Category Archives: Global Economy

Global Economy

Close To The Edge Or The End Of The Tunnel

4 June, 2012Global Economy, On the cover, Sin categoríaSpainDaniel Lacalle

(This article was published in Cotizalia on June 2nd, 2012)

Let me start from the end. We are arriving, slowly and with enormous difficulties, at the end of the tunnel. We simply don’t know it because the light at the end of the tunnel is not “back to 2007”. The end of the tunnel does not mean growing at 3% per annum, more debt, the stock market back at highs and holidays in Marbella. I expect a tough decade of adjustments and depressed valuations, because the world is slowing its growth. But it is a very healthy sign to see that Europe is finally exposing the skeletons of the closet, the need for recapitalization of the banking system and adopting the adjustments that the economy has demanded for years.

While the stock market plummets, driven by the weak data coming from the US, China and Europe, I would like to remind of what I always say. This market is a bad investment, but a good bet.

A few comments:

* Despite the fall of the Ibex in Spain, the valuations of most of its companies have not changed significantly relative to their European and global peers in debt adjusted relative multiples. It’s just that most are barely less expensive than they were a few years ago, when Spain traded at “high growth” premiums to peers. Look at the valuations of Russian, Chinese, Brazilian, French and American stocks that collapse every day… And debt is an important factor to curb expectations-hopes-prayers of takeovers. Because predators post-2008, after the value destruction of accumulated losses in corporate transactions, rarely seek to buy more indebted companies. Remember that over 78% of all corporate transactions in Europe between 2005 and 2011 have been value-destroying, according to Morgan Stanley. The only way in which the Eurostoxx or the Ibex will go up will be when companies show growth cutting off debt.

* In May the bond and stock markets in Europe and emerging markets saw more than 30 billion euro in outflows. We can complain as much as we want about short positions, but what we have here is pure and simple selling. Especially from Long-Only funds.

* 2011 and 2012 so far have been the years with the lowest percentage of share repurchases by companies and executives since 1998 (source: Goldman). It is almost ironic that those who complain about the price of their shares are not buying.

* The greatest mistake of investors in these months has been to remain positioned in risky assets waiting for an elusive ECB, Fed or China stimulus. As a friend always tells me, the only ones who now demand a stimulus plan do so not because of the state of the economy, but to see stock markets rise. And of course, we forget the chart below (courtesy David Einhorn). More stimulus means more debt and fail again.

Spain. Rescue? What Rescue?

This week the successive set of global economic figures, almost all negative, has driven markets to panic mode. But with all due respect to the poor U.S. data, the slowdown in China and the debt crisis, what I find really surprising is to read that 57% of citizens in Spain support a rescue package from the IMF or ECB, because it shows that much of the population supports more stringent austerity measures and the budgets cuts that would be imposed with a rescue package, as we have seen in Portugal. Let’s not forget that any bailout will be done to strengthen the creditworthiness of the country and that means cutting the large expense items -pensions, unemployment support, public sector. In fact, the largest additional effort that will be demanded by the EU, IMF and anyone that’s going to pay for the rescue will be a meaningful reduction in the public sector.

The world is aware that the 5.3% deficit target for 2012 is unachievable, since the estimates of revenues looks too optimistic. More taxes have proven to generate limited or negative revenue growth. The Laffer curve shown in all its glory again. So what will be critical will be to focus on reducing overheads (ministries, councils, subsidies, etc..), liberalize some sectors and cut energy costs.

But what surprises me most is to see how little liquidity is available in the global system to put out financial fres when they become as large as Spain. Last week we talked in this column about the huge debt that the Fed and the ECB hold, and their problems. But the IMF now has just 330 billion dollars of funds available, from a total of $560 billion, almost all of it debt-financed in New Arrangement to Borrow (NAB) , and the veto of both the UK, Canada, United States and China, who refuse to provide more funds, given their own specific domestic debt issues.

A lifeline to Spain of $300bn would consume most IMF funds, and make it impossible to prepare for a solution for Italy, for example. This does not mean that the IMF with the ECB could not provide an appropriate credit line, but a full rescue package seems unaffordable.

Incidentally, it is striking that in the orgy of debt of the OECD, the IMF has gone from providing support packages of 20 to 30 billion dollars to now talking about figures that are ten times higher to historic ones.

