Category Archives: On the cover

On the cover

Why the ECB plan is no early Christmas

Global Economy, On the cover, Sin categoría,

This article was published in El Confidencial on September 8th 2012

“In central banking, as in diplomacy, style, conservative tailoring and an easy association with the affluent count greatly and results far much less” John Kenneth Galbraith

Euphoria. All is solved. After Thursday’s announcement from the ECB regarding unlimited purchases of short-term sovereign bonds, Draghi and Merkel, the “enemies of Spain and Europe,” according to some press, are now our saviours. Investors seek to protect themselves against inflation through stocks and commodities. By now there is no doubt that we are moving towards an inflationary period driven by financial repression and aggressive monetary policies.

From my point of view, the ECB plan only manipulates the price of short-term bonds artificially. Access to ECB funding is not linked to growth and solvency and is not aimed at rewarding the efficient. It will provide liquidity judging only by price without questioning whether such price is fair or not. It also runs the risk that countries receiving the liquidity will delay reforms knowing that if they push the limits they will receive a bailout. In essence, the ECB could be breaking the principle of responsible lending, a mistake that, in my view, is affecting the entire EU and discouraging long-term investment and capital.

I also believe that this plan simply transfers peripheral risk to countries like France, which do not have sufficient economic strength to endure the added risk. But above all, the ECB plan leaves the medium to long term solution of the economies in pro-state policies that do not promote the creation of new businesses and jobs. In the US I hear talks of SMEs, private job creation and growth, while in Europe it seems we only read about more government debt, to maintain subsidies and how to protect an unsustainable state apparatus, which acts as a crowding-out predator of credit to companies and families.

Questionable premise

The first mistake the ECB plan has, in my opinion, is to think that the bond yields of peripheral countries are “unfairly high”. It happened before with Greece and Portugal. It starts from the premise that bond yields are higher only because of the “fear of a euro breakup” when the reason is pure and simple of solvency. The problem would be much easier to solve if Spanish bonds were discounting an “imaginary” exit from the euro, but what we are seeing discounted is a much more problematic issue. Spain spends twice its revenues.

The negative surprises such as upward revisions in the deficit of Valencia by €3bn –a tiny 82% “mistake”-, the Catalonia bailout, the savings banks’ bailouts, a state deficit that has already reached 4.6% of GDP and that, including regions, may well be significantly ahead of the government target for 2012 … All these issues make the market discount that the gap between expenditure and revenues will expand further because costs do not go down. If the market believed that Spain runs the risk of leaving the euro, bond yields would stand well above 6% due to the inability of the country to finance the primary deficit outside the Eurozone.

The risk of perverse incentives

I see the 10-year bond at 5.6% and I fear that politicians will dust-off the cheque-book for more unneeded infrastructure and construction projects. Savings banks are denying credit of tens of thousands of small and medium enterprises –which generate 80% of added value and 70% of jobs in Spain- yet they seem more than willing to provide lending to high risk construction projects promoted by the regions and financed mostly with debt.

The most dangerous incentive generated by the ECB plan is that countries with greater difficulties will concentrate most of their debt in short-term bonds, which is the tranche that the ECB would buy, because they know that the long-term maturities will have very little institutional demand. The ECB expects that by doing so it will “force” investors to buy long dated debt. I believe the ECB is wrong. Think of the example of a company with poor fundamentals that sees one of its controlling shareholders buy more shares “to support the stock”. Investors do not follow this move except for the very short term. The monetary regulator assumes that credit investors “must buy” European debt and expects that by announcing “unlimited purchases” it will create a steady demand. In my opinion, this is incorrect as the underlying problems of the economies of peripheral countries are not even close to be solved, and will likely be postponed and dragged once bond yields are “perceived” low enough to “spend again”.

I am concerned about countries which are concentrating too much short-term debt, as the chart shows. The risk is multiplied because they are funding unproductive state spending and long term government investments with short-dated bonds, a dangerous recipe.

We must also note the danger of having “cheap” credit, which could lead many governments to delay cuts and, taking advantage of the complexity of the administration, take another spending party before the Troika comes and citizens see another round of tax increases.

EvoDeudaEfec2011-12

The words that scare me: “unlimited capital”, “strict conditionality” and “sterilization”

The really sad part of the ‘rescue’ plan of the ECB is that not a single cent of that money goes to small and medium businesses, to create jobs. It goes to support a hypertrophied structure of the state, which will continue monopolizing the available credit under the promise that “something” will fall for the real economy … And it does not, because added to this ECB support countries face the urgent need to recapitalize banks, deleveraging. That is, less credit to households and businesses.Instead of supporting banks and government apparatus, and hoping that some crumbs will remain for the real economy, imagine what it would be if families and businesses were the recipients of this “unlimited capital”. Crisis over.Strict conditionality. The carrot and stick. Another problem is that the ECB plan makes countries very dependent on the ECB buying bonds to fund them while the European regulator threatens to withdraw such support if conditions are not met. The countries will be at the mercy of a quarterly ECB revision of its accounts and, therefore, subject to much greater volatility.

