Don Quijones: How the ECB Helped Spain “Recover” Faster than Italy from the Crisis

By Don Quijones of Spain, the UK,and Mexico, and editor at Wolf Street. Originally published at Wolf Street

In April 2017, the IMF predicted that by the end of the year the Spanish economy would overtake Italy’s in per-capita GDP. It didn’t happen, but Spain does continue to close the gap on Italy.

In 2017, Spain maintained its per-capita GDP at 92% of the EU average while Italy’s slipped another point to 96%. During the darkest depths of the Great Recession, back in 2011 and 2012, Spain’s per capita GDP sank 11 points below that of Italy’s. But now the gap has narrowed to just four points, the smallest since 2007, when, on the back of one of the world’s most mind-watering property bubbles, Spain’s economy very briefly overtook Italy’s.

In recent years, Spain has undertaken painful economic reforms while also benefiting from three tailwinds: the rise of geopolitical risks affecting rival tourist destinations, the ECB’s expansionary monetary policy, and low oil prices. As a result, the economy has grown at a fair clip since late 2013, to the point that it’s often held up as a poster child for Eurozone economic policy, despite 16% unemployment, a surge of low-paid, highly precarious jobs, and a general feeling (in this survey, by 80% of the respondents) that the country still hasn’t emerged from the crisis.

Nevertheless, as Bloomberg trumpetedtoday, Spain has got its swagger back:

Even the abrupt ouster of Prime Minister Mariano Rajoy this month couldn’t shake investors’ faith that Spain’s recovery is real, whereas Italy’s looks increasingly fragile. Yields on Spanish government bonds are about where they were before parliament voted Rajoy out of office on June 1. The Mediterranean countries’ divergent fortunes are reflected in the spread between their 10-year sovereign debt, which is the widest since 2012.

Italy’s economy is still roughly 10% smaller than it was before the crisis. Rome’s chronic political instability and policy inertia hardly help matters. But there’s also a far less-cited reason why Spain’s economy has fared comparatively better than Italy’s in recent years: the ECB’s extreme brand of monetary repression, which has massively favored Spanish households over their Italian counterparts.

In general terms Italy is a nation of savers while Spain, boasting one of the highest levels of home ownership in Europe, is a nation of debtors. Thanks to the ECB’s low, then zero-interest-rate policy, and eventually negative-interest-rate policy, intended to keep the Euro project and European banks from imploding, savers have had a horrible time over the last ten years. According to the ECB’s own figures, household earnings on interest-bearing assets such as deposits or bonds fell by 3.2 percentage points as a share of disposable income between autumn 2008 and late 2015.

While interest earnings have declined, interest payments have also decreased sharply, falling by around 3 percentage points relative to disposable income during the same period. As the ECB notes, the drop in interest earnings is roughly comparable to the drop in interest payments, meaning that household net interest income in the euro area as a whole has been largely unaffected.

But the reality at the individual level is very different. Millions of households across Europe have lost from lower interest rates while millions of others have gained. According tothe ECB, in Germany and France the total drop in interest earnings is similar to the total drop in payments, meaning the effect of lower interest rates on the household sector as a whole has been negligible.

The same cannot be said of Italy, where the drop in household interest earnings is more than twice as large as the drop in household interest payments. This has had a notable negative impact on households’ overall net interest income, which will have also had knock-on effects on consumption and investment levels.

In Spain, by contrast, the drop in interest payments is significantly larger than the fall in interest earnings, with a resulting positive impact on households’ overall net interest income. The larger decline in interest payments in Spain is due to three main reasons:

  • Its high stock of household debt, which, at 123% of gross domestic income, is significantly higher than that of France (82%), Germany (87%) and almost double that of Italy (63%).
  • Interest rates on a large number of mortgages are indexed to money market rates and have thus declined following the ECB’s monetary policies.
  • The preponderance of adjustable rate mortgages, which are far more responsive to changes in monetary policy.

By the same token, when the ECB eventually begins raising interest rates, Spanish households would probably be harder hit than households in Germany, France or Italy. According toBank of Spain estimates, a 100% basis point increase in short-term interest rates could shave up to 0.6% off an average household’s gross disposable income. For Italian savers, meanwhile, it could mean they might finally begin getting a return on some of their more conservative investments, albeit probably not at their local bank. By Don Quijones.

With impeccable timing, Spain’s three tailwinds are turning all at the same time. Read…  Three External Tailwinds Turn into Headwinds for Spain’s Economy 

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  1. Jim Haygood

    [Spain’s] high stock of household debt, which, at 123% of gross domestic income, is significantly higher than that of France (82%), Germany (87%) and almost double that of Italy (63%).

    It’s undoubtedly a factor in Spain’s rebound. Another element is that while both are debt junkies, Italy’s growth-killing 132% government debt-to-GDP is materially worse than Spain’s modest-by-comparison 98%.

    As for ARM mortgages, they are a fabulous windfall when policy rates drop to zero. But the dark ending to that movie played out in the US, where in 2004 Pied Piper Greenspan urged his marks and victims into ARMs just before he and his successor The Bernank jacked Fed Funds by a cumulative 4.25 percent.

    We all know the sad aftermath: CDOs crashed; Lehman died; European banks took dreadful losses; Bubble II crumbled as the middle class saw its housing wealth evaporate.

    Now the housing bubble is back — in Spain, the US and plenty of other countries. Those who do not remember the past are condemned to repeat it, as Carlos Santana said [h/t RabidGandhi].

    1. Andrew Dodds

      Is there any evidence that government debt ratios impede growth? There was the famous R&R paper that was based on a spreadsheet error.. (and very few data points besides).

      1. ChrisAtRU

        In the EZ (Euro Zone) they do, because the nations therein are not currency issuers. They are currency users (of the Euro).

  2. Enrique Fleischmann

    I am afraid that the emphasis on household’s debt is partial. If you sum up total PRIVATE ( i.e. not just households) + public debt both countries look more or less the same.

  3. ChrisAtRU

    With “help” like that, the “hurt” is built in, needless to say. I’ll never forget this article (which I believe I first read linked from #NC):

    The Momentum Of Lies

    Again, EZ debtors like Spain were being used to prop up the “banker dictatorship” set up by the ECB:

    “Think about it. The sovereigns could have gone to the ECB themselves and borrowed money themselves from the ECB for 1%. Instead the sovereigns let the private banks borrow from the ECB at 1% and then the sovereign borrowed from the private banks (remember when a sovereign sells bonds/debt the buyers of that debt are lending to the sovereign) at 5%-6%. Why? Answer – so they could say, ‘We’re not having to get bailed out by the ECB. No, we are selling our debt successfully to the market, who love us.’ It was a lie but it made it sound as if the ‘reovery plan’ and the unpopular austerity policies must be working. And at the same time it allowed the sovereigns to bail out the private banks without having to tell the people they were doing so. Two lies for the price of one.”

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