How to solve a problem called Spanish banks?All this intense support that the Spanish government is negotiating is to finally make an attempt to clean up the financial system after years of denial saying stubbornly that it was the best and most effectively regulated banking sector in the world, with no sub-prime. A final attempt to limit and clean the real estate exposure, therefore trying to stop the current effect of “contagion and collapse”. Contagion of bad non-performing loans on the rest of the portfolio of credit of banks and collapse of new credit to the real economy.The announcement by Bankia of its capital needs 23.5 billion euros, has revealed two things:

1) When it comes to provisions, the term that the ordinary citizen sees is “revealing losses”. If, as Draghi said on Thursday, banks subject the country to a steady increase of the amount needed for provisions, it creates uncertainty, lack of credibility and suspicion. A slow drip of bad news does not reduce risk, it multiplies the confidence problem . Markets sell the shares and there is a risk of an outflow of deposits. It is better to err by excess of prudence than to wait for markets to forget the previously published figure of real estate losses and see if it works.

2) The need to recapitalize Spanish banks probably reaches 70-80 billion euro, according to Nomura and Morgan Stanley. As always, Goldman Sachs, optimistic as they are, see only an estimated 17 billion euro of capitalization needs. Anyway you see it, an enormous figure that makes Spain “impossible to bail-out”. And even Goldman warns that banks may be spending up to 6% of Spain’s GDP annually to finish building houses and homes to avoid having to make higher provisions (if properties are finished the provisions required by law are substantially lower).

Therefore, Spain can not afford a Swedish solution, public money to bail out all banks and remove their toxic assets, given the monstrous amount of exposure to real estate of banks, and given the current level of government debt. Issuing public debt to fill the capitalization gap of banks could prove to be extremely damaging to Spain’s already high cost of borrowing.

A possible solution comes from a Bail-In with limited public cost. Forcing a conversion of debt into shares, even though banks dislike this measure due to the massive dilution that would result for their shareholders. The Instituto Juan de Mariana points precisely to that solution , which I also commented on twitter and in this column. Debt To Equity Swaps. An internal recapitalization, forced conversion of debt into equity, which affects only the bank’s shareholders, not the taxpayer, rather than a public bailout, which would be unaffordable and extremely costly.

A bail-in has the advantage that the bank loses the perverse incentive to return to making lending “mistakes”, “knowing” that it can be rescued with public money. As the bail-in affects its shareholders the most, they will be the first ones to force the bank management to behave appropriately in future lending.The solution is difficult and slow, but once Spain has finally imposed severe recapitalization measures the light at the end of the tunnel will be evident, as seen in other countries.

Confidence and credibility

In a country that has withdrawn billions of deposits from their banks in the first quarter according to the Bank of Spain, Spanish mainstream media (chiefly La Razon, Publico and ABC) still has the audacity to blame the international press, the Anglo-Saxon evil papers, and “speculators” for the decline in its stock market and the rise in bond yields. Blaming the wicked investors who Spain so desperately needs to buy its debt, or the foreign press, by the way, the same press that criticizes openly and aggressively Obama, Bush, JP Morgan, Goldman or Cameron. Yet the headlines “Spain under attack from speculators” and “the attack of anglosaxon press to our banks” is repeated like a mantra in different forms.

The beginning of the solution to Spain’s problem is foreign capital and we must attract it. When I hear atrocities about “scavengers” (on Spain’s public TV) referred to international investors I think that Spain’s media -unwillingly- is at risk of sabotaging the government efforts to seek funding and solutions.

The truth is that I have never seen any business / country prosper and be sustainable on the strategy of telling their clients / investors that they are ignorant and publicly blaming clients for the slowdown in sales. Nor have I ever seen a market that values in a positive way a constant change of targets, or missing them, even by a few decimals. Investors can not make acts of faith, because they are not allow by their own customers. If there is no trust, there is no investment. And if the country is not well understood, is it not our fault for not explaining ourselves clearly?

I live in London. Spain is a country valued for its solid corporations and professionals. Hard workers, serious and humble. This media concept of “they do not understand us” or “they attack us” parts of two very dangerous vices that were not typical of Spain. Arrogance and ignorance. The arrogance of thinking that we deserve the attention, forgiveness and eternal capital of investors, no questions asked, and ignorance of what happens globally, which is that almost all OECD countries are in trouble and that the money available is reduced by a deleveraging world.