The strict conditionality also implies that budget cuts will be very severe. But because those cuts should be reflected in the accounts urgently to continue accessing the ECB line, governments might not focus on long-term structural reforms, focusing instead on elements of immediate impact. Tax increases.

Unlimited capital.

The ECB has not yet bought a single bond and euphoria takes over markets based on a word: “unlimited”.

I’m surprised to hear those words as if they were logical. Unlimited capital. The Eurozone GDP fell by 0.4%, more than 2000 companies file for bankruptcy each quarter, unemployment keeps rising and Europe sees plummeting fiscal revenues. But we read “unlimited” without printing money. Unlimited means generosity with other people’s money. It means debt, and lots of it in a European Central Bank whose balance sheet in 2012 is close to 34% of Eurozone GDP, close to 3 trillion dollars, much more than the Fed (20%) and the Bank of England (21%) in their countries.

ECB VS FED
 “Sterilization” 

Sterilization means that for every bond it buys the ECB has to sell other assets to prevent inflation from rising out of control and to avoid borrowing massively. Sounds good? But so far Europe has proved unable to contain inflation, just disguise it, and the ECB debt has soared by 20% annually.The issue is that the central bank will be manipulating prices but will not increase liquidity in the system. Why do it then? It only impacts prices short term but the debt and liquidity crisis lingers.Another problem is called France, which would see bond yields soar just as it is growing debt and credit ratings will suffer, as Moody’s has warned. If added to this the ECB also sells French bonds, it will weaken another engine of Europe.From the point of view of institutional demand, foreign capital is likely to continue to avoid Europe as ECB intervention becomes a constant stream of “plugging holes” changing the price of assets and then, investors simply will not be able to invest in European debt on fears that prices are manipulated randomly and according to subjective criteria.

Reforms are not debatable

Every newspaper in Spain demands a bailout as if it was a donation and the end of budget cuts. It is neither. The ECB does not donate, it lends. Spain would not need a bailout if it managed expenses according to revenues, rather than waiting for the return of fiscal revenues of the housing bubble period to finance a hypertrophied state. And the consequences of a bailout are very relevant.

A bailout has a huge impact on the creditworthiness of Spain. And even if rating agencies will promise no downgrade to junk status, the market will do it, as it did with Portugal, Greece and Ireland. Spain has to assess this risk.

Minister De Guindos said Spain is carrying out the reforms that Germany undertook 10 years ago. Let us hope it is correct.

It is easy to reject reforms from Spain’s current perspective of a heavily subsidised nation with an “undeniable right” to debt, and claim that cuts don’t work. To illustrate why reforms are essential I would like to end with a few sentences of an article about Germany’s 2004 reforms, “The three crises that undermine the European colossus ” written by Jose Comas and published in El País in 2004, when many believed Spain was the rich champion of the world:

“Germany is riddled by corruption, recession and deteriorating public services. Its crisis is structural. Convinced of the need to renew a stagnant Germany, Schröder launched in March of last year the ‘Agenda 2010’ reform program. It was a plan to make cuts in social benefits rooted in post-war German culture, and to partly dismantle the achievements of social capitalism: reducing social benefits in retirement, health care, unemployment and making layoffs easier. Schröder opened the bottle and let go the spirits that will lead to political ruin”.

Schröder must be singing “I Hate to Say I Told You So” by The Hives.

Let’s hope Spain will not be trapped by the promises of unlimited capital and donations that don’t exist.
Thanks to @absolutexe for the graph

Catalonia: bailout and junk bond

Global Economy, On the cover, Sin categoría, Spain

This article was published in El Confidencial on September 1st 2012

“When you blame others, you give up your power to change”
“A sense of entitlement is a cancerous thought process that is void of gratitude and can be deadly to relationships, businesses, and even nations.” Steve Maraboli

On Friday, Standard & Poor’s downgraded the rating of Catalonia to junk after the region made a bailout request to the Spanish central government of €5bn. S&P warned in its report of the “economic and credit deterioration of the region,” and added that “the region’s request to modify key institutional and financial aspects of its relationship with the central government raises uncertainties that we deem incompatible with an investment-grade rating.”

