By Claus Vistesen, on May 18th, 2010
Edward does a nice job to sum up the flurry of the past week which saw the ongoing problems in Greece elevated to a full fledged systemic crisis in the Eurozone economy which, if it ultimately blows, will have ramifications far beyond the borders of the European continent. Being a firm believer in the notion of markets as conversation it is funny to see that although Lehman Brothers is dead and buried, people are talking an awful lot about it.
Consequently, the official figure for a Greek bailout has now risen to EUR120-130bn and with S&P downgrading Spain earlier this month it suggests that the ultimate cost of this mess may exceed the already dizzying number note above many times over. As the Economist neatly puts it this week;
THERE comes a moment in many debt crises when events spiral out of control. As panic sets in, bond yields lurch sickeningly upwards and fear spreads to shares and currencies. In September 2008 the failure of once-stellar Lehman Brothers almost brought down the world’s banking system. A decade earlier, Russia’s chaotic default on its sovereign debt rocked the credit markets, felling Long Term Capital Management, a hugely profitable American hedge fund. When the unthinkable suddenly becomes the inevitable, without pausing in the realm of the improbable, then you have contagion.
As the Economist goes on to argue events are indeed spiraling out of control, a statement with which I concur in full. One question then which, at the moment, may not seem particularly important is how we managed to get ourselves into this mess.
In my most recent working paper entitled Quantifying and Correcting Eurozone Imbalances – Fighting the Debt Snowball I try to provide an intial answer to this question. Well actually, I don’t set out to address this question specifically. But, I do think that if you want to understand why the Eurozone has ended up where it is today and why it is essentially threatened as an economic entity you need to take a long hard look at the issue of intra-Eurozone imbalances and why correcting them from within the Eurozone is almost impossible without some form of disruptive sovereign default in key member economies.
As an introduction, here is the abstract:
This paper quantifies and discusses the concept of Eurozone current account imbalances. Using panel data estimations, the analysis shows how the external positions of the Eurozone economies can be modelled as a function of divergences in unit labour costs. Specifically, the results indicate that the formation of EMU has exacerbated the extent to which even relatively small divergences in unit labour costs may materialize in large current account imbalances. These results are framed in the context of the idea of a debt snowball effect and why the idea of an internal devaluation as a tool to correct external imbalances is inconsistent with the current setup of the Eurozone.
So, do I bring anything new to the table in terms of the overall discourse on the Eurozone’s economic problems? Not really. The story I tell is pretty well known but I still see the main contribution of the paper as the attempt to give a concrete quantitative perspective on the effect of divergent inflation rates (in my case unit labour costs) in an economic setting where countries are grouped together with seperate control over fiscal policy and no sovereign monetary policy and exchange rate.
Crucially, I argue that the forces which have lead to the build-up of imbalances are joined at the hip with the same forces which make it almost impossible to correct from within the Eurozone. Specifically the idea of a debt snowball effect is a good way to show why it will be almost impossible for some economies to correct their external imbalances without an explosive evolution in government debt and since they need to correct external competitiveness issues in order to achieve economic growth, the whole thing turns into a vice and essentially a catch 22.
Please note that this is a first draft only and still subject to several re-reads and editing (especially the tables) before I send it off for hopeful approval somewhere. However, for now your comments are welcome both on the paper itself as well as the topic.
By Rok Spruk, on May 13th, 2010
The $140 billion rescue package to Greece is a milestone in the European Monetary Union. A lively debate on recent macroeconomic imbalances in the weakest economies of the Euroarea – Greece, Italy, Spain and Portugal – in the Eurozone has reopened the old debate on whether the Eurozone is an optimum currency areas (here, here, here and here). The idea of optimum currency areas was first proposed by Nobel-winning economist Robert Mundell. In general, if several countries form a currency union, they should have at least four common macroeconomic features as essential framework of the currency union. In this article, I’ll review the labor market criteria and fiscal adjustment criteria in the light of a recent imbalances in the Euroarea, and leave production diversification and export criteria for future discussion.
