trichet as ECB
president next year, told the legislators that Greece's situation was
worsening and that "the numbers are changing all the time," according
to the person. A Bundesbank spokesman declined to comment.

A spokesman for the German government referred questions to the
finance ministry, which couldn't immediately be reached.

Mr. Weber's comments will likely fuel a debate in Germany and
elsewhere in Europe over the wisdom of extending heavily indebted
Greece a bailout without a fuller understanding of the country's
long-term capital needs. If Greece does receive a bailout, its access
to capital markets would likely be severely curtailed, leaving it
dependent on aid for the foreseeable future, economists say.

The Greek economy is under severe pressure due to austerity measures
aimed at curbing government spending to bring down the deficit.
Athens, which has said its total borrowing needs this year are in the
range of €50 billion to €55 billion, is expected need a similar amount
in 2011 and possibly more in 2012.

Greece's entire debt totals more than 110% of gross domestic product
and its budget deficit was about 13% of GDP last year.

Members of the 16-member euro zone agreed this month to extend Greece
as much as €30 billion in loans, should the country need a rescue. In
addition to the European aid, the IMF is expected to offer Greece as
much as an additional €15 billion.

Before Athens can receive any European funds, legislatures across
Europe, including in Germany, must approve the plan. Germany, Europe's
biggest economy, is expected to initially contribute more than €8
billion if Greece receives a bailout.

The German government is expected to introduce legislation within the
next two weeks that would allow it to send Greece aid if it requires
assistance, according to people familiar with the matter.

Mr. Weber told the gathering on Monday, which included lawmakers from
the center-right Free Democrats, that he saw "no alternative" to a
rescue of Greece at this point.

A European Union-International Monetary Fund delegation was scheduled
to arrive in Greece on Monday to discuss details of a possible rescue
plan. However, with the cloud of Icelandic volcanic ash blocking much
of Europe's airspace, that trip was pushed back to Wednesday, dragging
out the rescue-approval process for Greece still further and weighing
on the euro.

The difference in yields between Greek 10-year bonds and German
bunds—the benchmark in Europe—reached 4.62 percentage points.

These levels—the highest for more than a decade—reflect continuing
concerns about Greece's financing prospects.

Despite such concerns, Greece is expected to proceed with plans to
offer €1.5 billion in three-month paper on Tuesday, a week after
selling six- and 12-month Treasury bills.

Demand is likely to be concentrated among Greek banks, but foreign
buyers are expected to appear as well.

Jean François Robin, strategist at Natixis Bank in Paris, said he is
"reasonably optimistic" about the outcome of the auction because the
T-bill market can easily cope with the size and maturity.

"You can expect quite a good auction in terms of demand despite the
current difficult environment. I think the offered €1.5 billion will
be received without big problems," he said. "Having said that, the
global sentiment around Greece is very choppy, and some investors are
waiting for clarification on the European Union's help."

Many European officials have expressed concern that if Europe doesn't
act to save Greece from default, the country's problems risk spreading
to other European nations, endangering the euro.

Markets gear up for Greek debt restructuring

By Anousha Sakoui and Kerin Hope

Published: April 19 2010 19:09 | Last updated: April 19 2010 19:09

http://www.ft.com/cms/s/0/4c7c6d3e-4bdc-11df-a217-00144feab49a.html

In a world where the unthinkable has become thinkable, markets are now gearing up for an event many had not previously been factored into the realms of possibility.

Even as Greek bail-out discussions continue – talks between representatives of the European Commission, European Central Bank and IMF were delayed on Monday by the volcanic ash cloud – market watchers are starting to question whether, in the long term, Greece can avoid a restructuring of its debts or even an outright default.
“Investors and analysts are now running the numbers to see what a haircut to Greek bonds would be,” says Steven Major, global head of fixed income research at HSBC.

“One way to do this is to compare restructurings for emerging market sovereigns. Based on the defaults over the last 12 years the average long-term recovery rate is close to 70 per cent. Ultra-long Greek bonds currently trade at a price below this.”

