Chart Wars

A new kind of battle is going on out there at the moment. In what must surely be a new twist to the old dialectic of blow against blow argument, a combination of the internet age and sophistocated data management software is adding an additional and striking dimension to the current crisis debate, let’s call it the birth of the “charts war”. I think you could safely say Paul Krugman kicked off the latest round off, with this simple blog image post.

The Kindom of Spain was not amused, and struck back in their London roadshow (courtesy of Elena Salgado and Manuel Campa) with their own version of the same issue.

Spain, we are informed is not so badly off, since Italy’s position is much worse. Even more to the point, adding 3 million or so unskilled workers to the dole queues, and closing down a large chunk of Spain’s core construction industry (driving the unemployment rate up to 19.5% in the process) has been extremely beneficial, since cleaning out all those low productivity, unskilled workers has meant that the productive power of the rest looks a lot better (since average productivity of those in work has risen). But isn’t this just where the fiscal deficit issue comes in? These workers are still being supported by the rest via the Spanish system of employment benefits, so the productivity improvement (as far as Spain as a whole is concerned) is simply an optical illusion.

This is a point that Krugman could have picked up on but didn’t, although he did follow through with a further post full of very revealing charts. The core issue here is that the problem Spain faces, as Paul stresses, is not essentially a fiscal one, a point which may be clearly seen in the following comparison of German and Spanish fiscal deficits over the last decade.

As he shows, Spain had no fiscal problem till the housing boom went bust. No of course, the need to prop up the economy, and support all the “unproductive” labour which doesn’t show up in the unit labour costs chart is producing a massive fiscal deficit. Thus the fiscal issue in Spain is a symptom, not a cause. The root of the problem lies in the structural distortions produced by the massive overheating of the economy during the boom years, an overheating which lead to excessive inflation, large-scale dependence on imports, and a complete loss of competitiveness in the non-tradeable sector – a loss of competitiveness which even the Kingdom of Spain accept.The problem with the Spanish argument is that it seems to neglect the rather inconvenient fact that those workers who are deployed in the tradeable sector also eat bread and go to hairdressers and ride in taxis and buy or rent homes just like everyone else. So they themselves need to pay prices set in the non-tradeable sector, and their salaries have to reflect this. Hence a problem in non-tradeables becomes a much more general one. And it shows up, naturally enough, in the current account balance.

Of course, just as there is more than one way to peel an onion, there are a variety of different ways to measure competitiveness (GDP deflator, unit labour costs, etc). My own favourite back-of-the-envelope measure is what is known as the Real Effective Exchange Rate (REER, which shows at roughly what sort of virtual rate the Peseta would trading with the Deutsche-mark (were the two still to exist, of course).

Smokin’ Gun

Indeed, analysts at PNB Paribas recently took the REER argument one step further, and showed how, far from addressing the competitiveness issues in Greece and Spain the recent bout of fiscal spending was in fact making the situation worse.


This is a point I have been trying to make in a number of recent posts by using two simple charts. The ECB eased liquidity in the Spanish banking system last June with a massive injection of one year funding.

This money went, via bank purchases of Spanish Treasury Bonds, to fund the government deficit, leading to a large injection of demand into the real economy. But what happened to that demand? Just look at the chart below. The trade deficit started to widen again, as Spaniards availed themselves of their additional spending power to buy yet more foreign products.

So essentially the issues is this one. Spain’s economy will not recover, and return to growth till Spanish products become more attractive in price terms, and this only means one thing: some sort of internal devaluation is inevitable, and all the talk about an exclusively fiscal correction is simply an attempt to get rid of the smoke without going to the trouble of extinguishing the fire which is producing it.

This entry was posted in A Fistful Of Euros, Economics and demography, 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 “Chart Wars

  1. Spain has to call back the Franco. Since Germany has moved to purely fascist state back, where the competitiviness of upper class is made from lower class sacrifices, Spain must also go this way and apply a 400 EUR wage to millions, as Germany does.

  2. Impeccable analysis as usual from Hugh.

    However, it seems that we are just now approaching the 800 pound gorilla in the room:

    Is it even possible to effectuate an internal devaluation of the scale required in Spain, Greece etc without causing unprecedented economic collapse? All previous experiences of internal devaluations in the context of fixed currency pegs point to the fact that the measures taken do enormous damage to the real economy, while not succeeding in restoring external competitiveness.

    I fear we (the Eurozone, the EU and the world) may be sleepwalking in a direction where the cure will be far, far worse than the disease.

