As events have swirled around Greece in the last couple of months the question has often been asked who is next? This acquires a new urgency because the last fortnight has seen an acceleration in Greece’s problems whereby investors in government bond markets demand ever higher yields to compensate them for anticipated risks from Greece’s financial problems. There is a word for the fears around this, contagion. At the worst point (so far) Greek ten-year bond yields exceeded German 10 year bunds by over 4%. As of last nights close the spread was 3.72% and as I indicated on Friday I suspect international bond funds are trading this spread and may well find such a gap attractive. They will be hoping for no more bad news and hoping for a bail out.
How to avoid being next in the list was demonstrated by Ireland who had and indeed has fiscal problems of her own before we even get to the size of her banking sector when compared to the size of her economy. The Irish government acted decisively with what were perceived to be aggressive plans for fiscal deficit reduction. Accordingly she remains on the “watch list” but she has not been punished further in the debt markets. So lesson one you might say is to act decisively. I will add to this with the view that perception is almost as important as reality in these circumstances. Whilst we all love to think of ourselves as rational players in financial markets ,the truth is we all have a little irrationality in our make up and some of us have a fair bit of it!
Now the debate centres on several Euro zone countries and the acronym Pigs is now used. It stands for Portugal, Ireland,Greece and Spain. There is no significance in the order and it replaces the more pleasant acronym “Club Med” which at least for me conjures up images of holidays in sunny climes. At first it looked like Portugal was next but Spain has her own problems and she is more significant for the wider Euro zone because her economy is much larger. Four times larger than Greece for example.
How has Spain got here?
A strong element of Spain’s problems come from a construction boom that has turned to bust. In essence this started around the summer of 2008 and it led to Spain’s housing market weakening and house prices falling. This then led to a fall in tax revenues and a simultaneous demand for higher government spending on unemployment benefits and as Spain has a government which likes to spend we also saw no particular effort to control the fiscal deficit. Whilst spending rather freely the Spanish government has also been over-optimistic on her views for the economy.This deficit expanded and looks like it will have turned out to be 11.4% of Gross Domestic Product (GDP) for 2009 which has started to concern people because of its size. Also the Spanish government was estimating its fiscal deficit up until very recently at only 9.4% of GDP, and this does sound like Greece (although it may have been optimism rather than deliberate misrepresentation) doesn’t it?
Where Spain really stands out is in her levels of unemployment and the numbers are genuinely scary for anyone who wishes her well. The unemployment rate is estimated 19.5% and appears to still be rising.The latest official figures show 4.05 million registered unemployed. One million jobs were lost in 2009. As she is still in recession and has had five quarters of negative growth there is not a lot of hope for an immediate improvement. Indeed the International Monetary Fund (IMF) forecasts that her economy will shrink further in 2010 by some 0.6%. There were some figures on manufacturing this week from Markit showing an improvement in manufacturing for the Euro zone,however the section on Spain showed another fall and this was the 26th fall for Spain in a row.
In response to this Spain’s Finance Minister offered a fiscal deficit reduction plan on Friday. You may have read of a fiscal consolidation plan leading to 50 billion Euros of cuts by 2013. In fact the wool has been pulled over people’s (and many journalists) eyes because the pages for budget deficits in 2010,2011 and 2012 had some blank spaces in them. So Spain’s government wants to cut her budget deficit from 11.4% in 2009 to 3% in 2013 but is unable or unwilling to tell us how. I can only conclude that there is no real plan at all. For such plans to work they need to be specified as they will need the support of such groups as the Spanish trade unions and local regions. If Spain’s government is actively trying to unsettle financial markets then this is how to do it.
Spain does not deserve this level of arrogance and stupidity from her politician’s. Perhaps taking the Presidency of the Euro Zone has gone to the government’s head. I remember when Secretary of the Treasury Henry Paulson went to the United States Congress with one piece of paper as his documentation for a request for some US$ 700 billion as the banking crisis was peaking. Congress rightly sent him away and told him to come back with a properly documented plan but the Dow Jones index that day fell heavily and at one point was down by one thousand points if I remember correctly. This is the dangerous game Spain’s government is playing.
The irony in this is that Spain’s ratio of national debt to GDP is low by current standards and is only forecast to rise to 74% of GDP in 2012 which is much lower than forecasts for other countries. Also Spain’s banking sector has so far avoided the need for rescue. So it is not all bad news. But plans like this will erode Spain’s credibility and as I pointed out at the beginning of this article perception in financial markets is very important. I think so little of this plan I will name and thereby shame the person who presented it Elena Salgado (Spain’s Finance Minister).
At this time Spanish ten-year government debt is yielding 4.05% which exceeds that on German ten-year bunds by 0.95%. Compared to Greece this is quite low and Spain is still receiving beneficial effects on her borrowing from her Euro membership in my view. Put another way if she were still using the Peseta she would be paying more on her debt in her current circumstances. If her government takes decisive action she can avoid what has happened to Greece but if they carry on as they are they may inflict contagion on Spain too. It is also a theme of this crisis that the politician’s of many countries seem unable to realise that because of the nature of this crisis the old solutions may not apply. I suggest they consider the quotation below.
“When the facts change, I change my mind” John Maynard Keynes