First, there should be a high degree of labor mobility between countries in the currency union. The basic idea behind the labor mobility criteria is that the lack of labor mobility triggers divergence of productivity growth rates and asymmetric adjustment of wages. If inter-country productivity divergence persists, there is an upward pressure on wages adjustment given the lack of exchange rate adjustment since the countries share a common monetary policy. The formation of the currency union in the United States was relatively straightforward given the fact that labor mobility between the states is very high. In Europe, the level of labor mobility is relatively low. The lack of labor mobility has a lot to do with labor market institutions in European countries. Workers from the European periphery can hardly move to Germany, Netherlands or Denmark as they do not speak the same language. The lack of inter-country mobility resulted in significant wage premiums and rise in rents since European labor markets share a pretty high degree of monopoly power since European workers can’t switch easily between labor market structure. The resulting outcome of the lack of labor market competition was a significant “union capture” of the labor market, leading to rigid wage determination and high market switching costs.
Paul Krugman recently argued (link) that the major problem behind the European Monetary Union is the lack of common fiscal policy. To a very large extent, the absence of common fiscal policy seriously affects the future prospects of the European Monetary Union. Common fiscal policy could easily absorb asymmetric shocks withing the Euroarea. However, instituting the policy could not alter the trade-off between fiscal autonomy and asymmetric shock intensity. In other words, the main problem of the Euroarea right now is the free-riding of Eurozone’s most problematic countries on a common monetary policy using disrectionary fiscal policy. Before the economic crisis, Spain had a budget deficit while, at the moment, the 2010 budget deficit forecast is more than 8 percent of the GDP. The estimate Greece’s balooning public debt in 2009 ranges from 110 to 115 percent, depending on the consensus forecast. If the EMU countries unified a fiscal policy, the countries would not have an incentive to free-ride on discretionary fiscal policy and further increase the stock of public debt. The major impediment on the recovery and long-term economic outlook of Eurozone countries is largely dependent on how these countries will reform the pension systems in the light of a growing old-age dependence and a near fiscal insolvency of the pay-as-you-go (PAYG) pension schemes. It will be impossible to reverse the aging population and its persistent pressure on an increasing public debt. The integration of fiscal policy would require a sizeable harmonization of taxes given high costs of coordination and sufficient incentives for moral hazard. Without the reversion of long-term public debt pressure from aging, discretionary spending and entitlements, countries such as Greece, Spain and Portugal would leave the Eurozone.
By Rok Spruk, on April 7th, 2010
The Economist published a fascinating overview (link) of the macroeconomic indicators in Europe’s most vulnerable economies in the current debt crisis (Portugal, Italy, Ireland, Greece, Spain).
By Claus Vistesen, on February 18th, 2010
GDP releases are, by nature, lagging indicators and thus do not say a whole lot on the current momentum in the economy. Moreover, the immediate attention span when it comes to the Eurozone remains, and rightly so, focused on the situation in Greece (and Spain) and what plan exactly that is to emerge from the busy meething schedules of Eurozone and EU finance ministers and heads of states. Yet, GDP remain the basic economic output figures we have and with the Q4 2009 GDP print we are able to put an interim conclusion [1] on an abysmal 2009, but more importantly also on a recovery which just do not seem to be materialising much to the chagrin, I am sure, of Eurozone policy makers (click for better viewing)
Color me smug but I, for one, am not surprised to see that France is all over this reading and basically it is thanks to France that the Eurozone is seeing growth at all. I would venture the claim that this is the beginning of a trend. In terms of the figures, the Eurozone (EU16) grew 0.1% from Q3 when the economy pulled out of recession by growing 0.4% qoq. The figure was primarily held down by continuing contractions in Greece and Spain (-0.8% and -0.1% respectively) as well as of course the stagnation in Germany where the growth rate was flat at 0% qoq after a strong showing in Q3. In Italy, the strong rebound in Q3 GDP at 0.6% qoq was somewhat given back in the form of a -0.2 contraction in Q4.
Year on year, Eurozone output fell by 2.1% with Germany, Greece, France, Spain, and Italy contracting 2.4%, 2.6%, 0.3%, 3.1 and 2.8% respectively.
The biggest losers with respect to national output remain Spain and Greece who, in volume terms over the quarters, have lost 4.8% and 2.4% respectively worth of GDP since the third quarter of 2008. Yet, the rest, save France, do not seem to be able to take up the slack for the these two hitherto sources of demand. The Economist pinpoints the order du jour quite adequately;
The main problem is a familiar one: consumers within the euro zone are not spending enough and the strong currency is making it hard to tap demand in the rest of the world. The best hope for a home-grown stimulus is Germany, where firms and consumers had practised thrift when the rest of the world indulged in a spending boom. Sadly Germany still relies too heavily on exports. Consumer spending and investment both fell in the fourth quarter and were it not for a boost from foreign trade, the German economy would have shrunk. This week Axel Weber, the head of Germany’s central bank, gave warning that cold weather could mean that GDP falls in the current quarter.