The report also warns that “Catalonia continues to show a poor individual credit profile, with a deteriorating liquidity position dependent on the support of the central government to repay its debt.”

The bailout of Catalonia has generated much controversy in the market, but it’s worth saying that my comments in this article are applicable to most of the regions in Spain.

Despite the huge amount of communication efforts towards investors conducted by the different regions, all with ‘more GDP than Luxembourg and less debt than Japan,’ all considering themselves entitled to borrow indefinitely, the fact is that regions have no access to capital markets. And this shows how, all across Europe, countries and regions continue to believe that credit is free, investor money is unlimited and deserved without questions. And there is no unlimited capital.

The excellent presentation to investors that the Catalan government, theGeneralitat, made in 2011, very complete and detailed, shows some of the common problems that Spain and the regions face, and the reason why investor confidence and interest are still low.

. Estimates that were very optimistic: “Our revenues cannot fall.” “In 2012, with very conservative estimates, revenues will increase by 10.5 percent.”

. A debt maturity schedule that implies annual needs of €3bn added to the current financing needs of nearly €9bn. Added to that, the habit of financing current expenditures with long term debt and weakening future revenues, as Catalonia has received advances on transfers of more than €10bn until June 2012 – advances spent today that will not be collected later.

. The average maturity of the Catalan debt is six years. More than 71 percent of its debt matures between two and five years. I always tell my readers of the importance of not accumulating short-term maturities in good times as risks accelerate exponentially in times of recession. Accumulation of maturities well above marginal institutional demand is a problem throughout the European periphery coming from the misperception that “there is plenty of available demand” in the credit market for all, when the United States and major countries account for nearly all of the debt market capacity.

. Expectations of international funding sources were not met and have only been partially covered by local retail investors.

. A primary deficit – the gap between income and expenses excluding cost of debt – which has done nothing but grow.
. The estimates that Catalonia provides of fiscal deficit – the difference between tax revenues received from Spain and paid out – which, even if we assume it to be valid, does not cover the hole of growing expenses. The problem is, therefore, the accumulation of previous debt and expenses and that, in any case, investors perceive the fiscal deficit figure as exaggerated, because it assumes no cost for Catalonia of EU transfers or value-added taxes to other regions. In addition, from 2007 to 2011, state tax collection in Catalonia plunged by 35 percent, while subsidies and allowances paid by the central government to Catalonia increased.. The estimates given of the Catalan economy forget the CatalunyaCaixa andUnnim bailouts (€2.3bn), which are not accounted as a cost incurred by the region.

The real problem, however – the reason why investors do not rush to buy Catalan bonds that give a return of nearly 12 percent in 2016 – is that it has been proven since 2004 that any increase in revenues is engulfed by the regional administration and as such, the risk of default is higher than implied by companies and the region’s financier, the Spanish central government or Germany.

I heard this a few times from colleague credit investors: “a country that doubles its expenses in four years while its revenues fall, either has oil, or gold, or it does not have my money.”

The 10-year-Catalonia bond has a risk premium –spread– to Spain of almost 600 basis points and 1,100 basis points over Germany. This difference is not because of Catalonia’s dependency on Spain, or the alleged fiscal deficit. It is caused by the massive deterioration of expenditure and revenues, and the accumulation of debt maturities far beyond institutional demand. And it is important to say this, Catalonia is one of the regions with better credit structure. So, imagine the rest.

In fact, if investors perceived the massive spread between Spain and Catalan bonds as unjustified by the fundamentals, they would take the arbitrage opportunity and load up in Catalan bonds. Any credit arb hedge fund would buy them in size. But they don’t.

Now the blame game heats up. Spain blames Germany, Catalonia blames Madrid, Andalusia blames the banks, etc. Meanwhile, with on-going downward revisions of the gross domestic product and failures in budget implementation, governments continue to believe in the mantra of eternal credit ‘because we deserve it,’ sinking the ship with the crew and passengers inside.

In the Spanish regions and the central government, each euro received of additional income, either through taxes or transfers and structural funds since 2004, has become inexorably a euro and ten cents of debt. Looking at the Spanish regions, all the money received has been spent, but all of them have expanded primary deficit as well. In 1993, the regions managed 20.1 percent of the country’s budget, today they manage nearly 60 percent, yet all of them spend far beyond their means and income, regardless of their business and economic differences. Here in Spain there is no poor state. No Alabama. We are the United States where everyone is Washington or California.

This leads us to a comment made ​​by my esteemed Xavier Sala i Martin, Spanish-American economist at Columbia University, who says that the problem of access to debt markets for companies is mainly because they are Spanish, and that if Catalonia were an independent country “it would be considered one of the world’s healthiest economies and financial markets would rush to lend it money.”

