Rescue Me

I guess we will never know whether or not Mariano Rajoy uttered the two magic words so effectively immortalized in song by Fontella Bass that Saturday afternoon in late May as he cruised down the Chicago River in what Spanish media called a “Love Boat” ride, but one thing certainly is now clear, Angela Merkel has finally and definitively accepted Spain into the German embrace. Whether it will be a tender and loving one remains to be seen.

What is obviously true is that Spain is in trouble, and needs help. Five years after the Global Financial Crisis broke out unemployment is at 25% of the labour force (and rising), house prices continue to fall, non performing loans continue to rise in the banking sector, bank credit to the private sector is falling, and, as Finance Minister Cristobal Montoro said two weeks ago, the sovereign is having increasing difficult financing itself. Hence the bank bailout.

On top of which Spain’s economy is once more in recession, a recession which will last at least to the middle of 2013, even on the most optimistic forecasts, and is in danger of falling into the dynamic which has so clearly gripped Greece, whereby one austerity measure is piled onto another in such a way that the economy falls onto an unstable downward path, as austerity feeds yet more austerity. Spains citizens are naturally nervous, anxious and increasingly afraid. Hardly a dynamic which is likely to generate the kind of confidence which is needed for recovery to take root.


The economy is steadily seizing up as the release of pressure (which was previously facilitated through the devaluation mechanism) which it badly needs cannot take place. All the dials move to red, but there is no safety valve available to drain off steam, so the danger of the boiler exploding through the giving way of one joint or another grows with each passing day.

No Mea Culpa From The ECB
Advocates of the proposed Euro Area debt redemption fund – which would pool all government debt over the 60% of GDP permitted under Maastricht – do so using the argument that we should treat the first ten years of the common currency’s existence as a “learning experience“. Fine, but what exactly have we learnt? Surely almost everyone who has read at least one article on the Spanish crisis now knows that the issue in Spain is private not public debt. But just how did countries like Spain and Ireland accumulate all this debt?

Well one thing should be clear by now, part of the responsibility for the situation lies with the ECB who applied (as they had to) a single size monetary policy even though this was clearly going to blow bubbles in the structurally higher inflation economies. And so it was, Spain had negative interest rates applied all through the critical years, and now we have the mess we have.

Back in 2006 inspectors at the Bank of Spain sent a letter to Economy Minister Pedro Solbes complaining of the relaxed attitude of the then governor, Jaime Caruana (the man who is now at the BIS, working on the Basle III rules) in the face of what they were absolutely convinced was a massive property bubble. Their warning was ignored. What could have been done, many say. Well, at least two very simple things could have been done, and well before things got out of hand – on the one hand apply much stricter loan to value and income documentation rules which offering a much higher proportion of fixed interest rate loans (quotas could have been applied), and on the other insist the Spanish government run a much higher level of fiscal surplus to drain demand from the overheating economy.

Of course, the politicians were not interested in hearing about any of this, since as measures they would have been highly unpopular, but where were M Trichet and his colleagues? They were too busy presenting Euro Area aggregate data to be willing to warn about growing imbalances between the individual economies. Now of course, the imbalances are undeniable, and the ECB is having to implement an asymmetric set of collateral rules (among other things) to try to counteract their impact.

The Root Of Spain’s Problem Was The Property Bubble, But The Key To The Solution Is Restoring Competitiveness
Internal demand in Spain is imploding. This is not surprising, with household debt just under 90% of GDP and private corporate around 120%, it is clear that both sectors badly need to deleverage. Classically the way to do this is by devaluing and boosting exports to sustain growth. But Spain is in the Euro, and has no money of its own to devalue. The common currency makes it very easy to generate distortions, and much harder to correct them. In that sense it is systemically biased towards negative outcomes, something the founders of monetary union didn’t give enough thought to. The key institutional stabilisers – a common banking system, a common treasury, and a central bank capable of targeting interest rates on all the participating sovereigns – weren’t in place from the start, and even now are considered controversial, so the constituent economies have a lopsided tendency to veer either one way or the other.


