All Eyes on Spain
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by Doug Noland
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April 13, 2012
“To talk about a bailout for Spain at the moment makes no sense. Spain is not going to be rescued.
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It’s not possible to rescue Spain. There’s no intention to, it’s not necessary and therefore it’s not going to be rescued.” Spanish Prime Minister Marino Rajoy, April 12, 2012
The respite from the European debt crisis has run its course, and with the return of market stress comes a ratcheting up of vitriol directed at the Germans. I find it all worrying. For a moment today I tried to take comfort from a UK Telegraph headline that scrolled by on the Bloomberg screen: “Worrying Is Good for You and Reflects Higher IQ.” I’m adding this to my list of notions that sound appealing and I only wish were true.
By this point in the ongoing global Credit crisis, it should be clear that the real villain is the anchorless global Credit “system” devoid of anything, any mechanism, or any sound money and Credit principles that might help to restrain excess. Self-adjustment and automatic self-correcting mechanisms would be invaluable.
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Instead, our central bank, steward of the world’s so-called “reserve currency,” indicates its willingness to become even more “activist” - and global finance spirals only further out of control. For decades now, global Credit has been allowed to expand unchecked – with no limit to either the quantity or quality of debt instruments. Perhaps the timing and sequencing of various crises was unknowable, though the end results were for the most part predictable.
Over the years I’ve been a fan of the euro. I’m saddened that my and others’ hopes for a sustainable sound currency failed to materialize. It is surely not going to be part of any solution to a rudderless global monetary system but instead appears poised to become its biggest casualty yet. But to blame Europe’s travails on the Bundesbank is really stretching the bounds of reasonableness – and sound analysis.
In hindsight, a common European currency was not a good idea. Yet European monetary integration is in jeopardy today because for too many years the dysfunctional global marketplace mispriced finance.
Greece, Portugal, Ireland, Spain, Italy and others for too long had access to unlimited low-cost borrowings (along the lines of Fannie Mae and Freddie Mac, and the U.S. Treasury). This prolonged mispricing of Credit led to financial and economic imbalances and deep structural maladjustment, just as one would have expected analyzing the situation from an “Austrian” (or, even, German) economic perspective. I often recall the words of wisdom from the great economist, Dr. Kurt Richebacher: “The only cure for a Bubble is to not allow it to develop.”
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The nineties saw Credit crises ravage Mexico, Thailand, South Korea, Malaysia, Indonesia, Russia, Brazil, and many others. The developing economies were the “periphery” for that Credit crisis period.
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Their problems were blamed on ill-advised policies, “currency pegs,” borrowing/spending excesses and other domestic shortcomings. Our and other developed world policymakers had complete understanding as to the causes of various crises, and the IMF delivered the harsh medicine. No one in power wanted to deal with the root of the problem – a dysfunctional global monetary apparatus. No one was willing to address the proliferation of leveraged speculation and derivatives that was integral to distorted market pricing, gross liquidity excesses and attendant systemic fragilities. Indeed, it appeared that officials from key developed countries were content to use the increasingly powerful leveraged players as political expedients and monetary transmission mechanisms.
In the U.S., the unprecedented expansion of (mispriced) mortgage debt and related leveraging was instrumental in fueling a New Paradigm economic expansion, complete with surging government revenues and budget surpluses (not to mention incredible wealth accumulations/redistributions). In Europe, leveraged speculation was critical to the historic yield convergence that permitted the introduction of a single currency.
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Policymakers on both sides of the pond were so enamored with their new tools and busy patting themselves on the back that they apparently did not have time to ponder long-term Bubble consequences.
As the historic global Credit Bubble gained momentum, I found it increasingly difficult to read bullish propaganda such as the “Bretton Woods II” and the “global savings glut” theses. And to this day, Washington is keen to blame the global “creditor” countries for currency manipulation and interest-rate distortions that they contend were instrumental in fueling our housing Bubble. These days in Europe analysts are keen to blame the big creditor country – Germany – for the terrible post-Bubble hardship now ravaging the European periphery. As someone who has followed developments closely for many years now, I find it quite ironic that some of the most eloquent economists warning of the dire consequences of Credit excess, “activist” central banking and global imbalances were indeed German (Drs. Kurt Richebacher and Otmar Issing come to mind).
Spain CDS surged 22 bps today (Friday) to surpass 500 bps for the first time, with CDS now up almost 150 bps since March 1. Spain 10-year bond yields jumped 22 bps this week, as the spread to German bunds widened 22 to 423 bps (wide since November 2011).
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Italian CDS rose 18 this week to 436 bps (high since January). The Italian to bund spread widened 7 to 378 bps (high since January).
Spanish equities (IBEX 35 Index) were hit for 5.7% this week, increasing y-t-d losses to 15.4%. The IBEX 35 Index is now only 7.5% above 2008 lows. Italian stocks sank 6.0% this week, with the FTSE MIB Index now down 4.8% for 2012.
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The German DAX Index fell 2.9% this week and is down 5.2% already in April. Speculators have been hurt, as European markets provide support for the leveraged players with “weak hands” thesis.