In this post, I am joined by my fixed income colleague to give readers an idea of ​​how the debt markets work, because it is false that the main indicators to buy bonds are just debt to GDP and deficit, and I remember the comments from one of the British investors when the premier of the Generalitat made the presentation of its bonds in London. “If Catalonia was an independent country it would have the same access to credit as Andorra,” he said.

But even more surprising to me, as an investor in equities and bonds, is to read that “financial markets would rush to lend money” to an independent Catalonia. That is not true, as we have seen from country after country that declared themselves independent, from Yugoslavia to the former Soviet Union. Either they have abundant energy commodities or credit evaporates until they have gained years of experience as independent states. Estonia, the example for independence movements, only saw some modest short-term credit because Germany broke the treaty rules and recognized the country quickly. Even with that, credit was modest and GDP collapsed by 14 percent in 2009 and 9 percent in 2010.

When investing in bonds – debt to GDP, which is an indicator, inflated precisely by government spending and real estate bubbles – is irrelevant. What matters is the institutional credibility, the acceleration of expenditure against income, the quality and predictability of that income, the weight of public spending, monetary stability and the primary deficit or surplus.

We assume that Catalonia has institutional credibility, but:

. An independent Catalonia would be an economy that depends by 57 percent on Spain for its “exports.” In fact, since the trade balance with “non-Spanish” countries is negative (Catalonia imports more than it exports), Catalonia’s exposure to “Spain” would remain the same if not higher, particularly on the risk of the bonds of the alleged independent Catalonia. The cost of belonging to the EU, however, which Catalonia does not pay today as a region, would expand its deficit. Add to this that an independent Catalonia would have to absorb 18 percent of Spain’s national debt on the way out, and Catalonia would have debt to GDP higher than 100 percent. In a Spanish recession, the independent Catalonia bonds would also aggressively discount that same recession.

That’s why, despite the huge attractions and exceptional positive elements of Catalonia – dynamic, open economy – the investors perceive as the biggest problem the structure of a state that swallows any extra income received as it has done since 1996, making the solvency and liquidity ratios very tight, and this will continue to impact their access to credit. In fact, it is precisely the liquidity ratio, even assuming the previously mentioned tax deficits, which scares investors. Because the deterioration of income – with the deindustrialization of the region into more competitive and less bureaucratic countries, like Morocco – is accompanied by expenditures which can only rise, and do not take into account that the economy of Catalonia is very cyclical.

We end with a note on the “negative impact of being Spanish” to finance large companies. Sala i Martin says that ”the reason (for not having access to credit) has nothing to do with the sector in which they operate or the state of their economic health. The reason is simply that they are Spanish companies.”

First, we have seen debt issues, divestitures and hybrid access by several of these companies (Gas Natural, BBVA, Telefonica and other Spanish companies have issued €7.05bn in bonds with over 10 times demand in 2012), and all are trading at less risk of default than Spain or Catalonia. What we have said in this column many times is the real problem. The average debt of the Ibex is very high relative to its peers due to the orgy of strategic acquisitions at crazy multiples, but we have seen companies do an exercise that neither regions nor the central government have done. Prudence. Aggressively reducing costs, cutting unnecessary investments, cutting dividends, funding themselves long term since 2007 to avoid the “credit crunch.” That is, the opposite of what the governments have done. Companies have been preserving cash generation as an essential policy against an uncertain future, both in its core business as in its “growth markets.”

Surprisingly, Sala i Martin takes as an example of the ‘bad influence of the Spanish state’ three companies with almost monopolistic businesses in national services, telephone, natural gas, and construction-concessions. Great companies which have financed their international expansion with a lot of debt that they have been able to accumulate thanks to very high returns generated in Spain, which allowed them to enjoy better growth than their peers in the past, with full access to borrowing that could not have been there without the support of those domestic revenues and without a Spanish government that supported high risk cost strategic adventures.

No company is Spanish only for the good times and not for the bad times. These large companies, which enjoy a very comfortable monopolistic position in our country, do not suffer lack of credit “for being Spanish.” This is like saying that France Telecom, Veolia, EDP, Telecom Italia or Areva suffer lack of access to credit for being French, Portuguese or Italian rather than their strategic mistakes of expansion with debt.