    Please tell me I am wrong…

  3. “Some sort of internal devaluation is inevitable: could you please translate that in action? Devaluation stands for deleveraging and deflation? I told Professor Krugman that to have relied on banking and real estate sectors bubbles for government’s revenues is a sort of fiscal irresponsibility. How do you now envisage re balancing tradeable and non tradeable prices whereas finance (services) is tradeable sector and real estate construction sector is non tradeable sector?
    http://mgiannini.blogspot.com/2010/02/too-little-to-fail-or-when-you-do-not.html

  4. Of course there is a fiscal problem…there was no deficit because the enormous surge in spending was covered by the massive tax revenues from the housing bubble.

    This is, unless you believe that a credit bubble is the “normal” state of the economy (the keynesian semi-boom)

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  6. Is it even possible to effectuate an internal devaluation of the scale required in Spain, Greece etc without causing unprecedented economic collapse?

    Well we’re about to find out aren’t we?

  7. Yes, but that is still a sensible question, because the attempt is a bad idea if the likelihood of success is small.
    But seriously, if this is an experiment, then it may fail. Then what?

  8. Last year the “buzz” was on “deflation”, how bad it would be to the economy if the recession would bring it, aso, aso…
    So now it seems that deflation is only bad when it happens in other countries (surprise surprise)!

    What I see in a nutshell is that the poor countries will be poorer as compared to their north… pardon me, richer counterparts. It’s a vicious cycle, initiated from the lack of spurt into productivity in the South. Thousands of Millions spent in roads, none in Education, railroads, modernizing factories and companies. The only companies that came to the South were coming after low salaries, not centres of excellency (like in Ireland). Economies based on low salaries and low education are always doomed, they will ultimately lose to China, productive or not.
    Now the “solution” is cutting salaries some 10 or 20%, and for what? That will reduce consumption, that is obvious, but will it increase productivity? How?

    Somebody please tell me why, because that was not discussed on my MBA…

  9. A. Serranho,

    cutting wages for 10-20% will bring barely something – in Latvia they were cut in some branches for 40%, but the decreases in PPI were minimal, because the induced monopolisation plays a bigger role.

    However, devaluation for 40% will bring something. Because the most striking evidence of the relative German competitiveness, and in Baltics that’s very visible, is NOT the competitiveness of German car industry. The pervert thing is the fact that shops are full of German cookies, German Knackerbrot, milk is made from dried milk powder from Germany, soap and washing powder is coming all from the Germany. Exactly this disbalance can be corrected with currency devaluation very rapidly, and it will be a significant relief.

    The paradoxon is that German cookies are competitive NOT due their special taste, because they are full of conservants in order to be able to transport, the German competitiveness is caused by extreme overvaluation of Baltic currencies.

  10. Hi Eddy,

    “Of course there is a fiscal problem…there was no deficit because the enormous surge in spending was covered by the massive tax revenues from the housing bubble.”

    Fine. But I am trying to make a traditional distinction between fiscal and monetary policy as it is normally conceptualised by central banks. The problem in Spain was incorrect monetary policy, not incorrect fiscal policy. Of course the incorrect monetary policy produced a flood of unsustainable income, but the issue wasn’t fiscal it was monetary, that is all I am trying to say.

    Now the bubble has burst, and the mess is a fiscal one, but it won’t be solved by fiscal measures, it will only be solved by undoing all the damage the monetary policy did.

  11. Hi MG,

    “How do you now envisage re balancing tradeable and non tradeable prices whereas finance (services) is tradeable sector and real estate construction sector is non tradeable sector?”

    Simple (or not so simple depending on how you look at it) – the 3 million or so people whose jobs depended on the construction sector or consumption spinning off from it now have to be relocated into the tradeables sector to start earning revenue which can be used to pay down the external debt. Easy to say, hard to do, but without this there is no solution, and Spain will become another Latvia – ie locked in Riga Mortis.

  12. Unfortunately, the German population is now TOO OLD for the type of consumer activity Martin Wolf would like to see to be realistic. We are almost all now condemned to export to live. France is, at this point, the big exception.

  13. “In this respect I always find contradiction in people that talk about an spanish housing price bubble and at the same time talk about the volume of supply that reached the market. Does this mean that we are seeing the law of supply and demand not working?”

    Supply and Demand wasn’t only the whole logic. Houses were regarded as a sort of a better Gold without devaluations, the only way was up cheating the Supply and Demand. Now it crashed, but this also depends if the people want to sell. We in Portugal have about 2 times more Houses than people but the prices didn’t crashed much, one of reasons is that we have a problematic rent market with an even worse Justice system to resolve rent conflicts.

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