Spain should not settle on being “one of many bad countries” but we have, precisely because of our current difficulties, to do our homework faster and better . Because we do not judge ourselves. We tend to see ourselves more beautiful, slimmer and with more hair than it is real. We are judged by the world.
Investor confidence can not be recovered in five months. We can not demand that speed. Trust will be recovered with hard figures, not of a quarter, but those of 18-24 months. I’m sure Spain can do it.

Originally published in Cotizalia.

To watch my interview in Al Jazeera about the Spanish banking issues go: (Quicktime or Oplayer required) http://dl.dropbox.com/u/62659029/iv_daniel_lacalle_250512_0.mpg

And my interview on Spain’s bailout

http://www.aljazeera.com/programmes/insidestory/2012/06/20126126534386935.html

What If Germany Turns Off The EU Funding Tap?

28 May, 2012Global Economy, On the cover, Sin categoríaInternationalDaniel Lacalle

(This article was published in Cotizalia on May 26th, 2012)Another week and as part of our leaders think that the rest of the world is wrong, capital continues to fly away from Europe. €700m a day according to press. The credit and financial credibility of the Eurozone couldn’t be any lower. Yes, my friends, investors will not return if the numbers are not solid, and politicians cannot prohibit selling.

Eighteen European summits in two years. European politicians seem increasingly more detached from the real problems of the economy. How can they meet again without reaching an agreement on anything? They seem to give a message of selfishness to the public, and that they are cheating to investors.

We get constant calls to promote growth, which would be fine if they were not calls to encourage the same subsidized wasteful spending of the past. Funily enough, if the EU had cut part of its €141bn budget, out of which 45% goes to “employment and growth”, by today the continent would have a lot less debt and a lot more growth. In any case, I think that we will gradually see a more logical reform agenda for Europe.

We are outraged to see that Germany finances itself at near zero rates while Southern Europe countries finance themselves at 6% or higher. But instead of thinking that, perhaps, the Central European austerity plans work, the press and politicians say that Germany is going against us, “drowning” us.

We hear that the blame for the debt crisis should be pinned on Germany which broke the deficit limits in the early 2000s, which “obviously” led everyone else to go into a debt frenzy. Here nobody is to blame for anything. It’s like those people that stuff themselves with Big Macs and blame McDonald’s for their obesity. If a bank fails, blame it on the “ill will of the anglosaxon press.” If the stock market falls, blame it on Greece or hedge funds, or both. And the giant real estate bubble, the massive subsidy culture and the savings banks’ recklessness have Helmut Kohl to blame. Please

However, countries that have implemented austerity and budget control, from Estonia to Germany, are those who are better off today. We should not demonize them, but learn together how to attract capital and get out of this debt mess. Austerity -cutting giant political spending- and growth -not subsidies.

Austerity and growth are not mutually exclusive. Reckless spend and growth are.

From a market perspective, the only way to reduce risk premiums and attract investor interest is just moving towards a single tax system, and to contain government expenditure, which has done nothing but grow even in years of “austerity”. Public spending in the EU has not fallen in most countries between 2008 and 2011. In Spain it is still 4% higher than in 2008.

The graph below is devastating. Either we adapt spending to “pre-bubble” levels or the CDS will not stop rising.

Why we should not allow the ECB to become the worst hedge fund in the world

When we say that countries should receive more money from the European Central Bank we forget that it can not infect its balance sheet at the rate of one trillion euros per semester.

Germany, the Netherlands and the countries of central Europe are those who have to carry the financing risk. Not France, which has a serious debt problem. And if they close the tap, it will be bad. But if they open the tap too soon and too much it will be worse. Because they run out of water for the next fire.

There are several things we should know about the European Central Bank:

. The ECB’s current debt is monstrous. At 23 or 24 times its assets, with only 82 billion euros in capital and reserves. Of course, the Fed’s balance sheet is also unacceptably high, 53 times its assets … The big difference is that the capitalization of the Fed does not depend on severely indebted entities such as the European states. But as I always say, we should not copy the ones who do wrong and reclaim our right to do worse. Let’s remember that the U.S. is on the brink of a “fiscal cliff.”
. The ECB weakens with the losses incurred from its purchases of sovereign debt. We are talking about latent losses between 55 and 70 billion euros (source Barcap and Open Europe). Of course, many will say that there are no “losses” because the ECB has not sold the bonds -a “bull market” argument- but anyway we want to see it, systemic risk is increasing and does not dissipate by buying more bonds, as we have seen since November. In fact, losses have increased in 2012.
. The European Central Bank has already contributed to the stabilization of the European market, excessively aggressive and quickly. With more than 1 trillion. And the ECB should keep powder dry in case of future emergencies, because the future ain’t what it used to be, to quote Jim Steinman.
. Saying that “we must use the money of the ECB” is false because it is not disposable money. It is debt, which must be funded through more sovereign debt. The ECB Balance sheet growth goes also against our future tax bills.
. To those parties that demand that Europe should “capitalize “the debt of the ECB: Where will that money come from? Furthermore, it an indirect default that would severely impact the creditworthiness of all solid countries of the Eurozone.

