A New Spectre Is Haunting Europe, A Spanish One

A spectre is haunting Europe, but this time it is not the spectre of revolt by the popular masses, or even one of yet another wave of bank bailouts. No, the spectre which is currently stalking the corridors of Europe’s most prestigous institutions is one of a Spanish economy which stays on a flatline while Europe’s other economies, one by one, start to struggle back to life. And the main reason that this particular ghostly image is giving everyone so many sleepless nights is because Europe’s current institutional structures, and especially the monetary policy tools available at the ECB are scarcely prepared for such a nighmare eventuality.

France Is Recovering, And The Rebound Is Robust

First it was just a rumour, then it was a possibility, and now it has become a reality – some of Europe’s economies are springing back into life. But only some. It all began quietly, with a barely noticeable 0.3% quarterly growth in French and German GDP in the second three months of this year. France and Germany will have maintained their modest growth into the third quarter , while Italy has now joined them, leaving only Spain among the Eurozone big four, registering yet another quarter contraction, and, more importantly, showing no evident sign that an early return to normal activity is anywhere near to the horizon.

In fact Spanish gross domestic product fell 0.4 percent quarter on quarter in the third quarter following a 1.1 percent drop between April and June , according to the Bank of Spain monthly bulletin. Spain’s GDP also contracted 4.1 percent year on year in the quarter, after a contraction of 4.2 percent in the second three months.

‘This is the least pronounced contraction since the beginning of the recession … and this improvement is linked to state-backed measures with a temporary effect,’ the bank said.

To this government stimulus effect, I would also add the net trade effect which is being felt as a result of the strong fall in imports, and the consequent closing of the current account deficit. With imports falling faster than exports (on an annual basis) the net impact is positive growth in the headline GDP number, and the Spanish CA deficit was closing very rapidly indeed in the third quarter (see chart below).

The impact of the stimulus package can also be seen in the seasonally adjusted unemployment numbers supplied to Eurostat by the Spanish Statistics Office (INE). Unemployment (which hit 19.3% in September – see chart below) has been rising continuously since mid 2007, but the sharpest increases were registered during the fourth quarter of 2008 and the first quarter of 2009.

It is very hard to see any real difference in the trend rate of increase between the second and third quarters of 2009, and we should expect this trend job attrition rate to continue until it once more accelerates under the impact of either the government being unable to continue funding the stimulus, or the banking sector having a financial crisis (possibly induced by someone being forced into trying to sell some of the housing units they are accumulating only to discover that there are no buyers, since the market is effectively dead).

Life, Unfortunately For Spain, Is Elsewhere

But for all our preoccupations growth in 2009 is now no longer the issue. All eyes are gradually moving towards the outlook for 2010, and it is here that those little red lights have suddenly started flashing over at the European Central Bank.

And the problem is a real and growing one, since according to a series of reports which have been published during the last week, while activity in the export dependent German economy remained very fragile, the French one has really starting to hum. The first sign of this came on Tuesday, with the initial reading for the October Purchasing Manager Index which showed that while the Eurozone economy in general entered the fourth quarter on a strong note, with growth accelerating in both manufacturing and services sectors, the private sector in France started to earn alpha grades by clocking up a third successive month of accelerating growth, leaving us with the impression that France is now seeing its steepest output expansion in nearly three years.

Then on Wednesday the ECB presented its monthly bank lending data, which showed that lending to the euro area private sector shrank by an annualised 0.3 percent in September, the first such contraction since the series began in 1992. But looking a little more closely at a lending activity on a country by country basis, we find that while lending continues to contract in Spain, in France the credit cycle has turned, and indeed lending to households is now once more rising steadily (see chart below), indeed it never fell below an annual 4% rate of increase and the annualised quarterly growth rate in lending has been rising since the end of the first quarter.

That is to say, credit is once more starting to flow freely round the French economy, while here in Spain banks continue to accumulate reserves, lending generously to the government, while money for struggling small companies and for young people looking to buy homes is hard to find. What is more, if we look at the chart below (which was prepared by Dominique Barbet and Martine Borde for PNB Paribas) we will see that the stock of unsold new homes – which was in any event never very high in France, maybe 100,000 in the spring – is down by 20% as sales steadily pick up again, while here in Spain we continue to play a guessing game to decide just how many (more than a million surely) such properties there are here, and the number is growing, not declining, since real new sales to private individuals (as opposed to newly completed properties contracted two years or so ago, or exchanges between developers and banks) are almost non existent at this point. Everyone knows prices will fall further, and are waiting for them to go down.

