In the “great minds work alike” category, both some readers (Hugh and LaMarchaNegra) and some of my investor e-mail correspondents (Scott, Ed Harrison, Marshall Auerback) took notice of how things are looking bad on the way to worse. Despite an unemployment rate of 25% and rising social unrest, the government just increased sales taxes to 21%. Ed Harrison sent a note to his Credit Writedowns Pro customers describing how Spain’s problem isn’t its government debt levels per se, but its deficits and the way it is soon to be saddled by regional debts and bank bailout costs. And because some of the creditor nations are dead set against debt mutualization, Spain will need to find a way to deal with its banking system losses.
The logical path, and the one the Troika is pushing, would be to wipe out equity and haircut sub debt and if need be, the next senior layer of bondholders. But depositors were pressured into buying preference shares and subordinated debt. Reuters reported that62% of bank subordinated debt investors are depositors at the same institution. Hurting small savers will not only be a political disaster, it will generate lawsuits against the banks and will further crimp the economy.
Spain is looking more like its contraction is accelerating, along with its social stresses. How close is it to a Greek style death spiral?
Delusional Economics is worrying along the same lines, with his argument amplified by charts accompanying his current post. As he notes:
Along the way I have warned that Spain suffered from significant macroeconomic challenges that, at the time, appeared unrecognised by the markets. I also provided some analysis that the country’s problems were far greater in magnitude than something than could be fixed by simply lowering government sector deficits:
The private sector accumulated large debts on the back foreign capital inflows leading to a housing bubble. This bubble has since collapsed leaving the private sector in a position of significant wealth loss and indebtedness, the banking system holding significant and growing levels of bad debts and the economy structured around the delivery of a failed industry.
The growing unemployment is leading to a slowing of industrial production, which means that even though the country is importing less it also appears to be exporting less. Combine this with the interest payments on borrowings from the rest of the world and at this point Spain continues to run a current account deficit which, in the most basic terms, means Spain is still paying others more than it is being paid back. That is, the external sector is still in deficit.
So with the external sector in this state and the private sector unable and/or unwilling to take on additional debt as it attempt to mend its balance sheet after an ‘asset shock’, the only sector left to provide for the short fall in national income is the government sector. If it fails to do so then the economy will continue to shrink until a new balance is found between the sectors at some lower national income, and therefore GDP.
It may appear logical to you that this must occur, and I don’t totally disagree, but that doesn’t change the fact that under these circumstances there is simply no way that the private sector will be able to continue to make payments on the debts it has accumulated during the period of significantly higher income. This is a major unaddressed issue.
And this is the monetary trap much of the European periphery now find themselves in. Structural issues within their economies together with their pseudo non-floating currency means they are neither able to shrink nor grow out of their debts. Without significant debt restructuring they are left to flounder in a viscous spiral downwards.
To add to the list of Spanish tsuris, home prices are down over 30% from their peak, industrial production is contracting sharply, and the current account is still in deficit. There’s no signs of vitality here, yet the alchemists continue to bleed the patient. To change metaphors, Spain is too large for it to be broken on the rack like Greece and not have the rest of Europe suffer along with it, but that seems to be the plan