Daniel Lacalle

The Impossible “Soft” Rescue Plan for Spain

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(This article was published in El Confidencial on August 11th 2012)

‘I never understood why it is considered selfish to keep the money you’ve earned, but it is not considered selfish to take other people’s money. “- Thomas Sowell

“Our debt is what it is” – Jose Antonio Griñan (President of the Andalucía Region)

I have read during these two weeks many comments criticizing Rajoy for not making a formal request of a rescue package. I will not be one who criticizes that decision. Because those who demand an EU rescue mistakenly expect donations, and those don’t exist. And because the placebo effect of kicking the can forward for a few months just multiplies the negative impact later.

The new term spread all over the press is “soft bailout”. Ludicrous. There is no such thing.

I said it yesterday. You wanted ECB? You got ECB. “Draghi demands lower wages, cuts in social benefits and lower corporate margins” in Spain, a country where wages have only come down in real terms where 23 of the 35 largest companies generate returns below their cost of capital.

Congratulations! We have achieved it. That is the implication of a rescue plan. Cuts everywhere except where needed. Look at the list of recommendations from the ECB to Spain. It is not mentioned even once to cut the monstrous political spending. And this is very important to understand. Neither the IMF nor the ECB nor the Troika will dismantle a hypertrophied state unless it is decided by the democratically elected government, which has been given an absolute majority to make the tough decisions and comply with what they stood for. Budget control.

Bond yields can rise further with or without the ECB

If Spain does not tackle the real problems –excessive spending- we are heading straight towards default, with the resulting consequences of further tightening our access to funding, after sinking our creditworthiness by ourselves.

I commented almost two years ago that there would be a day when Spain would be celebrating bond yields at 6.5% and the spread to the Bund “eased” to 500 points. Sad. And a round of massive purchases of bonds by the ECB is useless without cutting the waste political spending and subsidies, without attracting capital, without curtailing cronyism and duplicated administrations, because Spain will generate less real wealth, less economic activity and therefore lower tax revenues, running the risk of seeing bond yields rising further and spreads to the Bund at 700 bps in 2013, if the differential between income and expenditure exceeds 120 billion.

However, commentators continue to ask the ECB to intervene to save us, when we explained a few weeks ago in my article “Markets expect a full Spanish bailout ” that it does not work with the examples seen in the past. But above all it is worth repeating:

Purchases of bonds from the EFSF or ECB will not lower spreads to normal creditworthy levels (50 points), so asking favours to artificially lower bond yields “a little” is useless and will not attract needed private capital. Spreads will not reach anywhere near 50 bps while Spain is constantly breaking the principle of credit responsibility and rescues saving banks and regions which rebel against the state, after receiving the money -of course-.

Artificial purchases of bonds discourage real final demand (secondary market), and the cost of debt will increase after the short term placebo effect, if the system remains with a structural deficit. The ECB, which is already heavily indebted- or the ESM-EFSF –debt with more debt- cannot buy all the outstanding debt of Spain, and anyway it would not matter because we would still continue the reckless spending and sinking our creditworthiness. These measures temporarily lower bond yields artificially, but the yields rocket again afterwards, as we have seen many times, as if you threw a stone to the water.

These measures don’t “buy time”. They “borrow” even more and create perverse incentives- to keep unproductive spending. But more than anything, these measures do not generate confidence, rather the opposite. All European bailouts have ended up in junk bond. In fact, the bailouts so far generated no new demand for bonds, or improvement in credit for the real economy.

There are no “soft” bailouts, they are a hoax. Given the avalanche of comments from the press that will be talking about a national success because Spain received a “soft” bailout, the reality is that there is no money to rescue Spain and conditionality clauses will be very aggressive. The so-called “soft” bailout would actually be a series of small “lifelines” in a Greek way, to see “how it is going” … accompanied by constant “demands” on the economy, especially taxes, depressing GDP. Look at each and every single bailout since 1978 and its impact.

Artificially reducing bond yields does not solve our problem of competitiveness, or the monstrous primary deficit and the problem of subsidies and political spending. In fact, high bond yields have been critical to prevent the government from dusting off the cronyism check book, and go back to subsidize civil works, unions, parties, new useless trains, solar farms and ghost airports. As I told a friend, “every time I see spreads tightening I imagine a government official signing a check.”