Other countries are tapped out. Spain was once a rich source of internal euro-area demand but its consumers are now weighed down by debts accumulated during a long housing boom. The unemployment rate is perilously close to 20% and its rigid jobs markets mean it is unlikely to come down soon. Bond-market pressures mean Spain’s government is having to withdraw some of its support to the economy sooner than it would like. The wonder is that Spain is not in a deeper funk. GDP fell by 3.1% in the year to the fourth quarter, not much worse than in Germany.
Basically, this is like a relay race where the change of baton has gone horribly wrong. Consequently, we were supposed to see a rebalancing of intra-Eurozone growth whereby the consumers of Spain, Greece etc were given a much needed break with those of particularly Germany taking over. This has not materialised and while France is still standing strong it is hardly enough to propel the entire Eurozone economy let alone its export dependent economies growing rapidly in number. I have argued several times that this exactly is now set to be an enduring feature of the Eurozone as an economic entity which of course makes it even harder for those intra-Eurozone imbalances to be resolved in an orderly manner.
Additionally, Eurozone growth or the lack of an even more catastrophic contraction in some member countries is still driven by large fiscal deficits. In this way, it does not take much economic intuition to see that if 2010 is set to be the year of the big fiscal scare (in a global context) the natural and inevitable retrenchment of fiscal deficit spending is going to reveal, in all certainty, just what the underlying growth momentum is. Personally, this is where I think the biggest negative surprise will come in terms of overall activity measured by national output.
More generally something, naturally, has to give here and according to the FT’s Martin Wolf, Germany needs to return the favor as he puts it, or more specifically; the Eurozone needs German consumers.
(…) Germany was able to offset extreme domestic demand weakness with robust external demand, from both inside and outside the eurozone. Indeed, as much as 70 per cent of the increase in Germany’s GDP between 1999 and 2007 was accounted for by the increase in its net exports.
Germany needs to return the favour. More precisely, the only way for eurozone countries to slash huge fiscal deficits, without their economies collapsing, is to engineer another private-sector credit bubble or a huge expansion in net exports. The former is undesirable. The latter requires improved competitiveness and buoyant external demand. At present, none of this is available. It is difficult to regain competitiveness when the euro is strong, partly because Germany is so competitive, and eurozone inflation also so low.
This argument is similar to one Mr. Wolf made recently on Japan and in the context of which he and I had a tête-à-tête on just what the possibilities are for Japan’s economy and its consumers to stage a recovery driven by domestic demand. My argument and beef with Mr Wolf is the same here. Thus, it is not because I think that Wolf is wrong and certainly not because I cannot see the fundamental need for Germany to attempt a rebalancing of its economy. However, the key question here is not what Germany needs to do, but whether it is feasible to expect Germany to pull forward the Eurozone through growth in domestic demand? I think it is not and I think you need to take a long hard look at the increasingly ageing German population and how this feeds into the ability of the economy to generate growth based on domestic demand.
Yet, as Martin Wolf adequately pointed out to me during our bataille on Japan that argument hardly brings anything to the table in terms of solution. I concur that it does not in the state that I present here. Yet, the consequence of the argument (and thus in some sense the solution) is very clear I think. If the Eurozone before the financial crisis had economies that were able, or who were allowed/pushed onto an unsustainable growth path where domestic demand/credit flourished it does not have these economies anymore (save perhaps France). It follows logically from this that while Germany (and Italy) was the main export dependent economy in the Eurozone before the financial crisis, the whole Eurozone is now effectively dependent on exports to grow. Notwithstanding the Economist’s point that this means the recent weakening of the Euro is actually a blessing, it also provides a very important perspective to the discourse on the global imbalances and how to unwind them.