Catalonia is wonderful and deserves all the good things that can happen there and more, and it is worth a bailout, or twenty, if needed. Spain has regions-nations – whatever you want to call them – with wonderful, huge possibilities. The problem was, and remains, having an unsustainable structure of administrations that absorb any extra income they get. Everyone has the right to claim independence for romantic reasons, or whatever, but we cannot say that the markets would be jumping to provide credit. In five years we would see Barcelona wanting to cut ties with Lleida or Madrid with Guadalajara, until the final implosion of a country with a level of public spending crowding out the real economy that looks like Argentina.

In Spain today, there is a golden opportunity to change, and to unite the country in the solution, not separate ourselves in the debacle. But let’s not blame the other. The solution is in our hands.

——

Here is Mr Sala i Martin’s original article and his reply to my post above

On fiscal deficits. here is the contrarian view to Catalonia’s government one.

Massive Subsidies Endanger Spanish Energy Reform

Global Economy, On the cover, Sin categoría, Spain,
This article was published in El Confidencial on August 27th 2012 

“If technologies have economic merit, no subsidy is necessary. If they don’t, no subsidy will provide it”. Jerry Taylor.
“Governmental subsidy systems promote inefficiency in production and efficiency in coercion”. M. Rothbard

This week the press has highlighted the discrepancies between two of Spain’s top ministers regarding the much delayed electricity sector reform. The shares of many of the companies involved have moved between +7% and -6% depending on the words of one minister or another.
Let me begin by saying that I do not find anything wrong when a company hires a consultant to defend its interests and that, when they do, they do it with the best. And I believe this controversy creates a great opportunity for the government to demonstrate that their decisions are not influenced by one lobby or another, but focused on the only thing that matters: that Spain cannot continue destroying its competitiveness with a massively subsidized and inefficient energy sector, where the electricity bill has soared by 40% while demand fell and where excessive renewable subsidies count for 39% of the costs (excluding energy component) of the system.
renewables II
To eliminate the tariff deficit accumulated until 2012; electricity bills will have to go up by an estimated 35%.
The Spanish tariff deficit is the difference between the real system costs and those recognized in the tariff, where the result is an IOU from the government that is financed in the balance sheet of the companies until it is settled. This tariff deficit is part of the infamous “Spanish private debt,” which is in no small part made of outstanding commitments from the government and funded by the balance sheet of private companies. It is also the consequence of a highly optimistic central planning of the system that incentivised overcapacity and massive new build that has made companies more indebted, with or without acquisitions, and less and less profitable.
renewables I
The tariff deficit myths are:
– “Companies make billions out of it” We must differentiate between accounted and real profits. We sometimes forget that companies account for the tariff deficit as a “receivable” so their profit and loss is not made of real cash. As such they generate no free cash flow and borrow more and more. Investments in Spain, from generation to distribution, generate less than 7% return on capital employed. However, companies are told by governments to undertake massive investments, but without legal certainty or acceptable returns. And there is always someone willing to build more for less.
–  “It is a temporary problem that goes away with the latest measures.” The latest government measures to reduce the costs of the system seem to look to collect from the efficient and cash generating businesses to cover inefficiency errors, but these measures do not solve a problem of subsidies and overcapacity, as they have been mainly applied on one-off costs, with a maximum impact of 2 billion euros, yet they do not take into account that in 2013 renewables subsidies will rise by another 2 billion to almost 9 billion a year in 2014 due to the plants that are coming on stream, bringing the tariff deficit up again.
–  “Renewables are unfairly demonized.” This is true, in part. The tariff deficit is not an issue created by renewable energy, but by the excessive cost of certain subsidies-particularly solar photovoltaic- where massive premiums were given to build 400 megawatts, ending with 3000 megawatts built – the consequences of an extremely generous aid system and a poorly controlled approval system, where all regional governments gave permits to plants regardless of the 400MW limit. But who pays that “tiny” 5 billion per annum mistake?. No one has anything against renewable energy. I love to read that Spain will build nearly 600 megawatts in solar PV without subsidies. The problem in Spain is the accumulated upfront cost of those subsidies, the fact that the excess cost is not paid but deferred in the tariff, and the claim from some operators to continue with the same scheme of subsidies and installations when all 2020 targets have been fully met. Many renewable companies in Spain have followed a model of builder-developer entering a country, and maximizing capacity to move on and grow in others. But there is no eternal growth in each market.
– “Coal generates no deficit because it is a social cost.” Other subsidies maintain inefficient capacity alive, like coal, which gets 600 million a year. If the rationale to keep coal is “social” it should not accumulate costs to the power bill, but be paid by the regional governments like healthcare or social services. The problem is the habit of subsidizing outdated technologies while building up the deficit that is generated by other new technologies.