Spain’s export companies have put in a heroic effort since the crisis began, and export levels have well surpassed their pre crisis peak. The problem is simply that, after years of neglect, the sector is now just too small to do the job which is being asked of it. Exports surge, even while the economy does not.
A very different state of affairs from that seen in Germany, where a revival in exports leads to strong growth. Advocates of the “competitiveness” of Spain’s economy should ask themselves “why the difference?”.


Another interesting comparison comes from a nice measure of capital goods investment – spending on machinery and equipment. In the German case such spending recovered sharply after the crisis, even if it has recently tailed off again as the global economy has steadily slowed.

In the Spanish case however, the recovery was muted, soon ground to a halt, and then tapered off again. That’s what competitiveness means, ability to sell in sufficient quantities in global markets. Germany has it, Spain doesn’t, and all the rest is simple pedantic casuistry. Or ask yourself, why is Germany bailing out Spain, and not vice-verse? Come on!

Half Finished Business

In fact, Spain has clearly carried out part of the needed correction. The current account deficit is less than half of what it was.

And the trade deficit has been reduced.


But all of this is relative. There is still a long way to go. If we look at industrial output, we will see that far from having revived it is way below the pre-crisis level, and is now falling back again.
And its the same picture wherever you look. Unemployment keeps rising.

And in recent months, as the country falls back in recession, it has been doing so at an accelerating rate.

House prices keep falling, and again at an accelerating rate. According to real estate valuers TINSA they have now fallen something like 30% from peak, and credit rating agency S&Ps estimate they have another 25% to fall, although the truth of the matter is no one really knows, since stopping the housing slide involves fixing the economy, and fixing the economy involves stopping the housing slide. Such is the double bind which Spain economic policy finds itself in. And the problem posed by falling house prices is an important one since, as we will see, the whole effectiveness of the bank recapitalisation process involves putting a floor under house prices.

Meanwhile there is little sign of credit moving in the economy, and mortgage lending outstanding is dropping by something like 2% a year.
With the evident result that there is little sign of house sales improving, despite the fact that there is now a backlog of something like 2 million unsold homes either finished or in the process of being built.

Naturally in this environment it is not difficult to understand that people are having difficulty paying their bills. Bad debts held by Spanish banks rose to yet another 17-year high in March. According to data from the bank of Spain, 8.37% of the loans held by banks, or EUR147.97 billion, were more than three months overdue for repayment in March, up from 8.3% in February–the highest ratio since September 1994. The total number of non-performing loans is now almost 10 times higher than the level reported in 2007, when Spain’s decade-high property boom peaked. And of course, this steady increase will continue for as long as the economy is not fixed.

And to cap it all, the uncertainty over the future of countries like Greece and Spain is now bringing the whole global economy steadily to a halt, and this is boomeranging back on Spain, since it hits exports directly. In fact, Spain’s exports have been down on an annual basis since February.

What’s In A Name?

Whatever name you give to the EU financial support for Spain, one thing is clear. Spain alone was unable to go to the financial markets and raise the 100 billion Euros or so it needs to meet the capital requirements of its banking system for 2012/2013.

The country’s leaders wanted one of the European funds (the EFSF perhaps) to inject the money directly into the banking system, but Europe’s leaders said no, it would need to be the Spanish sovereign that borrowed (via its bank reorganization fund FROB), and responsibility for repayment would lie with the Spanish state.

So, five years after one of the largest property bubbles in history burst, with an economy which has fallen by around 5% from its pre crisis peak and is now expected to contract by around another 2% this year, while unemployment is hitting the 25% mark, Spain has finally had to accept that it cannot manage alone.

Whatever way you call the aid Spain is now receiving from Europe it is clear that this is the beginning and not the end of what is likely to be a long process, one which will now inexorably lead to either the creation of a United States of the Euro Area, or to failure and disintegration of the Euro. There will be no middle path, so the stakes are now very high for all involved. Unfortunately Europe’s leaders are still too busy thinking short term, and practicing one step at a time-ism. In a pattern that has now become so familiar since the crisis started back at the end of 2009 with the Greek deficit problems, they are so concerned about negotiating the details of how to handle the next stage that they tend to miss the bigger picture.