The plan

Once we understand that going back to 2007 can not be the goal, that the bubble and the party is over, we will see things are much clearer and less negative.Eurobonds cannot be implemented when one party in a small country can bring half of Europe to its knees. Creditworthiness would collapse when there is no unity in economic and fiscal policy, and the risks spread, as we mentioned here. Eurobonds, no thanks. I hope we have learned something from the subprime crisis. Packing and hiding toxic assets does not reduce the risk, it increases.No, Germany is not closing the tap, in my opinion. Neither they are going to let anyone drown. Let’s not be dramatic. What Europe has to do here is to stop the party of political spending and subsidies. That’s not drowning. Germany has an exposure to the EU of 500 billion euros and the risk of financial contagion between European countries far exceeds the estimates of many banks.

However, I keep hearing that we need a growth plan, which sounds great if it was not for the fact that it’s a borrowing plan. As of today, and after two years writing about it, I can not believe that Europe is betting on more debt. Remember that almost no European country has created GDP growth ex-debt in the last 22 years. Have we not learned from all those ridiculous infrastructure plans?. I leave you a figure: the European economy generated less than $1 of GDP for every $ 2.5 of debt (Barcap and IMF data). That is, we continue to build the huge ball of debt in the vague hope that growth will multiply exponentially some day.

This week I have seen some possible proposals that would go to the June summit. The recapitalization plan in Europe would happen of three phases:

1) A fund to pay debt (Redemption Fund) that incorporates the indebtedness of over 60% of GDP backed by gold reserves of the States. This fund would repay that debt against a commitment to economic reforms, adjustments and more severe cuts guaranteed in the Constitutions of the member states. The problem? The gold to debt ratio of troubled countries is very low. An average of 6.1% for the Eurozone and 3.5% for Spain or 5.8% for Italy.

2) A line of credit to banks to ensure liquidity needs, but not capital needs. We seem to forget that these are mostly all listed companies that can and should access their investor bases to recapitalize themselves.

Additionally, the idea is to try not to create false inflation . The economic miracle of Central Europe is based, among other things, on multiplying by three the number of low-paying contracts (mini-jobs). An increase in inflation would be lethal because the euro-zone countries have never been able to control it when it overshoots, especially when it’s external inflation (commodities).

And finally, tackle the unjustified strength of the Euro currency versus the US dollar, to devalue and promote competitiveness, reducing the need for internal devaluation we have seen so far. It will take the market to do this last bit, as economic expectations of the euro-zone are adjusted to more realistic figures.The key is shows in the above graph. Either we attract private capital back once we have proven real creditworthiness, or we continue whinging blaming the Germans, the markets or Hedge Funds.

Germany and the ECB are not the problem, but they are not the solution. Only countries can save themselves. If not, there will come a time when Germany and the ECB runs out of money for bailouts.

Hopefully in June, EU leaders will forget about trying to re-create 2007 and think of a more rational future.To watch my interview on Al Jazeera about the Bankia and Spain (Realplayer Quicktime or Oplayer needed): http://dl.dropbox.com/u/62659029/iv_daniel_lacalle_250512_0.mpg

The Myth of European Austerity In Five Graphs

23 May, 2012Global Economy, On the cover, Sin categoríaMacroDaniel Lacalle

This article was written by Manuel Llamas and Domingo Soriano published by Libre Mercado here. All copyright Libertad Digital and Libre Mercado. (Wednesday 23rd June 2012).

“A lie repeated a thousand times becomes the truth”. This well-known sentence, attributed to the master of Nazi propaganda, Joseph Goebbels, could also serve to illustrate the great deception of the alleged public austerity in Europe. Since the outbreak of the debt crisis, it is widely repeated that Germany has sought to impose on the rest of the EU partners an adjustment plan focused on cutting costs and implementing structural reforms that would foster economic growth.