Then on Friday we had the key piece of information, which confirmed what many of us already suspected, since Markit PMI data for October retail sales made plain the presence of very divergent trends across the Eurozone, with ever more robust growth in France contrasting with falling sales in Germany and Italy. As Jack Kennedy, economist at survey organisers Markit Economics said “While the sense of growing optimism should be treated with some caution – it appears the increase in sales was also supported by widespread discounting and the continuation of the government’s car scrappage scheme – the outperformance of France relative to Germany and Italy offers further evidence that it is France that is leading the Eurozone recovery.”

And here, with this very outperformance comes the problem, since the ECB policy rate will be set to target average eurozone inflation, which will certainly be lower than inflation in France, and possibly significantly lower. Which means the ECB policy rate will be below the one which the French economy will, in reality, need.
Between 2000 and 2008 the structural dynamics of the Eurosystem were different from now. Spain was the “exceptional student”, with above-average growth, and inflation which was consistently over the Eurozone average, and for long periods above the ECB policy rate. This had the consequence, of course, that French inflation was nearly always below the average. Now things have changed. We are coming out of recession with a eurozone divided into three groups. French growth is becoming robust, while Germany and Italy are dependent on exports and just keeping their head above water. Spain, on the other hand, fails to recover and continues to contract. This is what makes the current situation critical, since starting in 2010 France will have an inflation rate over the EU average, and in all probability over the ECB interest rate. Which means that if something isn’t done, and soon, to force the situation in Spain, and produce a recovery, France will have negative interest real rates during a sharp economic rebound, with all the risks that that implies.

Only last Wednesday Norway became the first western European country to raise interest rates since the start of the financial crisis after its central bank reported finding “signs of renewed growth” in the global economy. Central bankers from across the global, from Washington, to Sydney, to Delhi and to Oslo are all now busily telling us they are going to take increasing account of future accelerations in asset prices in an attempt to avoid repeating policy mistakes that are presumed to have inflated two speculative bubbles in a decade – and left the entire Spanish economy in a lamentable state. If France had its own monetary policy I have no doubt La Banque de France would be itching to follow the Norges Bank and raise rates, but there is one small problem, La Banque de France has no capacity to decide on monetary policy in this way, and herein lies the heart of what is now Europe and the ECB’s greatest dilemma.

This entry was posted in A Fistful Of Euros, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

16 thoughts on “A New Spectre Is Haunting Europe, A Spanish One

  1. If things are so great in France, why does M Sarkozy insist on taking out a bigger loan?

    Don’t watch their lips, watch their hands.

  2. I think all this emphasis on interest rates is nonsense. If I had a sound and viable business idea, a rate of 1% or 5% wouldn’t matter. And since low rates produce bubbles, just keep the ECB rate at a minimum of 5% at all times.

  3. Thanks for the analysis.

    But my emphasize would be rather on the trouble in Spain (that you covered thoroughly before) than potential problems with negative real interest rates in France. Your point is well taken. But on the other hand, higher inflation in a stronger rebounding economy like France is exactly what is good for Spain right now – to gain intra-eurozone competitiveness. So I would be more optimistic about the hopefully strong recovery in some parts of the Euro area.

  4. Hi Dave,

    “But on the other hand, higher inflation in a stronger rebounding economy like France is exactly what is good for Spain right now – to gain intra-eurozone competitiveness.”

    But if we solve one problem by creating another one, aren’t we simply peddling very hard to go nowhere. I would argue interest rates matter much more than people seem to imagine. Otherwise how do you explain how Spain and Ireland got into this housing mess in the first place – they had inflation expectations way above those of their neighbours, while the ECB policy rate was targeting the average, and people bought property as the “inflation hedge”. It worked till the day it didn’t. I don’t think we should go down the same road again, and certainly not with the only major European economy which is still showing serious signs of life.

  5. You are right. But as you said, there is only one monetary policy in the Eurozone. I would think of this in terms of the “one instrument – several objectives” debate around monetary policy and financial stability. In principle, regulators should take care of any potential problems in France stemming from too low interest rates – this could be a first assignment for the ESRB 🙂

  6. Basically, the essence of what you are describing here is a situation where it would make sense for the French government to spend money in Spain rather than in France.

    That would have a contractionary effect in France, and an expansionary effect in Spain.