Essentially there are three key players in the present situation – the EU in Brussels, the German government in Berlin, and the Spanish administration in Madrid. All three have probably walked away feeling satisfied they have gotten something out of this latest deal. The EU leadership in Brussels have long wanted to draw Spain in. After months of issues about number quality relating to both public finance and the financial system, they will now feel they have a firmer grip on the situation. They will also be perfectly well aware that Spain’s financing needs go well beyond the 100 billion euros which has been agreed to as the current ceiling.

At the time of writing it still isn’t clear just how much of this will be injected initially. Press leaks suggest that the figure could be between 60 and 70 billion Euros, slightly more than the 40 billion euro number recently given by the IMF. This is more or less in line with a recent report from Standard and Poor’s, which said they anticipated losses in the Spanish banking system before the end of 2013 of between 80 and 112 billion Euros. Naturally recognising these losses up front now will present Spain’s banking system with a difficult challenge. As S&P’s say:

“In the event that banks are required to recognize provisions for 2012 and 2013 already this year, the amount of capital support that the banks could require could be substantial. This is because banks would face greater difficulty to absorb the impact of required provisions in such a short period of time with anything other than excess capital over the regulatory minimum. In this scenario, and assuming no changes to minimum regulatory capital requirements of 8% or 10% of core capital plus the buffer established by the Royal Decree 2/2012, we would expect that only Banco Santander, Banco Bilbao Vizcaya Argentaria, and CaixaBank would have capital levels comfortably above the regulatory minimum. The remaining banks in the system would likely face significant challenges to remain compliant with the abovementioned minimum regulatory capital requirements, in our view “

Three points need to be made here. The first is that what we are talking about is provisioning against anticipated losses and writing down problematic assets over the two year 2012/13 period – if the economy doesn’t recover and house prices continue to fall (both highly probable given the policy mix currently on the table) then further injections will be required over the 2014/15 period – although this is very academic, since the future of the Euro will more than likely have been decided one way or another by that point.

Secondly, there is the issue of how those banks who don’t apply for government funds will do the necessary provisioning. Apart from operating profits, the only real measure on the table is what is colloquially know as a “bail in”, whereby owners of hybrid instruments like preference shares and subordinated bonds are forcibly converted into equity. Now Spain is already reeling under the scandal of what many consider to have been regulatory negligence as the insolvent bank Bankia was allowed to go to Initial Public Offering on the Spanish stock exchange. As the Victor Mallet writing in the Financial Times put it:

The Bankia saga has prompted thousands of angry savers to consult lawyers and pressure groups, and is expected to lead to a flood of lawsuits that will cause new headaches for the government, as well as for banks and regulators already struggling to deal with the eurozone’s sovereign debt crisis. This and other cases involving billions of euros worth of products sold by Spanish banks to their retail clients will complicate any effort by bank managements or European regulators to impose losses on shareholders and bondholders to reduce the bill paid by Spanish and other European taxpayers for bank bailouts.

The debacle at Bankia, however, is merely the latest and most grievous blow inflicted by banks and cajas on Spaniards who were sold or mis-sold lossmaking financial products by their local branches.

In March, a court in Alicante ruled that Santander should return money to a client who invested in its so-called valores bonds, of which it issued €7bn in 2007 to finance the purchase of its share of ABN Amro. The Santander bonds are typical of the controversial convertible products sold by many Spanish banks, except that they are due to convert into equity at a fixed price of over €13 per share in October – and because Santander shares are now worth just over a third of that, the 139,000 retail clients who bought them stand to lose most of their capital.

While details of the bank rescue package and its impact on bondholders have yet to be worked out, most analysts are busy speculating that subordinated debt holders will be forced to contribute to the recapitalisation effort. But as I say any such “bail in” would involve subordinated debt holders – and in particular holders of hybrid instruments like preference shares – taking losses. The hierarchy is just like that, you can’t haircut seniors before you have hit “juniors”. These are the banks own customers, who were basically sold the instruments on the understanding that they were “just like deposits” and very low risk. Bank of Spain inspectors warned Minister Pedro Solbes in a letter in 2006 that these very instruments were being sold to finance high risk developer loans, but no action was taken. Far from making irresponsible investors pay this measure would penalise the very people who help keep Spain’s banking system together, those small savers who forwent going for holidays on credit to Cancun,Thailand or Japan, and failed to increase their mortgages in order to buy lavish SUVs in an attempt to save for their retirement. These are the people who now face the prospect of losing their precious savings to cover the losses generated by those who did both of the above.