This strategy has been harshly criticized by many economists and by the Southern European countries, the weakest in this crisis, with Greece leading the critics. In fact, analysts, politicians and union leaders blame all the current problems of Europe, including the Greek default, on the imposed austerity measures. After the recent French and Greek elections, the critics of Merkel’s strategy have begun to gain notoriety, to the extent that the European summit to be held on Wednesday will focus more on how to boost growth through government spending (stimulus) than on further cuts in policy to reduce the deficit and debt burden.

However, official data (Eurostat) shows that the much-touted European austerity is today little more than a myth. The Greek default was not due to the demanded cuts but due to the decision to keep a bloated state unchanged. Likewise, the evolution of spending, deficits and public debt in the euro area shows that the austerity only exists on paper. Neither governments have stopped spending well above their means, nor have they undertaken structural reforms to enable their economies to improve their productivity and grow solidly in the near future.

More public spending

The most striking figure, amid all the rhetoric against the cuts, is that public spending in the euro area as a whole has grown by almost 7% between 2008 and 2011, reaching 4.65 billion euro.

In the South of Europe, those most affected by austerity in theory, the evolution is similar: Public spending in France rose by 8.6% since 2008, in Spain, 4%, in Italy, 3%, in Portugal, 7.8%, while in Greece, despite all the announced cuts, spending fell just 8.5% over the 2008 level, although today its public sector continues to spend 2% more than in 2007 (just before the crisis).

In essence, no European country has managed to reduce their public spending to 2004 levels, a few years before the start of the international crisis, which itself could be considered as an exercise in austerity. Not at all. The following chart summarizes the evolution of public spending in these countries, measured in nominal terms at current prices.

In fact, the situation hardly changed if we look at the evolution of public spending in real terms after inflation.

More deficit and debt

Of course, increasing public spending also meant higher deficit and public debt. As such, in the middle of alleged austerity, the deficit in the euro area as a whole, far from diminishing, has tripled since 2008 , from 2.1% of GDP to 6.2% in 2011, while public debt has grown from 70.1% in 2008 to 87.2% of GDP last year.

As we can see in the graph below, the public sectors in Spain, Greece, Italy and Portugal, the four southern European countries most affected by the debt crisis, are still spending more than they earn. Only a few countries in the North and East of the continent (exemplified here by Germany and Estonia) have maintained their public at deficit under control during these years of crisis.

Chart above shows public deficit.

Obviously, if the deficit is out of control every year, public debt will continue a worrying upward trend. As we can see in the image below, all the countries of southern Europe have public debt figures that are much higher than that held at the beginning of the crisis. Even Spain, which began with a very reasonable level of public debt of less than 30% of GDP, is now touching 70% and could end 2012 above 80%.

Greece, meanwhile, is at levels close to 200% and Italy is moving steadily to 130%. With these levels of debt, it is logical to see international investors unwilling to buy more South European government bonds, and the to see the CDS and spreads versus the Bund soar. But governments and political parties continue to blame the “evil speculators” or the unfairness of German taxpayers, strangely reluctant to lend more money when nobody else wants to either.

Chart above shows public debt growth.

Along with the complaints about unreasonable “cuts” allegedly “imposed by the markets” (or the Germans), in recent weeks we have seen a growing public debate that wrongly puts austerity and growth as two opposite concepts. They are not. Austerity is the antonym of waste. In fact, recent history shows that more government spending does not foster growth, and does not help to get out of economic difficulties.

The current crisis began in 2007. From then until late 2011, the four southern European countries we are considering implemented aggressive public “investment” policies that Keynesian economists would qualify as clearly expansionary, with deficits close to or above 10% for several years. If this theory were true, Greece, Portugal and Spain would have already recovered and the growth generated by the “virtuous circle” created by government spending would be paying their debts. But none of this happened.

deficit-publico-22052012

Meanwhile, Germany and Estonia followed the opposite path and imposed austerity. The result is that both countries had a strong relapse in 2009, with the political cost that it entails . But they are recovering faster and now have much stronger economies. Meanwhile, in Spain, the “Plan E” of investment in infrastructures, an enormous waste of public funds with its vast implication on cost of borrow and deficit, and other public spending measures have failed to stem the crisis. But the message currently repeated over and over is that it takes even more government spending, for much longer, to foster growth. But… For how long?