Greek 10-year bond yields on Monday hit a new record high since the country joined the euro, with yields reaching 7.76 per cent and closing up 26 basis points.

Greece debtThe cost for investors to insure against a default on Greek bonds also hit a new high with five-year credit default swaps reaching 472bp, according to data providers CMA Datavision. It said current levels imply a probability of default of about 30 per cent over five years, higher than Iraq.

The IMF is expected to raise the question of debt restructuring at imminent meetings with the Greek finance ministry, according to one person with knowledge of the agenda. It is not likely to be a detailed discussion “just a pointed reminder of the debt forecast”, the person adds.

The IMF has already told the finance ministry informally that Greece’s debt will reach 150 per cent of GDP by 2014, according to this person. Greece’s debt to GDP level – 113 per cent in 2009 – is already the highest in the eurozone. The IMF calculates that Greece will need to find €120bn ($162bn) over the next three years.

In spite of these challenging numbers, finance ministry officials say default risk “is only a theoretical possibility”. The Greek government has not officially addressed the possibility of a restructuring, but it is expected that it might consider some form of liability management – ie, swapping short-dated bonds for longer-dated ones – later this year, according to one person familiar with the government’s thinking.

Debt restructuring covers a wide range of possible outcomes. At one extreme is a default event such as changing the terms of the bonds and imposing a haircut on creditors. However a softer option of liability management could ease refinancing pressure and avoid a default.

Some emerging market economies such as Lebanon and Mexico undertake liability management via regular bond exchanges, where investors tender their bonds for longer dated securities voluntarily. A similar model could be extended to Greece, some bankers have speculated, whereby investors could choose to tender a bond due in the short term in exchange for a longer term to pick up additional yield.

Voluntary is a key word, as some rating agencies would consider a debt exchange that was forced on bondholders as a default.

Carl Weinberg, chief economist at High Frequency Economics, proposes that Greece uses a multi-year restructuring of its bond obligations as a way to lower the debt service burden similar to Mexico’s debt restructuring in the early 1980s. Then Mexico’s lenders stretched all debt obligations maturing over the following 14 years over a 27- year term. The effect was to smooth a refinancing “hump” of principal repayments into a manageable long-term stream of princplal and interest payments.

Greece faces a similar hump over the next five years. Mr Weinstein calculates that total debt service including interest will peak near €50bn in 2014 and, assuming no economic growth between now and then, that would equate to borrowing more than 20 per cent of GDP. Total debt service over the next 5.5 years totals €240bn, roughly equal to its current GDP.

“Investor scepticism of Greece’s ability to service its debt has its roots in an amortisation and debt service schedule that bunches principal payments over the next five years, with a second ‘hump’ in maturities building for 2019,” says Mr Weinstein. “Greece has to be allowed to replace each of its existing bonds with a longer-term self-amortising note.”

He estimates that Greece would save €140bn in debt payments over the next 5.5 years, with no haircut on principal required, if it followed a Mexico-style restructuring over 25 years.

Some analysts could view a restructuring positively. “We are in unchartered waters. If Greece were to default in an orderly manner, with an agreed debt restructuring, then the impact might at least be contained to Greece,” says Gary Jenkins, analyst at Evolution Securities.

But few believe a restructuring announcement is likely soon. “I dont think it’s likely that a restructuring would happen this year,” says HSBC’s Mr Major. “The longer the uncertainty around Greece goes on the more unsustainable the funding position becomes and markets will push for a restructuring.

“But Greece cannot be allowed to default in any way because of the risk of contagion and damage to the single currency. Dubai was a good example of how even the suggestion of restructuring, at the time it was called a ‘standstill agrement’; can shut down funding channels and make things a lot worse.”

ECB Funding For Spanish Banks

2010-04-04T10:32:00.000-07:00

What Do You Yuan?