Hence the sort of bank “bail-in” EU regulators want, is politically impossible in Spain, especially after the Bankia scandal, and Mariano Rajoy knows this only too well. Only the Swedish path of direct nationalisation and subsequent resale is open to Spain. Unless, of course, your objective is to totally politically destabilise the country. As is evident, Spain’s developers who offered no guarantee for their lending beyond the property are now handing back the keys and assets as fast as they can, while individual mortgage holders who guaranteed the mortgage with their lifetime salary struggle to pay down mortgages which are often now worth twice the market value of the property they are associated with. If this manifest injustice is also followed up with a wipe out of small savers while large institutional bondholders walk away scot free, well I think the next best thing to a populist revolution is what you are likely to see.

It is still unclear what conditions will be attached to the loans to cover capital needs which total around 60-70 billion euros, according to a source close to an audit of Spanish banks due to be completed on Monday. Forcing losses on junior bondholders is currently illegal in Spain, but legislation could be rushed through in an emergency situation, as it was in Ireland, lawyers and economists say. However unlike Ireland, where junior bondholders suffered losses of up to 90 percent at Allied Irish Banks and Bank of Ireland during state bail-out processes, a large part of Spanish banks’ subordinated debt was sold to bank customers as savings products. Barclays estimates 62 percent of subordinated bank debt is held by retail investors in Spain, stripping out Santander and BBVA, compared to 34 percent in Ireland.

Sonya Dowsett and Helene Durand writing for Reuters

Naturally, the details of the loan conditions are still being negotiated, and will be become clearer as time passes. At this point I would simply emphasise three things. Firstly the money the country has asked for is not a problem fixer. It is a stopgap to enable Spain’s banks to maintain capital levels as losses are crystalised over the next two years. In this sense the money addresses one of the symptoms of the problem, but not the root of the problem itself. What we can now certainly say is that Spain’s banks will be well capitalised through to the end of 2013.

But credit isn’t flowing to the private sector in Spain, and these funds will do little to change that situation. So this is the second point I would make, to get credit moving again a necessary (but not sufficient) condition will be deleveraging the banks – which have a loan to deposit ratio of something over 175% at present – and achieving this deleveraging most certainly means taking some of the problematic property assets off the balance sheets, to be “ring fenced” and deposited in a Nama style bad bank, for example, following the line of the reports the Spanish economy Ministry were recently reported to be studying. Doing this will need finance even after these troubled assets have been written down – it is hard to put a number till we know the extent of the write down, but 200 billion Euros would be a conservative estimate, so furbishing that finance may well be the next stage in the bailout.

Then, thirdly, we have the sovereign funding issues. As is well known foreign investors have been exiting their Spanish debt holdings, and there is no reason to imagine this posture will change. Spain’s banks have been filling the gap by using LTRO liquidity to buy government debt, but there has to be a limit to this process, otherwise the banks will be as bust with the bonds as they are with the property. In fact Spain’s bank dependency on the ECB is growing with every passing month, and hit 288 billion Euros in May.

So financing Spain’s bond redemption needs between now and the end of 2015 – something like 200 billion Euros – plus the deficit (another 100 billion Euros, at least) will be the third bailout stage. Royal Bank of Scotland analysts headed by Alberto Gallo put the full ESM package size needed to get Spain through to the end of 2015 at between €370billion and 455billion. This seems a perfectly reasonable estimate to me.

As I said, removing property related assets from the balance sheets is a necessary but not a sufficient condition for getting credit flowing. The other condition is having solvent demand, which means getting the economy moving again, and this means addressing the competitiveness issue. If the economy isn’t turned round then property prices will continue to fall, and the banks will continue to have losses, which means at the start of 2014 we will need another round of capitalization just to cover for the losses to be anticipated in 2014/2015, and so on.

