Brussels and the Curse of Lender’s Generosity
“Debt is the slavery of the free” Publilius Syrus
In Spain we have spent weeks hearing the supposed benefits of “relaxing deficit targets” and listening to many regional governments talk about “sharing the funds” as if debt was a donation and not a liability. Then, suddenly, the Troika arrived in Madrid and reminded us of what no one wanted to acknowledge. That debts have to be repaid and that there are no unconditional loans. Now, after a lost decade inflating the political spending burden, Spain faces more problems because the country has delayed for too long the inevitable reform of the Public Administration, and the bursting of the housing and civil work bubbles probably leads to a much more challenging solution.
Faced with such an uncertain scenario, it is not surprising that foreign investors are selling Spanish bonds after a strong rally and ahead of another set of measures that markets fear will be focused again on tax increases and not on public sector reforms.
Whenever I visit Spain I hear that Brussels demands many harsh measures. However, Ireland and other countries do not carry out the same economic policies as Madrid -keeping public spending and increasing taxes- and they belong to the same EU and face similar problems. From the outside it seems that Brussels is resigned to just accept the missed targets. Given the risk of implosion of such a large economy, the EU suggests lender-type proposals that Spain willingly accepts because applying them allows the country to keep the statu quo of a fragmented and inefficient state, whose reform requires fighting with many colleagues from political parties.
What does that mean? As Xavi Sala i Martin says, “the EU thinks that the Spanish state spends too much, and spends it badly”. Brussels recommends cutting administrative spending at all levels and an efficiency plan of the Public Administrations by the end of the year. The problem? The perverse incentives.
Tax increases in Spain are always immediate but spending cuts are always deferred and temporary. By the end of the year, if the proposals are implemented, and not disguised, Spain will spend 70 billion euro more than it collects in tax revenues. That is before counting the cost of bailing out unprofitable toll roads -expected to be c€1bn-, and possible additional capital injections to the bad bank or the savings banks.
However, given that Brussels is worried that Spain might breach its targets again, the government decided “to work in a systematic and comprehensive tax reform that serves to rearrange the tax model.” Translation: Raise taxes.
Would you invest the billions of euros that the country needs to restore jobs and growth in a period of tax increases?. Spain needs foreign investment. Now. I explained it in my ten proposals to attract capital and promote growth. A balance sheet crisis can only be solved recapitalizing, and those investments will only come with low taxes and cutting red tape.
The problem of lender proposals is that they perpetuate structurally failed indebted economic models and prevent the clean-up of the system.
The media seems to think that the most comfortable policy is to miss targets, pretend and extend, waiting to see if next year the crisis will be over. Kick the can. Such is the problem of lack of credit responsibility. You cannot solve a balance-sheet crisis with more spending.
Brussels’ credit patches prevent the hard measures that are so badly needed, delay the recovery and choke SMEs and families with new taxes. There is always room for spending, but not to lower taxes and boost the economy. Then, when the economy sinks into depression, governments propose more public spending to “overcome the crisis” that was created by overspending in the first place.
However, when governments follow the same policy for years, good times last less and the crisis periods are more prolongued. Because countries forget Keynes recommendations to save in expansion times and lower taxes in a recession. Governments only cite Keynes when it comes to spending.
It is no coincidence that the largest unemployment, government spending and debt accumulation happens in countries that today enjoy exceptional credit conditions, low rates and all types of palliatives when carrying out fundamental reforms. The perverse incentives of the lender’s generosity.
The measures for Spain
The “relaxation” of deficit targets means 6.5% this year, 5.8% in 2014, 4.2% in 2015 and 2.8% in 2016. I will disagree, because if unemployment in Spain is maintained above 20% in 2015, as expected, I do not get anywhere close to those deficit figures. Even with a solid current account surplus in 2014.
To achieve this deficit, the structural effort should be 1.1% of GDP this year, and almost 1% per year in the following three. What does that mean? They have to find 10 billion euros each year, only to meet targets if all goes well and the Brussels Excel spreadsheet is not wrong.
More taxes? Just check the disastrous effect of previous tax increases (table below). A drop of 6.6% annualized. In every item.
Cut expenses?… Let’s see, 10 billion a year … Oh, surprise. The amount Spain spends every year on subsidies. No, but that can not be cut, sorry. Well, then one third of the black-box spending on “economic activities”. No, no, that cannot be cut either. Wait, then cut 45% of spending on provincial administrations, municipal and island councils. Well no, that can not be cut either. There is “no room” even when Spain’s regions have increased spending by 30% since 2008 in real terms and local governments are still spending at bubble peak levels.
Balance sheet problems are not solved with internal devaluations because disposable income falls, consumption falls and the debt hole gets bigger. Neither by raising taxes because it repels investment. And they are not solved with more debt. Because the tax revenues of the bubble are not coming back.
The end of this crisis will come when European governments begin to realize that the revenues they consider “abnormally low” are the new norm, and what they perceive as “acceptable” are tax revenues product of undue credit expansion created by the “European construction” free money. Those revenues cannot return when all agents, states, companies and families are already highly indebted.
Our debt, our problem
Government debt held by Spanish banks increased by 10% in the first quarter of 2013 and currently exceeds 245 billion – almost 40% of total – as shown in the graph below (courtesy of perpe ). Needless to say, the country’s Social Security and pensions are invested up to 90% in government bonds. Sovereign risk is being isolated to prevent contagion. And the European Central Bank and Brussels will support the process.
The fragmentation of the risk of the euro-zone, that I mentioned here in my article “The Day After The Bailout”, is leading to the internal absorption of most state debt.
There are only three ways to try to get out of a balance-sheet crisis:
- With a huge write-down -and that would bankrupt many of our banks, stuffed with sovereign debt, but also our social security and our pensions, up to 90% invested in government bonds. Investor confidence sinks with write-downs. There is no concept of a haircut “keeping investor confidence.” Think of Greece.
- With a huge devaluation and inflation. And we have seen the futility of such policies in the UK or Japan. Debt actually increases, government spending doesn’t fall but the process impoverishes the whole nation, as budget cuts and reforms eventually have to be implemented anyway.
- Cutting expenses and lowering taxes, attracting investment and recapitalizing the system with foreign money. It’s slow, but cleans the system.
The first two benefit the political apparatus. Argentina without oil. But it does not work. European states are so indebted that they cannot spend hundreds of billions annually in unnecessary infrastructure, and the cost of those subsidies and disproportionate expenses is leading to de-industrialization and unemployment, which are so huge that they endanger the entire system .
Relaxing deficits, increasing debt, maintaining political spending is not lender generosity. It’s slavery. And at this point, it’s not even politically profitable for the bureaucrats.