Spain is not Greece, it is several Greeces. As Antonio España said in El Confidencial. If we surrender to a rescue we will go down the same road, but with the huge problem that no EU money or the ECB can extinguish this fire. We are not as important to be too big to fail, but we are too large to be rescued.

And just in case we wanted ECB, here’s some more. Moreover, inflation increases if the ECB carried out the monetization of the debt. Because “printing” increases the cost of raw materials and food, see the case of the U.S. or the UK. And the U.S. “exports” inflation. The EU imports it.

It seems incredible that we continue to demand to do the same as the US-stalled despite the monstrous spending and the push of the oil and technology industry- or the UK-in a recession despite massive stimulus-, when such stimuli did not generate any benefit to the real economy. Six trillion dollars spent globally in “stimulus” to generate a real GDP growth of… 0% (source Boenning & Scattergood) and a decline in lending to the real economy.

In fact, it is proven that increased public spending and borrowing does not generate a multiplier effect and that it cannibalizes the private sector. According to IMF figures, in the U.S., an increase of 7.3% of public spending between 2007 and 2009 to generate an 8% drop in real GDP (not nominal), in the UK an increase of 6.9% over the same period to generate a fall in real GDP of 11%, and all this debt by devaluing the currency impoverishing savers. Of the 34 OECD countries, those that stimulated the economy the most were the ones that generated a slower growth of real GDP.

All this shot of adrenaline to “reduce” bond yields for a few months, last time it lasted less than three months, only to continue spending so that the Spanish regions can all have a debt of 16% and to try to force a stock market rise before the string of capital increases. Pretend and extend.

… And then nothing will be done and commentators will say again that “we need time.”

Of course, there are positive recommendations from the ECB such as open competition reduce bureaucracy and invest in R&D, but those are all long-term policies that will not be likely to take place when there are seventeen governments fighting over the cake of crony-ism.

The recommendations of the ECB, or the IMF, are recommendations of a lender. And as we mentioned in this column over and over again, the ECB does not donate. And as a lender, it demands.

The solution was, and is, the private sector. Show that we are a good investment

There is nothing more entertaining than a manipulated market. And in one we are. But while we pat ourselves on the back for the temporary placebo effect, we are throwing away investment capital, which is what we need. More than 163 billion euros have left Spain in the first five months (source BoS).

Lower taxes now, curtail the ridiculous bureaucracy and attract capital to create businesses, generate jobs and tax revenues, not to consume them as the public sector does. In Spain, a country with interesting assets and modern cities, we could get billions of investment from financial and venture capital funds if all efforts were not focused on limiting foreign investments.

Demonstrate that investment in government debt is attractive. How? Exceeding –not meeting- our objectives. Cutting off useless political spending as the majority of voters have asked, reducing the primary deficit. Do not ever fall back into the temptation of “meeting targets hiding and not paying bills”.

Absolute conditionality. No bailout of savings banks and regional communities. And if they happen, they must meet the same rigorous conditions that the ECB or any lender demands. Now. Not in 2015.

Stop moaning of revenue assumptions that may have been, fictitious and invented figures of tax fraud, and excuses of “we expected” and “we could have”. Focus on what the government controls: spending. Revenues will come, as always, when the economy grows.

I read an article this week accusing Bill Gross of PIMCO and other large investors to be the evil hand not wanting to invest in Spain, when the problem is that we have made Spain uninvestable to many funds through the habit of manipulating and pretending. If there is a bad policy it is to insult those that can fund us, and to think that without private capital, asking for impossible bailouts, we will get out of this, when the state, our banks and our businesses have to refinance, increase capital, and make divestitures of hundreds of billions in the next three years.

One Response to The Impossible “Soft” Rescue Plan for Spain

  1. Vincent Boiteau 27 August, 2012 at 9:25 am

    Fantastic post again Daniel. I agree with the supersized civil servant group in Spain. In essence, most of the debt represent the cost of the inefficiencies. In other words, if you slash their numbers (as canada did in the 90s), you really only change the location of the problem as the cost of these inefficiencies would the be supported by the unemployment benefits and eventually by the same people: the taxpayers. The real problem is insufficient output due to insufficient productivity/competitiveness.

    Reply

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