–   “The renewable subsidies are offset by the fall in wholesale prices.” The cumulative net reduction in wholesale power prices between 2005 and 2011 was less than 9.2 billion euros, according APPA- while accumulated subsidies to renewable energies shot to 25 billion in the same period. In any case, talking about the benefits of renewable energy on price is almost comical when the power tariff to consumers has risen almost 40% in four years.
–   “The tariff deficit is created by the manipulation of wholesale price by large utilities”. It would be the most disastrous manipulation ever, when wholesale prices have remained exactly in line with the energy mix, below Italy’s, France’s and Britain’s, and in line with Germany.
renewables III
–  “Nuclear and hydro should pay the deficit.” They do, but it makes no sense to use cheap sources of energy to subsidize more expensive ones. And let’s not forget the string of regional and national taxes that traditional utilities suffer.
–   “If nuclear capacity is shut down, there would be no overcapacity.” Sure, and if EDF and France dismantle their 58 nuclear reactors, there would not be any overcapacity there either. And if Saudi Arabia closes Ghwar and Khursaniyah there is no oversupply of oil. We have to take advantage of technologies that are cheap while they work, and work well, because we need cheap, non-interruptible power. We forget that solar and wind are interruptible and cannot be installed exponentially because the land occupied by megawatt is finite. And the cost of adding a network connection is not properly taken into account.
renewables IV
What has led to this problem? 
An optimistic central planning based on demand expectations -2% pa growth- which were completely unjustified, an increase of generation capacity and infrastructure -25 000 megawatts of additional capacity in gas and 35,000 megawatts of renewable- and the joy of subsidies to every technology without control –renewables, coal subsidies, capacity payments, island grants…
As subsidies mounted over each other, capacity rose and demand collapsed, we find a power system in which the annual costs -guaranteed by the state- exceed revenues by c4 billion euros … and regulation has always been modified to tax the efficient to subsidize not only “nascent” technologies, but also “dying” ones.
The solution
The solution to this issue will have to be a compromise between the industry, the entire sector-traditional and renewable-, the State and the consumer, and cancel future subsidies in all technologies. From the existing deficit, part will have to be absorbed by the energy sector, the state-responsible for the optimistic planning- and consumers, who wildly applauded the green economy and coal-mining subsidies without knowing its costs.
The German model is simple: subsidies are paid 100% by retail consumers, so people know the true costs of green energy – and 70% strongly agree- while industries, many highly energy intensive as BASF or BMW, do not pay the cost of those subsidies. Therefore, competitiveness does not sink and the country doesn’t suffer from industries closing down due to excessive power costs. Additionally, unnecessary capacity is removed, while inefficient companies go bankrupt, as they should.
The American model is interesting. Investors are given tax incentives, not direct subsidies, for renewable projects. Thus, if there is no investor interest or projects are not economically viable, the system will be reducing unnecessary capacity by the law of supply and demand and, of course, if a company has to file for bankruptcy, it does.
Spain needs to be absolutely clear in its power sector regulation, guarantee legal certainty and avoid changing rules retroactively to solve past mistakes. But the consumer cannot support all costs if everything is subsidized and if there are no market mechanisms that enable cheaper and more efficient technologies to displace the expensive inefficient ones. Our excellent renewable companies are competing exceptionally well in the previously mentioned international models. So let’s not ask at home what we don’t need abroad.
Seizing revenues from the efficient to give it to the inefficient does not help. More importantly, a couple of years later the need for revenues will make the inefficient of today suffer as well.
I commented a few months ago in my article “the problem of fixing the price of power in government offices and not in markets” that Governments and some companies do not like to liberalize. They live very well asking and giving favours while the bill is either not paid or sent to the consumer. Amazingly, while governments see power costs soar, they are surprised to see that the country’s industries close down and that demand falls.
Mistakes in planning –always from excess, of course- have led to a power sector overcapacity that has many similarities to the housing bubble. The generation fleet overcapacity in Spain is enough to cover demand for years. Let us use this opportunity to end the current tariff deficit through market mechanisms.

The myth of “financial terrorism”

Banks, English, Global Economy, On the cover

This article was published in El Confidencial on August 20

“The phenomenon of economic ignorance is so widespread and its consequences so frightening that the objective to reduce that ignorance becomes a personal goal”, Israel Kirzner.

I spent eight years of my career in the area of ​​Investor Relations and despite suffering the Latin American crisis and others, I never saw the Spanish media insulting investors and spreading conspiracy theories of British attacks on Spain as I am seeing today.

In those days we didn’t approach everything from a sense of entitlement. We had to earn the interest of a market with limited capital. We learned especially from those who criticized us. Today, the global deleveraging process is making capital even more scarce, but our country seems to invoke a right to receive “unlimited capital” unconditionally.