Approaching The Psychological 100% Debt To GDP Threshold

As I have been saying, Spain’s debt problem was primarily one of private debt. In 2007, when the crisis started, Spanish sovereign debt was a mere 36% of GDP. This year, once the 100 Billion Euro loan for the banking system has been accounted for it will probably be very near to 90%. At the very latest it will pass through the 100% level in 2014 (that is to say, assuming there are no more “unexpected losses” to be added in the meantime – for a full account of the background to all this, see my Homeric Similes and Spanish Debt post). And it won’t stop there. As long as the economy isn’t fixed and returned to growth the level of public indebtedness will continue to grow, as private debt steadily gets written down and shuffled across to the public account. If the country moves to budget deficit zero, then if the competitiveness problem remains the economy will simply contract, and probably contract and deflate, which will mean the ratio will rise even without more deficits, as we are seeing right now in Italy.


But we are getting ahead of ourselves here since we still don’t know how Spain and the Euro are going to get through to the end of 2012, let alone where we will be in 2014. Obviously accepting that Spain needs a full bailout is going to be hard for the German leadership, but the alternative of Spain Euro exit and default will probably prove even less appetising for them.

After several years of neglect and refusing to face up to issues, talk is in the air of internal devaluation to address the loss of competitiveness Spain suffered during the boom, but so far nothing has been done. Maybe this is the next reform Brussels should be discussing with Madrid, the most recent IMF proposals certainly point in this direction . Beyond all the talking, if Europe’s leaders really do want to save the Euro, and not have Spain go back to the Peseta to devalue, then one day or another this internal devaluation will have to happen or the Spanish economy will simply never recover. If it doesn’t recover then the issue will not be simply saving Spain but rather how to save the global economy when the Euro then finally falls apart. Time is now running out, as Christine Lagarde recently reminded us. I think she and Soros are being a little unfair – they have till Christmas.

This post first appeared on my Roubini Global Economonitor Blog “Don’t Shoot The Messenger“.

This entry was posted in A Fistful Of Euros, Economics, Economics: Country briefings 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".

24 thoughts on “Rescue Me

  1. “internal devaluation will have to happen or the Spanish economy will simply never recover”

    Does this just mean cutting public sector wages? or is something else involved? Is there a mechanism for cutting private sector wages without firm bankruptcy?

  2. Lets say Greece exits, they go into a crises, the drachma falls 50%, or whatever. But i few months later, they begin recovery. All those bank deposits that left as Euros start coming back as as drachmas, tourists flock in to take advantage of the cheap prices, etc. And within a year, Greece will be floating new drachma bonds. Just as Argentina was able to do after giving investors the shaft.

    Spaniards, or anyone going through an internal devaluation,say, “why are we putting ourselves through this?”

    I think the leaders of the EU should make more of an effort to separate the Euro from the EU in their rhetoric Because it seems pretty obvious no one is going to go through an internal devaluation who has a choice.

  3. I’m sure Aretha did a fine version of “Rescue Me” but the original and greatest version was by the peerless Fontella Bass.

  4. Carl, thanks for this. You are obviously right. In my own defense I can only say I never said Aretha wrote the lyrics, just that she immortalized them. At least for me.

  5. Otto,

    “Does this just mean cutting public sector wages?”

    No, absolutely not. This is just what is called a “fiscal devaluation”, and was what was tried in Argentina by Domingo Cavallo and failed. It is normally advocated by people – like the IMF in Latvia – who are convinced that the root of the problem is government spending, and not a broken and distorted real economy.

    I normally put it this way, in Greece the real economy is broken because government finances have gone bust. In Spain, Ireland, etc, government finances are going bust because the real economy is broken. The diagnosis is very different, and so should be the remedy.

    To be clear when I (and most other macroeconomists) argue for an internal devaluation of 20% in Spain, we are talking about a drop in the CPI of 20%.

