Have just spent the first few hours of this Sunday morning running through the numbers on Spanish sovereign debt dynamics and exposure to it of banks of different countries, followed by reading each of the Wolfson Prize entries to see if there is any way out.
It was depressing reading. If you haven’t been reading the financial press the debt vigilantes have now switched their attention from Greece and Italy to Spain and Portugal. The numbers for Spain don’t look good, last Wednesday it came within a whisker of a failed auction. Gonzalo Lira
Spain has redemptions totalling €149 billion in 2012. It will issue a total of €186, with an eye to extend the maturity of the outstanding debt. But even with these concerted efforts, in 2012, the maturity of Spanish debt will in fact shrink from 6.4 years to 6.2 years. Add to that, in 2011, interest payments totaled €28.8 billion—up from €22.1 billion the year before. Why? Because of rising bond yields: Spain is considered riskier—due to the Troika’s inability to finally “fix” Greece and Spain’s own obvious domestic financial issues—and thus Spain has to pay more to borrow money.
In other words, Spain has fallen into the classic “borrowed-short-but-my-income-is-long-and-on-top-of-that-my-loans-are-getting-more-expensive” trap.
Last week, April 4, Spain’s Treasury held a bond auction—and fuck-all was it nasty: Of the expected €2.5 to €3.6 billion, Spain barely managed to get bids for €2.6 billion—and the yield on the 10-year spiked to 5.85%, before settling at a still-way-high 5.75%.
Worldwide markets all got down on this auction—
—but here’s the thing: Spain has a lot more of these auctions coming up—on average one every two weeks.
They have to raise €186 billion in 2012.
And of the first of these, they had a quasi-failed auction.
One hundred eighty-six billion euros—in less than a year.
They’re not going to raise that kind of money—simple as that. The April 4 auction was not an outlier—it’s what’s in the post forall of the next 17 auctions.
Spain is both two big to bail and too big to fail.
Add on that of that the craziness of the austerity imposed by the EU on its debt dynamics. Vox Research
Reaching the [Spanish} deficit target of 4.4% in 2012 would require a fiscal consolidation in the vicinity of five percentage points of GDP. This would represent the largest fiscal consolidation ever achieved by Spain, and one of the largest among OECD nations in recent decades (see Devries et al 2011).
- The enormous contraction in the fiscal position will take place in a year of economic slump and thus be excessively procyclical.
- The fiscal consolidation would be much greater than what was originally planned; Spain would reach the medium-run goal well ahead of the objectives of the Stability Treaty….
- The EU must make changes to the fiscal consolidation strategy now demanded of member states.
- The obsession with nominal deficit targets must be replaced with a credible and rigorous multi-year fiscal programme that avoids a spiral of negative growth.
So Spanish debt is spiralling out of control and austerity is making it worse, with potential debt auction failures every two weeks throughout 2012.
So will the new european stability mechanism E800bn ‘firewall’ or ‘big bazooka’ represent a possible mechanism? That wont be up and running until July and is still subject to haggling with France pushing for as much as 1 trillion. The risk is of a failed auction and Spain having to rely on debt firewall/ESM funding and effectively existing the money markets, which would put pressure on banks to agree a debt haircut or for Spain to exit the euro. Even with such funding it is difficult to see Spain being able to make the cuts required to meet Eurozone targets. Spanish unemployment is at Great Depression levels – forecast at 24.3% in 2012, but this is with automatic stabilisers such as pensions and unemployment benefits which have so far been excluded from major cuts. However the debt dynamics above show that however Spanish debt is funded there will either be huge pressure for haircuts or cuts in those stabilisers which would collapse GDP and lead to much greater unemployment. Research published last November by JP Morgan Economist Greg Fuenzi – using Okrun’s law – forecasts if the Spanish unemployment rate continues to move in line with its historic norm, it may reach a shocking 27% by end-2012. Why so high?
First, in Spain, the pace of growth needed to keep unemployment stable was very high at 3%, likely reflecting high immigration and rising labor force participation. The responsiveness of the unemployment rate to growth was also extremely high in Spain at almost one-to-one, likely reflecting a low responsiveness of the workweek to economic conditions and the dual labor market with rapid firing of temporary workers. Due to these two features, the dramatic increase in Spanish unemployment since 2007 has not been that unusual.
So labour market flexiprices are stabilising huh?
Now these forecasts were made before the latest EZ imposed cuts or the new higher interest rate on borrowing required by the bond auction meltdown.
You can do the Math yourself and forecaster like Vox are doing so. But if as has been typical in advanced economies we see a 2% decrease in output for every 1% increase in unemployment then the combined impact of austerity and unemployment could see a sharp downsurge in GDP, possibly greater than 10%, and a sharp upsurge in unemployment – to over 30% – by early 2013 – Spain would be in meltdown. No country can survive that level of decline: coup, default, EZ withdrawal or revolution would all be on the cards.
And if there was default, partial or full where would it fall on, in the main France and Germany. Over £300bn of debt probably leveraged up to 20 times, 50% bigger than Lehman by itself but because of the closely interlocking nature of bank debts in the EZ it has been estimated that it could be 6-7 times worse. Many French banks are frighteningly weak, and France and Germany are both experiencing property bubbles – only slightly slowing in France but exploding in Germany – with 10% year on year growth in house prices in Munich and Berlin. A combination of bank failure, credit crunch and house price crashes – where eurozone banks balance sheets are propped up by these counterparty assets. What if interest rates went up in the Eurozone?
I mention this because of the various Eurozone exit strategies in the Wolfson Prize. The most ingenious from Engineer/Quant Cathy Dobbs requires a split into a hard yolk and a soft white with all existing Euros split proportionately into the two. This would be painless initially but with the white periphery devaluing the hard yolk would be forced to put up interest rates – at the peak of the property market. Boom Pop Bang.
Similarly several of the other entries envisage that countries existing the EZ would be forced to default, by as much as 60% , shortly after exit, notably Roger Bootle’s. What then for French, German etc. banks?
So EZ exit and periphery default just shifts the crisis to one of core eurozone (and UK given its exposure) bank collapse. And because of Us bank exposure to european banks US banks would come under severe pressure. What would happen if there was another Lehman style collapse in the US? Economic Times
Unemployment could jump to 13 per cent, recalling the breadlines of the 1930s. The Dow Jones industrials might plunge 50 per cent to 5,668, a level last reached before the dot.com boom in the mid-1990s. At the depths of a brutal year-long recession, output might shrink at an 8 per cent annualized rate, wiping out two whole years worth of growth.
Anyone lucky enough to have a job or cash left after the carnage could snap up a home at November 2000 prices.
This dire picture is what the Federal Reserve wants US banks to imagine when they test their balance sheets for resiliency against a major economic shock. …
It sounds shocking. But it’s actually similar to the firestorm that swept through the United States after the shock bankruptcy of investment bank Lehman in September 2008, which ushered in the worst recession since the 1930s.
Next time around, however, damage could be even worse because the US economy would enter in a weakened state. It is still healing from the last recession and a second blow could be crippling.
So with either austerity or sovereign debt default or EZ exit their seems no way out. Spain is a ticking time bomb set to explode some time later this year or early next year, that in whatever scenario – if current European austerity policies are maintained – would trigger a global economic collapse greater even in scale that the Great Depression.
Now the Eurozone in its usual manner may well pump up the firewall, use it to rescue Spain in the event of a Bond auction failure, but it just kicks the can down the road if austerity makes the structural deficit worse. With the use of the (failed) conventional measure of neo-classical economics there would seem to be no way out of this trap. We have to look beyond them.