2010-04-02T00:34:00.001-07:00

Bank Of Spain Outlook

2010-04-01T10:15:00.000-07:00

Bank of Spain Sees Lower GDP, Bigger Budget Gap Than Government

By Emma Ross-Thomas
March 30 (Bloomberg) -- Spain’s economy will grow half as much as the government forecasts next year, making the deficit- cutting process slower than the Finance Ministry expects, the Bank of Spain said.
Spain’s gross domestic product will grow 0.8 percent next year, the Bank of Spain said in its monthly bulletin in Madrid today. That compares with a government forecast of 1.8 percent. The budget shortfall will drop to 10.2 percent of GDP this year and 8.9 percent in 2011, the bank said. The government expects a deficit of 9.8 percent this year and 7.5 percent in 2011.
Spain, struggling with the highest unemployment rate in the euro region and the third-largest budget gap, has been in a recession since the second quarter of 2008. The government projects the economy will contract 0.3 percent in 2010, even as it forecasts quarter-on-quarter growth throughout the year.
Hit by the collapse of a debt-fueled construction boom made worse by the global crisis, Spain’s government created one of the biggest stimulus programs in Europe, including tax rebates and public-works projects. That helped push the deficit to 11.2 percent of gross domestic product last year, which it aims to bring within the European Union limit of 3 percent in 2013.
The central bank forecasts unemployment will rise to 19.4 percent this year and 19.7 percent in 2011. That compares with the government’s forecasts of 19 percent this year, and 18.4 percent in 2011.

El Paro: Desanimados o Simplemente "Missing" (Dos)

2010-03-31T00:27:00.000-07:00

Según un articulo reciente en este mismo diario, el Gobierno Español ha decidido abrir la puerta de salida a los trabajadores inmigrantes que se encuentren parados para que regresen a sus países de origen. Y para que esta oferta no se quede corta de demanda, el Ejecutivo parece dispuesto a ofrecer ayudas económicas de hasta 2.600 euros por familia, más el pago del billete para viajar.

Como indica Expansión, en estos momentos el 30% de la población extranjera afiliada a la seguridad social (o más de 600.000 personas) sobrevive sin rentas del trabajo, mientras que para cerca de 300.000 la caducidad de su seguro de paro es cuestión de semanas. Entonces hace falta encontrar alguna solución u otra, y con urgencia. Pero la pregunta que esta nueva política de respuesta pone de relieve es lo siguiente: ¿es conveniente que las personas con capacidad de trabajar, al faltar el trabajo, salgan del país? Como voy a explicar más abajo, mi opinión es que esta solución sería un desastre para el país.

Ciertamente, señales de que algunos estaban marchando han ido apareciendo cada vez con más frecuencia en los últimos meses.

En primer lugar, el saldo migratorio ha ido bajando constantemente (ver gráfico abajo).

Según el ultimo informe del INE, en su Población "nowcast", en septiembre del 2009 , 9.048 personas más entraban en España (incluyendo nacionales y extranjeros) . Tal cantidad puede exagerar el número significativamente por dos razones básicas. En primer lugar sólo se sabe si un inmigrante ha dejado realmente el país, cuando no renueva su permiso de residencia, cosa que sólo se hace cada dos años, y por lo tanto hay una demora considerable. Por otro lado, los nacionales solo constan cuando emigran definitivamente, pero de estas personas indudablemente hay bastante pocas: los que simplemente se van a buscar trabajo, sin planes que vayan más lejos ¿quién los contabiliza a ellos?

¿Los desanimados, dónde están?

Otra indicador que puede resultar interesante en este sentido es el desfase entre el número de personas que pierde su trabajo, y el total de parados. Yo, personalmente, he quedado sorprendido por el de hecho de que el número de parados no ha subido tanto como esperaba. También parece que los técnicos del INEM han tenido la misma sensación, porque han ido constantemente modificando sus datos de parados, estacionalmente corregidos y depositados en Eurostat, desde Semana Santa del 2009. El último ejemplo ha sido la revisión que han hecho de la tasa de desocupación de diciembre que ha bajado de un 19,5% a un 18,9% al terminar el EPA por el cuarto trimestre.