    Naturally, 5 years into the crisis this hasn’t even begun (compare the Spanish and German CPIs). Being realistic I don’t think it will now happen, which is why I don’t think the Euro will make it to xmas in its present form. But give people the benefit of the doubt. They claim they will do anything to save the Euro. We should never rule out the possibility they mean what they say.

  6. Bob-in-MA

    “Lets say Greece exits, they go into a crises, the drachma falls 50%, or whatever. But i few months later, they begin recovery.”

    Yep, but I don’t buy this scenario. First I don’t think the Greeks will want to leave, so they will need to be expelled for this to happen. I doubt there is political will to do this, there is hardly any political will to do anything, and this would be the toughest of decisions. Secondly chucking them out would mean accepting losses of 300 billion Euros or so – a very rude awakening for the German taxpayer.

    If they aren’t prepared to accept the cost of fixing the Euro, why should you imagine they will accept the cost of breaking it?

    Thirdly, Greece would not recover after coming out. It is reputationally destroyed. In addition after a hard default there would be no credit. I see no reason why real investors, rather than carpet baggers would go there.

    The kind of political instability involved would not attract tourists, better Tunisia, Turkey or Morocco is what you are looking for is price. On top of this there is the geopolitical element. Syriza regard the EU and the IMF as criminals. They would nationalize the banks. Who do you think they would be allied with?

    This easy recovery story doesn’t hold water as far as I am concerned.

    Young people would/will leave, and the country will die. Remember, I don’t think the Euro can hold. I am just arguing that the real problem isn’t a Greek exit.

  7. Internal devaluation ? Really ?! In an economy where, as you said yourself, people are already struggling to pay their mortgages, that would be suicide. The overcommited Balts barely managed a few % reduction in costs anyway, and we need 20% here ? Come on, the only realistic options are (a) regime change at the ECB and reflation in Germany or (b) repesetaization.

    As for Greece, it may not be a super-business-friendly destination in any sense, but why do investors even have to *go* there ? There are lots of young people in the country who would start a business if only they could get a loan in whatever currency, and if their costs were in line with international prices. Whatever happens after grexit, compared to the current situation it will look like a boom.

    Generally speaking, I feel that you underestimate the role of monetary conditions (not that I know better, but, well…).

  8. Hmm. okay, lets see, fixes that would actually work.

    1: Dirigism! Everything in economic theory written since the 1970 is apparantly wrong, so lets party like it *is* 1970, and fix the economy be viciously targeted state investments. Build ELSY’s (European Lead Cooled System. Mostly Spanish fast reactor design. I like it a tonne) until the imports of Natural Gas, Oil, and Coal all hit zero. What? Crash building nukes is irresponsible? More so than 25% unemployment? . Then build some more and sell the power to the germans.
    Poke the spanish auto industry with a sharp stick to roll out a cheap electric veichle for domestic use to further cut oil imports. If it is neat, export it.
    More rail. Pumped hydro stations. Basically, if you see an unemployed person hanging around? Make him or her build something.

    Ohh, while we are engaging in lunacy, Maritme adventuring. Reopen the shipyards, build nuclear powered freighters. The numbers on fuelsavings for a long haul freighter versus security and reactor costs are /insanely/ attractive. And since security mostly means “Armed guards”, this employs some of that unemployed youth, too.

    Nationalize the banks.

  9. “Internal devaluation ? Really ?! In an economy where, as you said yourself, people are already struggling to pay their mortgages, that would be suicide”.

    Well, I never suggested it would be an “optimal” solution, but the thing is all the other alternatives are suicide too. You are completely right, the Baltics never carried out a substantial internal devaluation (see Krugman’s latest piece) and their economies are generally in worse shape than most are prepared to recognise.

    But what is the alternative? The thermonuclear one of going back to the peseta. Apart from being a highly traumatic event for everyone from Rio to new Delhi Germany would NEVER recover from the Euro disintegration and domino defaults which would follow.

    As i say, at this point I don’t think internal devaluation is going to happen, I just think that it – back by real helicopter money drops (ie not loans) from the ECB. On the best case scenario the Euro Area becomes another Japan.

    Reflating Germany? I now exclude this possibility. It won’t work. They are already too old.