Blaming the waiter for the bad food of the restaurant

Today, the national sport of blaming everyone except ourselves for our problems has reached delirious levels, peaking with articles in the mainstream media accusing the United Kingdom and the markets of “financial terrorism.” It is a handy scapegoat, to use a diffuse entity, the market, as a sort of “evil Dr No” behind our troubles.

This “market” is nothing but our savings, operators which are a secondary consequence of the real causes of a crisis created by ourselves, the states with reckless spending and their central banks. An economic policy based on monetary expansion that generates structural inflation, artificially low interest rates that create bubbles and masses of debt, which ultimately becomes unaffordable, leads to defaults and devaluations that impoverish the entire population.

These media commentators demand every day that the European Union prints, devalues, and raises taxes. However, afterwards the same journalists wonder why inflation rises, and food and raw materials rocket. And their conclusion is obvious: It is the fault of some “evil conspirator” in Westminster or ‘traders’ in London that envy Spain and want to make it fail. Easy. Of course, the hedge funds all together handle a fraction of the funds that the EU manages, but in our ostrich policy of “pretend and extend” the media repeats over and over that hedge funds attack us. Reminds me of my parents’ village, where every time there is a robbery, the people blame the tourists.

Now Spain needs investors like oxygen.

It’s funny that we complain of our unfair bond yields “when the UK is in much worse condition”, the “Perfidious Albion attacking us because of envy”, as the press said of Britain in the Franco times.

When Spain multiplied its debt in four years from €390bn to €734bn and all its regions increased their debt from €60bn to €140bn no one in Spain branded the reckless spending as ‘financial terrorism’, despite squandering money that the country didn’t have. Spending is always justified, and citizens presume good intentions behind it, while now the mainstream media and many politicians attribute dark evil motives and invent conspiracy theories to explain why investors do not trust the country and decide not to buy bonds. Not purchasing, by the way, is not attacking. The country cannot force anyone to “buy.”

In terms of sovereign debt management, Spain should learn from the UK

Let me clarify one thing first. No one is more critical of the UK economic policies than me, I live in London and have been vocal about the very erroneous policy of the previous government of excessive spending and believe the current QE and monetary expansion policy is no solution for recession. But the British ten-year bond is perceived as a solid investment, and there are fundamental reasons for it.

Let me summarize the ongoing debate all over Spain’s economic media. It says: “Spanish bond yields are unreasonably high and the UK’s are unreasonably low despite the fact that the UK is in worse financial shape because the London financial institutions and media attack and exploit our weakness”. Right?, No.

Let’s start with what creates mistrust in the Spanish debt, which needs to be tackled urgently:

-The concerns when accounts do not match. Spreads started to widen aggressively despite ECB interventions with the increase in government spend (the failed 35bn “Plan E” stimulus, the 125bn injected in the savings banks) and the well-known unpaid bills, debts not accounted, while deficit figures had to be revised twice.  If Spain does not give credible and consistent economic data, bond investors, by definition the most conservative and long-term driven, will simply avoid the risk. The UK on the other hand has been detailed and clear not only about swift cuts but stimulus and about budget limitations.

-Institutional credibility and credit responsibility. Everyone knows who to blame for the deficit in the UK, and there is one body and one chancellor who can act on it. There are no debates between parties of “who is less corrupt” than the other, and institutions and their responsibilities are clear and enforced rigorously. Another problem is lack of credit responsibility. In Spain, between savings banks and 17 regional communities with 17 decision centres, each with its vested right to default and be rescued, there is no real political responsibility for the consequences. Regions miss debt targets and then “rebel” against the state. How do they rebel? Not paying their suppliers.

–The perception that reforms are cosmetic. Spending cuts in Spain so far have been reductions in expected increases, not real cuts, while the UK has made very deep cuts. Therefore, ahead of uncertainty in the economy, Spain can only count on improving revenues to achieve its targets and that’s a huge risk.

–The acceleration of spending. In Spain spending has doubled while revenues stagnated. This acceleration is very relevant. What creates more distrust among investors is the evolution of dynamic solvency ratios (increased costs versus revenue growth), not static (debt / GDP) and also future refinancing needs over the global supply of debt. In the UK, for example, issues tend to be made with very long maturities, and always seeking to avoid saturation of supply. Spain has to refinance, between 2013 and 2015, 259 billion euro, almost the same amount as the UK, 320 billion, but with less than half of GDP and much lower revenues.