Por supuesto, el paro ha ido subiendo, y seguirá subiendo, pero no tan rápido como yo, personalmente, tenía previsto, y aunque todavía creo que superará las previsiones tanto del mismo Gobierno como del Banco de España, no creo que no llegamos al lindar del 25% que inicialmente tenía previsto. Pero la razón por la que no llegaremos no es ninguna buena noticia.

Tal y como destacan en su último informe del mercado laboral IESE-Adecco, en el último trimestre del año pasado era la caída de la población activa - del 0,4%, la primera caída en 30 años y provocada por el desaliento entre los desempleados - lo que impide que el número de personas sin empleo llegue a los 4.500.000 de parados.

Según el informe de no haberse contraído la población activa, los desocupados sumarían 100.000 más al final de año, con lo que se hubiera alcanzado fácilmente la cifra de 5 millones si la población activa hubiese mantenido una evolución normal. “El resultado del desánimo en la población es la moderación en el incremento de parados”, indica el informe de IESE-Adecco.

Pero la parte mas interesante de ese discurso son las razones que dan. Según IESE-Adecco este "desánimo" ocurre por dos principales motivos. Por un lado, una parte de quienes pierden su empleo no inicia la búsqueda de otro y, por otro, personas que desearían trabajar no comienzan a buscar empleo. "Tales comportamientos pasan a ser comprensibles por el desánimo y las malas expectativas en el contexto actual", dice el informe. Pero luego matizan: "Para ser más precisos, el efecto desánimo coexiste con otros dos movimientos, aún poco visibles pero ya en marcha: inmigrantes que retornan a sus países, efecto retorno, y españoles que deciden probar suerte en el mercado laboral de otros países de la UE, efecto salida”.

Según el informe, el hecho sobresaliente en 2009 es el descenso de la población económicamente activa, algo que no había ocurrido en las tres décadas anteriores - en los últimos doce meses, se ha producido un descenso de 92.300 personas activas. Y en el último trimestre, y por cuarto trimestre consecutivo, el número de puestos de trabajo perdidos interanualmente ha superado el millón, concretamente, 1.210.900 ocupados (descenso de un 6,1%). Específicamente, a lo largo de los últimos doce meses se han perdido 819.900 empleos adultos (descenso de un 4,5%) y 391.000 ocupaciones juveniles (bajada de un 23,5%). Es decir, 1 de cada 3 puestos de trabajo perdidos estaba ocupado por un menor de 25 años, y el número de jóvenes ocupados (ahora 1.273.000) es el más bajo en al menos 40 años (ver gráfico). Esta situación se repite en todas las Comunidades Autónomas analizadas.

Por lo tanto, desde septiembre de 2007, momento de máxima ocupación, han perdido su empleo 1.864.700 personas, lo que equivale al 9% del total de ocupados de aquella fecha. Es decir que, hasta ahora, la crisis ha quitado el empleo a 1 de cada 11 personas ocupadas.

Al mismo tiempo el numero de afiliados de la seguridad no deja de bajar. En términos desestacionalizados, el desempleo se ha situado en 4.015.625, lo que supone 59.088 parados más que el valor desestacionalizado del paro registrado en febrero. Por otra parte el numero de los afiliados a la Seguredad Social en marzo - en términos desestacionalizados - ha caido en 34.660 trabajadores - de 17,747 millones a 17,712 millones - en comparación con febrero.

Según las previsiones de IESE-Adecco, en junio próximo, el porcentaje de personas activas sin empleo será de un 19,2% - un incremento interanual de 1,3 puntos porcentuales. De confirmarse esta previsión, desde junio de 2007 se habría acumulado un incremento en la tasa de paro de 11,3 puntos porcentuales. No obstante, el informe argumenta que si la población económicamente activa volviera a expandirse de modo parecido a como lo hizo hasta marzo de 2009, la tasa de desocupación podría ser hasta 2 puntos porcentuales mayor a la cifra antes indicada - y una parte significativa de esta diferencia puede llegar por parte de las personas que, simplemente, ya no están aquí.