    I understand fully why this is politically difficult, but is there any other details I have missed here?

  7. @ Edward

    I read your article and it looks that the Spanish economy is in very bad shape, and the unemployment rate is rising steadily.
    But is a bad economy automatically only bad for the society? This is a bit a question of perspective of course, I can guess how the average unemployed would answer this question. And for the short term this economical situation is obvious very bad for Spain’s inhabitants. But on a more fundamental level; does the current situation not also brings Spain’s society new chances? You always tell us that the demographic situation (the aging) will cause inevitable a huge problem in many European countries. Society will need a big workforce to take care for the elderly, and the money to train and pay for those workers. Well, with the current rate of unemployment it would be not so difficult to find enough people who can be trained for those jobs. Those new jobs in the healthcare would significant bring down the unemployment rates. Maybe the current closing CA deficit will give room for the government to finance this re-training project.
    Because taking care of old folks does not contribute to exports, the Spanish living standard will inevitable going down. But the living standard in Europe is very high compared with a lot of other places in the world. To earn less doesn’t mean here to become poor, just to become less rich.
    Economy needs a constant grow, but for a society enough is enough. When you have enough money to take care of your basic needs, more money is no longer one of the most important things to contribute to your wellbeing. After you are provided in your basic needs, having a satisfying job, a good relationship with family and friend, good health etc, are becoming more important factors for having a happy life.
    I think the Spanish government must not only look to the problems, but also see new chances, and must be prepared to take some difficult and unpopular choices.

  8. Hi Ron,

    Thanks for the input. I think the whole dempographic thing is too complex to go into here, but basically the Spanish economy is dying slowly, a day at a time, at the moment. Raising interest rates at the ECB will only serve to help it die more quickly, and cutting the quasi quantitative easing that is buying all that government debt up will only create a financial crisis which will baloon the bond spreads. No easy answers at this point. I absolutely agree with the following:

    “I think the Spanish government must not only look to the problems, but also see new chances, and must be prepared to take some difficult and unpopular choices.”

    But I don’t think it is realistic. Franco died in his bed remember. Spain is a country of complete “immobilism”. People are simply waiting for someone to come and rescue them. There are no serious proposals on the table.

    Will the rescue come? I simply don’t know, I wish I did.

  9. And if the rescue doesn’t come, the unemployment will steadily rise and rise, until one day the banks simply blow up given all the bad debt they will have to swallow. Then we will all be in a fine mess.

  10. Tord.

    “Basically, the essence of what you are describing here is a situation where it would make sense for the French government to spend money in Spain rather than in France.”

    Definitely. One part of the solution here would be this, create a bad bank, and then the French (and German) governments pay for the bailout. But we need to live in the real world. This is not the United States of Europe, and this isn’t going to happen. So the future remains “uncertain”, and frankly “worrying”.

    Watch this space for the next episode. It shouldn’t be that long in coming.

  11. Edward.

    “Watch this space for the next episode. It shouldn’t be that long in coming.”

    I agree. Considering the latest comments from Dr. Doom Roubini & co, it may actually come later rather than sooner (in perhaps 2010/11 instead of next month), making it ever more painful.

    And as a byline, what do you think a weak dollar, with a correspondingly strong Euro, will mean for the imbalances in the Spanish economy? Bad? As I presume a weaker dollar is a necessity in order to reverse the huge imbalances in the US economy, it seems like a situation unavoidable…

  12. Tord,

    “As I presume a weaker dollar is a necessity in order to reverse the huge imbalances in the US economy, it seems like a situation unavoidable…”

    Definitely. This is one of the key points. We may all cry “pain”, but if we go back to a higher dollar, and another US CA deficit the whole thing will be very unstable, since the US cannot grow, and US citizens are now too much in debt.

    I think people generally underestimate the need to export. For some countries – like Germany – it may now be endemic, but for other countries, like Spain, the UK, Ireland, the US – exporting in the short run is essentially as it is the only real way to pay off debts (short of defaults).

    When I make the cryptic point about the next episode, I am only talking about Spain (and maybe Latvia), since I don’t disagree that the short term situation is generally stable (it seems), but I think people are badly underestimating how serious the situation is in Spain. Not that it will blow up tomorrow or anything, but the deterioration will be constant and unremmiting, and thus there will be constant news – like yesterday’s manufacturing PMI (the worst across the globe of those surveyed) – for those who are listening.

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