Post script:
It is all about the Eurozone at the moment of course and not so much about the Q4 reading but more fundamentally about the Eurozone/EU itself in the wake of the growing economic crisis in Spain and most notably Greece. My good friend Edward Hugh is pretty much pushing forward the discourse at the moment (on Spain and in general) with his recent piece in La Vanguardia (in Spanish!, see also this) as well as his amusing yet important post on Chart Wars featuring as prominent a cast as the recent economics nobel laureate Paul Krugman and the Kingdom of Spain itself. Meanwhile, in a different media another good acquaintance of mine, Jonathan Tepper from Variant Perception, has an interview on the economic situation in Spain which is also much worth a look. Finally, I had a piece this week on the Guardian’s Comment is Free edifice which got a host of interesting comments.
So, enjoy reading!
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[1] – We don’t have a detailed break-up yet on country and Eurozone wide level.
By Rok Spruk, on February 17th, 2010
Paul Krugman has blogged an interesting analysis of the anatomy of the recent economic crisis in Europe (link).
Europe’s difficult macroeconomic situation in the aftermath of the financial and economic crisis has exacerbated rising fiscal deficits and public debt alongside strong deflationary pressures. These pressures were triggered by the highly negative output gap – the difference between the economy’s potential output and the real output. In fact, a brief observation of the output gap estimates (link) shows that the sick men of Europe (Portugal, Greece, Spain, Italy, Slovenia) are likely to face negative output gaps. In 2010, Spain is likely to reach -2.12 percent output gap. Slovenia, Italy and Greece will also face a negative output gap. The negative output gap triggered strong deflationary pressures since the nominal aggregate demand is insufficient, causing a decreasing price level.
Before the financial and economic crisis of 2008/2009 evolved, Europe’s peripheral economies faced strong asset price bubble. As real estate prices were soaring, these economies attracted significant capital inflows which lead to inflationary pressures. Before the crisis, the inflationary dynamics in the peripheral countries of the Eurozone were strong. In Greece, Spain and Slovenia, consumer prices increased by more than 3 percent on the annual basis. The asset bubble was further spread by low interest rates. The asset price inflation in these countries was very high. In Slovenia, five-year asset prices increased by 500 percent (see: IMF, International Financial Statistics). As the increase in asset prices widened, Europe’s sick men were faced with rising current account deficit.
In 2007, Spain’s current account deficit amounted to more than 10 percent of the GDP. In such circumstances, a clever monetary policymaker would push up interest rates. As interest rates were at historic lows during the pre-crisis period, the real cure was on behalf of the fiscal policy. Before the crisis, Spain’s fiscal picture was very well indeed. From 2004 to 2007, Spain was running a fiscal surplus which reached the level of 2 percent of the GDP in 2006 and 2007. However, massive capital inflows were not sterilized by raising interest rates which further inflated the real estate bubble and overheating of Spain’s economy.
Independent fiscal policies and a common monetary policy – which is an economic model of the EMU – cause asymmetric shocks. During the years of high growth, these shocks are mostly neglected. However, during the crisis these shocks might cause a serious trouble in the macroeconomic adjustment. Greece, which recently declared a worrisome possibility of debt default, is a typical case of what happens when asymmetric shocks persist.
As Greece, Spain, Italy, Portugal and Slovenia now face high fiscal deficits and poor economic growth, these countries will likely face years of deflationary pressures and high unemployment. The fiscal policymakers already exhausted the ability of governments to boost spending. Further growth of government spending is impossible unless European countries want the Greek debt episode to evolve in a domino effect throughout the Eurozone. The ECB will sooner or later this year raise the baseline interest rates to avoid the inflationary swings in Germany, Austria, Netherlands and other countries with current account surplus.
The macroeconomic outlook for the Eurozone is backlashed by the debt crisis in Mediterranean countries. An economic recovery may include indepedent monetary policies to adjust interest rates and prevent another asset bubble episode as well as to target current account balance. However, European countries will have to rethink the role of indepedent and discretionary fiscal policies pursued by the sick men of the Eurozone.
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By Claus Vistesen, on December 30th, 2009
Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.
Churchill 1942
Summary
- The extent, so far, of the internal devaluation process depends on the time period used for analysis. Using Q3-2007 as the beginning of the economic crisis suggest that Greece and Spain have not corrected relative to Germany as a benchmark. However, if we look entirely at the world in a post-Lehmann context the picture is different with Greece and Spain having observed excess deflation relative to Germany to the tune of -1.7% and -4.5% respectively for unit labour costs and -5.4% and -1.7% respectively for the PPI.