Es por eso que yo destacaría dos "grupos de riesgo". En primer lugar, la mano de obra inmigrante, mayoritariamente ligada al sector servicios y la construcción, ambos muy golpeados por la crisis, cuya tasa de paro ha llegado hasta el 29,7%, frente a la del 16,8% de los nacionales. Y en segundo lugar, jóvenes con menos de 30 años, y sin contrato de larga duración. En ambos casos, un estancamiento del mercado laboral durante mucho tiempo puede producir la consecuencia indeseable de que se vean forzados a marchar del país, en busca de su futuro.

Mantener La Población Activa: Factor Crítico En La Recuperación

La economía es una ciencia compleja, donde todo depende del punto de partida y de su trayectoria, lo que quiere decir que es difícil predecir, muy a menudo, y que los resultados producidos son sustancialmente diferentes a los que esperaría una persona aplicando una postura de "sentido común".

Así, por ejemplo, podría parecer, a simple vista, que con la tasa tan alta de desempleo que tenemos y la gran cantidad de emigrantes, con una vuelta de los emigrantes, a su país de origen, habría bastante menos desempleo.

No obstante, a pesar de esa conclusión inicial, un análisis más detallado, revelaría que se trata de un proceso de razonamiento falso, ya que si la fuerza de trabajo disminuye, habrá menos personas en la mano de obra para pagar las futuras pensiones, menos personas trabajando para producir las exportaciones que el país necesita para pagar su deuda externa. También, menos población para comprar y alquilar casas, lo que haría mucho más difícil estabilizar el mercado de vivienda y frenar la morosidad de forma que los bancos quedasen solventes. Así que, si se deja que las personas se marchen del país, los españoles corren un mayor riesgo de tener que trabajar mas años, por una pensión reducida, además de precipitar una verdadera situación explosiva en sus bancos.

Según un estudio reciente de la Fundación de Estudios de Economía Aplicada (Fedea), las malas perspectivas que ofrece la economía española pueden convertir España en un país sin inmigración. Las estimaciones detalladas de llegadas de inmigrantes para los próximos años que hace el informe indican claramente que los ritmos serán menguantes: este año llegarán 285.000 nuevos inmigrantes; serán 203.000 los recién llegados en 2011; 128.000 en 2012; 61.000 en 2013... Y en 2014 la recepción de inmigrantes queda prácticamente en nada, con sólo 3.000 nuevos extranjeros.

Pero, por las razones dadas antes, yo temo que la situación puede llegar a ser mucho peor. Creo que el saldo de inmigrantes puede ser incluso negativo este mismo año y que la falta de perspectivas de trabajo puede hacer que nos enfrentemos a una bajada sustancial de la población activa en los próximos años, sobretodo si añadimos el número de jóvenes autóctonos que no tendrán más remedio que salir en búsqueda de su futuro.

Es evidente, que la burbuja inmobiliaria ha producido muchas consecuencias indeseables, entre las que se encuentra la subida dramática de la población, sin tener un modelo económico capaz de ofrecer puestos de trabajo adecuados y sostenibles. Pero lo hecho, hecho está. Si ahora mismo España hace marcha atrás, se puede producir una situación infinitamente peor, y algunas regiones del país podrían quedar como Alemania del Este u otras partes de Europa Oriental. Por eso y por muchas otras razones, es de primera importancia poner en marcha una política económica que pueda producir crecimiento de empleo de forma urgente, ya que, en la situación actual, semejante caída de la población lejos de ser deseable seria una catástrofe y podría precipitar España hacia una espiral descendente, que una vez iniciada seria difícil de detener.