  10. That is silly – a variation of learned hopelessness. Germany is old, yes, but it has also practiced very excessive wage restraint for well over a decade. Reversing that and boosting wages back into line with productivity would go a long way towards rebalancing the european economy. Also, Germany has quite considerable reserves of untapped labour that could be mobilized by the provision of better child care services and the rest of those social structures that makes being a working mother a tolerable life, so the fact that it is somewhat gray around the ears need not mean that the dependency ratio must inexorably climb.

  11. Thomas,

    “That is silly – a variation of learned hopelessness”.

    Possibly. I certainly now consider myself a founding member of what could be called “the new global pessimism”. Funny how Malthus keeps coming back to haunt us. And you would be my Godwin.

    The conclusion I have come to is that what we call the “modern growth era” is not open ended, but in fact bounded in time.

    But how to convince you? This is like the arguments about which goes round which, the earth round the sun, or vice verse, there is no fact in the world I can possibly point to which would help clarify things. All I can say if that I have been studying this problem of ageing populations for a decade now, and this is a conclusion I have come to – economies in countries like Italy, Germany and Japan now depend on exports.

    Fully agree on child policy though, and not simply to free off more labour, to make the population pyramid more sustainable, before it cracks under the weight.

  12. ““Does this just mean cutting public sector wages?”

    No, absolutely not. … To be clear when I (and most other macroeconomists) argue for an internal devaluation of 20% in Spain, we are talking about a drop in the CPI of 20%.”

    Thank you — and, sorry to be persistent, what policy measures are involved in producing a drop in the CPI of 20%? Leave aside political feasibility for the moment, would this be raising VAT while cutting income tax, or changing planning laws, or services deregulation (the latter two not likely to have a year-on-year immediate impact)? I suppose a grand bargain of the trade unions and government to lower wages by 20% – including in the private sector – might do it? But that may not be what you have in mind…

  13. Hello
    Great post

    We just made a Video on the Euro Situation.

    Get your Macro Right! Show is the third video of the Fun & Finance´s Second Season.

    In this episode –recreating a television game show- we talk about: the role of Central Banks, the Euro Zone, Latin America, among other subjects.

    Best regards. And great blog by the way.


  14. None of the PIIGS are willing to leave or be ejected from the Euro, because they see membership of it as confirmation of their standing as advanced nations within the European Union. As the finances of these PIIGS deteriorates under the pressure of their citizens trying to protect themselves, the Eurozone will collapse. Few if any of the PIIGS will be able to take appropriate action – none of them has the political will or even mandate to leave. They will just attempt to bumble through.

    I suggest that we shouldn’t be looking at what happens in the PIIGS. The fate of the Euro was in fact determined long ago during its inception when its creators decided to fashion a so-called reserve currency without any of the institutions that such a beast required.

    We must instead watch the politics in Germany, as Merkel is pushed further and further into a corner by the rest of the Eurozone. I haven’t seen any indication that Merkel, let alone her party, or parliament or the constitutional court or, dare I say it, the German people, are prepared to give way on the issue of sharing the debt burden of states they see as profligate. Such an outcome is politically impossible.

    Germany will therefore be the first to leave the Euro after everyone else tries to “gang up” on them to become the lender of last resort. They would see this act as confirmation of their standing as one of the last bastions of fiscal rectitude.

  15. Edward: “Greece would not recover after coming out. It is reputationally destroyed. In addition after a hard default there would be no credit.”

    Aren’t similar statements always made before a country defaults? Yet what are the examples of a country “not recovering”? Argentina didn’t seem to have much trouble.

    Germany is going to have to recapitalize its own banks one way or the other.

    To save the Euro now, you’d need joint Euro bonds, free movement of labor, fiscal consolidation and an ECB willing and able to take an activist role. Now of those things seems likely in the near term.

    I think the the Euro was a worthy experiment, but sometimes you have to learn from failed experiments. From this one, we know that political consolidation must preceed monetary consolidation.

    This rubber-band and duct tape approach isn’t going to cut th emustard.

  16. “…From this one, we know that political consolidation must preceed monetary consolidation.”