–The unhelpful messages on default and exit from the euro. If an opposition leader says “if Spain was out of the euro our risk premium would be 300 basis points,” a leader of a majority party says “debt must be declared odious and stop payments” and a minister says “the German banks also benefited from our bubble”, they are unconsciously highlighting in public the risk of default. And investors do read those statements.

Of course, the UK is a country that attracts capital, maintaining investor’s interests as the State’s primary policy, the economy is extremely flexible, and with 8.6% unemployment. The challenges in Spain remain in a regulation that makes investment and job creation extremely bureaucratic, onerous and slow, and an unusually restrictive and cautious approach to foreign investment.

To think that the UK bond yields are low only because the state devalues the currency and monetizes debt is another mistake.

If the panacea to lower bond yields is to print money and have an active central bank easing, Zimbabwe or Argentina would be the countries with the lowest bond yields of the world. Without institutional credibility and credit responsibility, legal certainty and a suitable investment environment, the impact of interventions are temporary and ultimately irrelevant.

The BoE has bought less than half of the debt issued by the UK between 2009 and 2010, the other half was bought by institutions and banks, including, surprise, surprise, a few big Spanish banks.

In Spain the ECB has injected over 400 billion euro to banks, used mainly to buy sovereign debt, more than the Gilt purchases of the Bank of England in 12 months. If the monetization of debt is the reason given by the media to explain low bond yields, Spain has seen a much larger EU-funded program of bond purchases –through its domestic banks- relative to its GDP and its refinancing needs.

Without institutional trust and credit responsibility that prevents default risk on Britain’s debt, the country’s yields would also soar despite BoE purchases.

Bond yields are a reflection of the secondary bond market, ie the investor appetite for the country’s debt. Nobody profits or attacks the country by not buying bonds.

I read that the Spanish government will make a diplomatic offensive to attract investors and I think it’s a wonderful idea.

Three ways to improve:

–Stop issuing short-term debt to finance long-term spending, it will take bond yields to stratospheric levels, with or without ECB purchases. It would be positive to see lengthening maturities and a national agreement to attempt the conversion of debt held by domestic entities-nearly 70% of total-to long-term debt.

–Attracting capital, as the City of London does. Issue debt to investors who can also have access to assets. One reason for the distrust of investors is because in Southern Europe they are allowed to buy debt but not companies or assets. A national regulation that encourages investment and stops trying to keep out foreign capital would be very productive.

-Enforce compliance and responsibility to those regions and banks with problems. Irrevocable, immediate and demonstrable. If investors see that the money is given out but not controlled, they will not invest.

–Strengthen laws to defend creditors and debt repayment. It is not worth changing the Constitution as last year and then a few months later deny of such agreement.

The problem of wasteful spend disguised as ‘real’ economy

I’m getting used to read in the mainstream media that useless investments, duplicate administrations and cronyism are not so bad because they “maintain GDP and employment” and, after all, unnecessary investments in infrastructure “at least are spent in something tangible –real”. Furthermore, these “wasteful activities also generate growth”. This belief is part of a monstrous mistake that began to take shape in the mid 90s when Spain started to see money pouring in from Europe. It had to be spent to get more afterwards. It’s the widespread belief that money is free and that the right side of the balance sheet does not matter or does not exist. “Public money belongs to no one”

This is not true because it assumes that the “money” spent is capital and not debt. If it was capital, I would partially agree. That is, if I’m rich and I spend a significant part of my salary in drinks it is my decision, but it does not have a direct negative impact on my finances. But when it is debt, bad economic decisions cost a lot. That is, if I’m poor and I have two mortgages and I spend a significant part of my salary in drinks I create a double negative effect, the cost of debt and the futility of my expense. The money squandered is not only wasted but it costs, because debt and interest have to be paid by a declining percentage of the profitable and productive part of the economy.

The popular perception in Spain is that if a bridge, a phantom airport or a ghost city that is not needed is built, at least there is something real and valuable. Like China but without its economic power and wealth. The idea that the economic use of those “things” is irrelevant just because some jobs were temporarily created, when in fact there is not only an asset, but an associated liability, and the cost must be covered with the productive returns of another activity or through taxes, or more debt. Therefore, unnecessary infrastructure is not only wasted borrowed money that does not create “real activity”, but it crowds out and eventually erodes the real productive activities, enlarging the debt balloon. The useless bridge-airport-city would only have zero cost to the economy if it were funded with surplus wealth or a donation. And Spain has neither one nor the other.

In summary, Spain must attract capital, learn from its more financially mature peers and forget to support GDP with hot air. No one is attacking Spain, if anything we attack ourselves by scaring investors. The day that the country learns that inflating GDP based on useless spending generates debt that cannot be paid with air; we will start to end our problems.