Chart above shows growth in GDP

Follow Manuel Llamas on @manuel_llamas

Spain: Exit The Euro? A Long and Painful Death

21 May, 2012Global Economy, On the cover, Sin categoríaSpainDaniel Lacalle

(This article was published in Cotizalia on May 19th 2012)

This week everyone is talking about the possible Greek exit from the euro and the apparently appealing idea of “why not Spain?”. Let’s press the Reset button and start over. We have discussed Greece in detail here (http://energyandmoney.blogspot.co.uk/2012/05/greek-drama.html).

The Greek state, which has more public employees than Spain with four times fewer inhabitants, wasted bailout after bailout and continues delaying reforms, saying that “they’ll come, be patient”. And now, some demand breaking the agreement-yes-after having accepted the money. One thing is to belong to the European club with its obligations and rights, and another is to demand to participate only for the party and not to collect the broken glasses … But it is their sovereign decision to shoot themselves in the foot.To read the arguments in favor of breaking the euro, I recommend the interesting and detailed analysis of Jonathan Tepper here. But I’ll give my opinion focusing on Spain. Leave the euro? No. And I think Spain should not, due to the dangerous implications for the country, its partners and the financial system . Why?

. Because Spain is not rich in oil, gas or natural resources as most countries that have made default and devaluation in the past decades, which allowed them to contain hyperinflation.

. Because even if Spain leaves the euro and enters into a default, it will not be freed to carry out the reforms, adjustments and severe cuts needed due to its structural primary deficit.

. Because Spain can ease its debt problem with reforms and budget control, continuing as a major country in the OECD without breaking the rules.

Leaving the euro, and re-structuring -default, bankruptcy, it’s all the same- to start again is like cheating at cards to try to continue in the casino without paying the debts, and as such you get thrown out. It would lead to a collapse of of 25-40% of GDP quite likely, according to UBS, with 45% unemployment, and hyperinflation.. and then, hopefully, grow.

The examples of devaluation and default in Spain are not encouraging.

Spain devalued the peseta seven times between 1959 and 1993. Inflation and unemployment overshot but what is most important is that by the end of the devaluation frenzy the economy was not stronger, unemployment remained stubbornly high and real inflation -not official- rose well above the expected targets. In the early 90s the so-called “devalue for growth” measures delivered no strong growth and just the obliteration of the middle class for years until the country recovered in 96, mostly due to a massive real estate bubble. Spain devalued in 1992 twice its currency by 6% and 5% and in 1993 by 8%. Unemployment reached 24% (3.5 million), public debt to GDP shot to 68% and public deficit soared to 7% of GDP.

To grow after the shock departure of the euro would require capital. Who would lend or invest in Spain after a blow of such caliber? Just look at the list of countries that have abandoned the reference currencies. Either rich in natural resources or examples of extreme poverty.

In the best case there would be a V effect on growth of GDP. A very doubtful effect that, if anything, would lead to the same starting point. Of the twelve countries that have made mega-devaluations in the last 20 years, none generated a GDP growth remotely similar to the devaluation imposed. Average devaluation of 40% for an average increase in GDP over three years of 10%. Immediate poverty without increasing wealth. As U2 would say, ‘running to stand still’.

An exit of the euro would lead to a devaluation of 35% minimum, default on debt, and the contraction of GDP would be enormous, up to 20% but Spain would continue with a primary deficit problem, which is 3% to 4% currently. The primary deficit is the difference between revenue and expenditure without incorporating the financial burden of public debt.

Spain, as in the bad years pre-euro would have to finance this primary deficit… where? At what cost? In fact, in all cases in the past, the runaway deficit has been the first consequence of the departure of the reference currency . Thus, Spain would have make severe cuts in addition to the drop in investment and disposable income . Leaving the Euro does not free Spain from the much needed cuts and reforms.

At what cost would the Spanish State finance itself outside the euro? The 10 year bond at 6%, which today seems too high, would go to much higher levels. Spain’s financing rate soared to 13% in the devaluation frenzy of the 90s. And CDS in Argentina is 1,196 compared to Spain at 500. And what would happen to corporations? Half of the private debt of the country is held by 28 companies of the Ibex 35 Index. These would bankrupt with the subsequent massive impact on employment.

To think that a Spanish exit of the euro would have no contagion effect in Europe and Latin America, its financial and trading partners, with the subsequent effect on export capacity is also dangerous. Spain would create a domino effect of risk on some European banks, our lenders- as well as defaults on domestic ones, with the consequent spread to Latin America. But once done, Spain would become like Argentina or Ecuador … but without oil and gas, natural resources to keep inflation under control.