    …as predicted by Paul Einzig nearly thirty years before the euro came into being.
    As for Germany being so far out in front a mere decade and a bit after its inception, Jane Jacobs long ago stated flatly that a currency union favors disproportionately the most competitive economy within it, and will have a strong tendency to atrophy the weaker ones until they can no longer function independently. So, no surprise there either.
    It’s not like these things weren’t known.

    And…a drop in the CPI of 20%? Huh? Spain doesn’t set the price of most of the commodities it uses: it’s too small to be anything but a price taker. How are you supposed to achieve this if oil doubles because of increased demand from China, India, and the US (keeping in mind that oil has a very wide range of uses besides just being burned for energy)? If lesser but necessary things like nickel, lead, aluminum, and zinc do the same? It’s not like they can isolate themselves and produce all this stuff on their own and then on top of that price it with no regard to world markets.

  17. “You are completely right, the Baltics never carried out a substantial internal devaluation (see Krugman’s latest piece) and their economies are generally in worse shape than most are prepared to recognise.”

    It has been a long time since the last time you wrote about Estonia or Latvia. I understand that your are quite busy now with what is going on in Greece and Spain, but you offered the best in depth analysis concerning the Baltics, so I hope one you’ll pick up that thread again.

  18. Thirdly, Greece would not recover after coming out. It is reputationally destroyed.

    Never recover? I think you underestimate how short people’s memories are. Argentina recovered. Iceland seems to be recovering.

    Rather than talking about kicking Greece out of the euro or Spain out, I think Europe should talk about kicking the Germans out. Then let the euro drop 30% or so and get on with rebuilding…

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  20. Hi James,

    “Never recover? I think you underestimate how short people’s memories are. Argentina recovered. Iceland seems to be recovering”.

    This one wasn’t a typo, it was intentional. I mean never. Argentina was an emerging economy with a birth rate above replacement level. It still had the so called demographic dividend in front of it. Not sure if it has “emerged” too far yet though. The country’s reputation is still pretty bad.

    Iceland is a different case, we are a long way from seeing what is actually going to happen, but they just burnt a few senior bond holders, not the IMF. Actually, my feeling is Iceland – apart from the excesses and stupidities of the boom years – has remained reputationally reasonably sound. Not sure investors would discriminate for or against Iceland or Estonia. The thing is Iceland is still weighted down with substantial debts.

    Greece is a whole new ballgame. Despite the fact that I note today that index provider MSCI has put the country on review for a return to emerging market status, I think this is a msitaken way of viewing things.

    Greece is not the latest in a long line of emerging markets to default, it is the first in a whole new set of developed economy defaults. We are entering a whole new world. Really, to explain fully why I think Greece will never recover I would need to present a theoretical argument about path dependence in economic systems and the demographic penalty which goes with ageing populations.

    If you are interested I am working on a wonkish piece on all this, which explains in part why I don’t buy the structural reforms argument (on theoretical grounds) and what I mean by path dependence. My prototypical case is Latvia, which I now consider to be unsustainable as an independent country.

    Essentially the argument goes like this – as population median age rises over 40 the balanced growth rate falls steadily. Having a huge crash like Greece will have forces out lots of young people which in turn pushes down fertility and up median population age. This slows the trend growth path, and then you repeat the game over a number of iterations. Well, I don’t necessarily expect you to agree, but this is why I made that statement. To shock, and to try and get people to move away from irrelevant stereotypes and think.

  21. Jan,

    “It has been a long time since the last time you wrote about Estonia or Latvia. I understand that your are quite busy now with what is going on in Greece and Spain, but you offered the best in depth analysis concerning the Baltics, so I hope one you’ll pick up that thread again”.

    Thanks, and don’t worry, I’ll soon be back on the job (see last comment).

  22. Pingback: Brussels blog round up for 16 – 22 June 2012: ACTA rejected by the European Parliament, Europe in the dock at the G20, and is there a life beyond Brussels jargon? | EUROPP

  23. Hi Edward:

    Thanks for the response. I look forward to reading the wonky paper. I have not made up my mind of demographics and destiny, so I like hearing more thoughts on the issue. Should be interesting.

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