Global markets turned unsettled this week. Consistent with the Bubble thesis, the U.S. stock market’s attempt to downplay European and global risks is of little surprise. Yet U.S. and global markets were hit hard Tuesday, as surging Spanish and Italian yields weighed on the euro and risk markets more generally.
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Global markets somewhat stabilized Wednesday and then rallied strongly Thursday on comments from Benoit Coeure, a French member of the ECB executive board: “We have a new government in Spain that has taken very strong deficit measures. All this takes time. The political will is enormous. This is what leads me to say the market conditions are not justified. Will the ECB intervene? We have an instrument, the securities markets program, which hasn’t been used recently but it still exists.” Spanish and Italian bonds rallied; Spain bank bonds rallied; the dollar sold off and global risk markets surged.
Spanish and Italian bonds, the euro and global risk markets were right back on their heels Friday. Hopes that the ECB might be ready to backstop Spain’s sovereign bonds were somewhat dashed by comments from ECB Governing Council member, and President of the Netherlands central bank, Klaas Knot. He stated that the ECB was not ready to revive its bond support program: “I think that we are very far from that situation.
The instrument hasn’t been used for some time, but it’s still there. I hope we never have to use it again.”
As I’ve tried to underscore, Spain is in dire straits. Its debts are spiraling out of control and its badly maladjusted economic structure is today incapable of producing sufficient real wealth to support itself, let alone to service its obligations. It’s not Greece, but Spain’s much more significant economy has begun to demonstrate similar post-Bubble “financial black hole” tendencies.
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LTRO euphoria has subsided, and I don’t expect it to reemerge anytime soon. The troubled Spanish banks significantly increased their holdings of sovereign debt over the past few months, likely only increasing systemic vulnerabilities. The markets are increasingly of the view that the backdrop ensures a major banking system recapitalization and only greater fiscal strain at the local and national level. Basically, it’s difficult to see Spanish debt appealing to the marketplace in the near-term.
So the backdrop points to ongoing European debt stress and financial/economic crisis. There will be enormous pressure on the ECB to bolster faltering debt markets. There will be more finger pointing at the Bundesbank and German politicians. There will be only louder calls for a larger “firewall,” along with joint Eurobonds, special purpose vehicles and other sophisticated structures that would amount to risk-sharing by all member states.
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Basically, it still boils down to the marketplace expecting Germany to back the debt of weak euro zone member countries. And my thesis has been that the farther the world proceeds down the path of faltering Credit Bubbles the more determined the Germans will be to protect their own. If one looks at the world through the prism of a historic global Credit Bubble, with the epicenter in an increasingly fragile U.S., why should anyone fault the Germans for safeguarding the interests of their citizens and institutions?
No discussion of current Credit Bubble Dynamics would be complete without touching upon China. China’s March bank lending data was out this week and such data continues to amaze. New lending surpassed 1.01 Trillion yuan, or $160bn, the strongest loan growth since January 2011 (1.04 TN).
Lending was up 40% from February and was fully 25% above the consensus estimate (according to Bloomberg). Analysts were quick to point to the impact of policy loosening. As an analyst of Credit, I’m contemplating how a Credit system in the midst of a significant housing slowdown can nonetheless extend $160bn of loans in a single month.
From Bloomberg: “Aggregate financing, a measure of funding that includes bank lending, bond and stock sales, was 3.88 trillion yuan in the first quarter, down 8% from the same period last year.” On an annualized basis, that’s almost $2.5 TN of system Credit. I have posited the thesis that China succumbed to the “terminal phase” of Credit Bubble excess. System Credit has exploded since policymakers imposed the massive post-2008 crisis stimulus package.
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I am familiar with the bullish “soft landing” view, yet such a scenario is basically impossible from the perspective of a historic Credit Bubble. I continue to expect Chinese policymakers to tinker and loosen, yet I also anticipate that they will have an increasingly difficult time managing an unwieldy Credit system and maladjusted economic structure. My instincts tell me that we need to follow developments in China with even greater diligence.
The world is convinced that the Fed will do everything to ensure ongoing liquidity abundance and decent U.S. economic activity. This guarantees unrelenting massive trade deficits and resulting global liquidity abundance. The world is similarly convinced that China will do everything to ensure ongoing strong domestic growth, providing steadfast global demand for everything real and financial.
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Much of the world believes that Europe’s (debtor/creditor) mess can be largely ignored so long as the world’s key symbiotic debtor (US) and creditor (China) relationship is maintained. And it is rather obvious why folks are complacent and embracing risk.
Yet when one takes a step back and contemplates the backdrop, there is overwhelming support for the analysis of troubling parallels between Greece and U.S. subprime: the first cracks in respective historic Bubbles. And once the unavoidable downside of the Credit cycle takes hold, there’s little policymakers can do but to postpone (and exacerbate) the inevitable. Federal Reserve rate cuts in ’07 and early-2008 only made things worse. ZIRP, QE1, QE2, SMP, EFSF, ESM, LTRO – worse. From my framework, Greece was the catalyst for the bursting of the global government finance Bubble – global not just European. It wasn’t going to stop with Greece, Portugal or Ireland. It won’t end in Spain or Italy. And while it was all fun and games while it lasted, the LTRO spike to the punchbowl has the world again vulnerable to the hangover blues.
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