Do not forget that Spain is already a net importer of commodities, including agricultural ones. Hyperinflation in such products would lead to extreme poverty, and oe can not be re-orient a nation to autarchy and agriculture in a year.

I remember seeing staff at supermarkets in Argentina changing price tags every half an hour while the government repeated over and over that inflation was just 9%.

Those countries that abandoned reference currencies, made huge devaluations and defaults, kept prices of its domestic oil and gas artificially low to contain hyperinflation. And despite this, inflation shot up to levels of 9% -11%. And in Spain, the “high inflation vs hyperinflation” debate is irrelevant. With 24% unemployment already, 9-10% inflation is hyperinflation.

In Spain, hyperinflation would consume the economy again, as a net importer of raw materials. And the example of other devaluations shows that unemployment is not reduced substantially. Although Argentina doubled its number of civil servants after the de-dollarization, unemployment rose from 14% to to 22% three years later only to fall to an 8% “official” -11% real- rate today, more than 10 years later.

On the other hand, ‘default’ would have a financial domino effect . Given the huge exposure of the banking world to Spain and its private companies, it would create a credit ‘crunch’ at least in Europe if not global. If it happens now with the Greek risk, where we do not know if the impact is 400 billion or a trillion euro, imagine with Spain, which is three times larger than Greece.

But in addition, assuming that the international financial system recovers from the effect of “Spain is out of the euro”, which would take away a good part of the assets of our investors, the country would have very severe financing issues, as it happened in the previous seven devaluations. Because Spain has no natural resources, gold or technology sufficient to make us able to force an autarchy that doesn’t mean “poor for 100 years” . A country back to poor shepherds, farmers and tourism services as in 1960.

Spain is Spain, not Iceland

It seems obvious. The bankruptcy of Iceland, a widely used example, was a national agreement of mutual impoverishment in a country of 320,000 inhabitants. Fewer inhabitants than Bilbao. Spain has 47 million. The implications are devastating. Iceland, when broke, was not as relevant for the global economy as Spain is. In 2007, Iceland had a GDP of 8.5 billion compared with a trillion from Spain. The debt of Iceland, at 800% of the GDP was nothing, tiny, in the global financial world. Nevertheless, its default generated a ‘credit crunch’ that affected many countries. The impact of the debt of Spain, which is 3.5 times the GDP of the country is a major risk of an international financial meltdown.

The cost of leaving the Euro of Greece is estimated between 400 billion euros and 1 trillion euros. Spain would be around 2 to 3.5 trillion euros. With that cost, and an impact on financial markets and banks that could last years of provisions and losses, Spain would not see much of a dime of external financing, which would curtail its return-to-growth options.

A problem created in a decade is not solved in one day.

Spain and Europe suffer the hangover from over a decade of debt. And you don’t not cure a hangover from years of alcoholism in two months. Trying quick solutions has a monstrous side effect.

Spain has to lower its debt within the euro, slimming its wasteful spending (14 billion in subsidies, 100bn in duplicated political spending) to improve its creditworthiness and, therefore, make debt less expensive, while reducing total debt. Attract investors and make State with lower and more sustainable costs. Additionally, it must reorient its production model to high-productivity sectors, making an attractive environment for investors, for the entrepreneur. Not all civil works, infrastructure, useless subsidies and housing.

Devaluations and defaults destroy long-term capital investment because it becomes well known that the country will make more and more devaluations, as we did in the past, and defaults.

Spain needs a process of deleveraging in the private and public sector, which, on the other hand, the country can afford without breaking the rules. Another thing is that until today they have not wanted to do because it was easier to wait until more funds from the EU arrive.

In short, the deleveraging is healthy . Growth will not spectacular, but cleaning unproductive sectors unclogs the fundamental problem, that the country borrows to pay current expenses and interest charges. Spain, if it reduces useless expense and the culture of subsides, can reduce debt with modest growth of a mature economy, but with an affordable and sustainable cost and size, appropriate to the cyclical nature of its production model. Not running to stand still.

To watch my interview on Al Jazeera about the Bankia and Spain (Realplayer Quicktime or Oplayer needed): http://dl.dropbox.com/u/62659029/iv_daniel_lacalle_250512_0.mpg

Further read from Juan Rallo: http://www.iea.org.uk/blog/bringing-back-the-peseta-won%E2%80%99t-solve-spain%E2%80%99s-problems

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Daniel Lacalle Blog

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