- The correction observed in the context of unit labour costs appears technical as German unit labour costs have increased sharply since Q4-2008 due to a large reduction in working hours and an increase in short time work. In comparison, the relative correction in the PPI looks more solid.
- The internal devaluation has not yet trickled down into the overall price level represented by the CPI. Both using the period Q3-07 to Q3-09 and Q4-08 to Q3-09 as the relevant time horizon reveals that there has been no meaningful internal devaluation in Greece and Spain measured on the CPI.
- While the analysis presented here may go some way to quantify the intra-Eurozone imbalances and the course of the internal devaluation so far it is impossible to say precisely how far (and for how long) Greece and Spain (and indeed Latvia, Hungary etc) have to go here. More importantly, it is impossible to say exactly which measures that must be taken albeit that they have to be severe in the context of reigning in public spending and, ultimately, the public debt and ongoing deficit. Likewise, it is difficult to quantity just how high unemployment should drift and for how long it should stay there in order to grind down past excess.
As 2009 is fast approaching an end it is worth asking whether this also means an end to the financial and economic crisis. Even if 2009 will be a year thoroughly marked by a global recession it could still seem as if the worst is behind us. Most of the advanced world swung into positive growth rates in H02 2009, risky assets have rallied, volatility has declined to pre-crisis levels, and interest rates and fiscal stimulus have been adeptly deployed to avert catastrophe. However and precisely because the last part has been a crucial prerequisite for the first three and as policy makers are now adamant that emergency measures must be scaled back or abandoned either because of necessity or a balanced assessment, it appears as if Churchill’s well known paraphrase is an adequate portrait of the situation at hand. In this way, what is really left in the way of global growth once we subtract the boost from fiscal and monetary stimuli and what is the underlying trend growth absent the crutches of extraordinary policy measures?
This question is likely to be a key theme for 2010.
Nowhere is this more relevant than in Greece and Spain who, together with Eastern Europe, have slowly but decisively taken center stage as focal points of the economic crisis. With this change of focus a whole new set of issues have emerged in the context of just how efficiently (or not) the institutional setup of the Eurozone and EU will transmit and indeed endure the crisis.
I won’t go into detail on this here mainly because I would simply be playing second fiddle to what Edward has already said again (and again) in the context of his ongoing analysis of the Spanish and Greek economy to which I can subscribe without reservations. It will consequently suffice to reiterate two overall points in the context of Spain and Greece.
Firstly, the main source of these economies’ difficulties, while certainly very much present in the here and now, essentially has its roots in population ageing and a period, too long, of below replacement fertility that has now put their respective economic models to the wall. It is interesting here to note that while it is intuitively easy to explain why economic growth and dynamism should decline as economies experience ongoing population ageing, it is through the interaction with public spending and debt that the issue becomes a real problem for the modern market economy. Contributions are plentiful here but Deckle (2002) on Japan and Börsh-Supan and Wilke (2004) on Germany are good examples of how simple forward extrapolation of public debt in light of unchanged social and institutional structures clearly indicate how something, at some point, has to give. Whether Spain and Greece have indeed reached an inflection point is difficult to say for certain. However, as Edward rightfully has pointed out, this situation is first and foremost about a broken economic model than merely a question of staging a correction on the back of a crisis.
Secondly and although it could seem as stating the obvious, Greece and Spain are members of the Eurozone and while this has certainly engendered positive economic (side)effects, it has also allowed them to build up massive external imbalances without no clear mechanism of correction. Thus, as the demographic situation has simply continued to deteriorate so have these two economies reached the end of the road. In this way, being a member of the EU and the Eurozone clearly means that you may expect to enjoy protection if faced with difficulty, but it also means that the measures needed to regain lost competitiveness and economic dynamism can be very tough. Specially and while no-one with but the faintest of economic intuition would disagree that the growth path taken by Greece and Spain during the past decade should have led to intense pressure on their domestic currencies, it is exactly this which the institutional setup of the Eurozone has prevented. I have long been critical of this exact mismatch between the potential to build internal imbalances and the inability to correct them, but we are beyond this discussion I think. Especially, we can safely assume that the economists roaming the corridors in Frankfurt and Brussels are not stupid and that they have known full well what kind of path Greece and Spain (and Italy) invariably were moving towards.
Essentially, what Greece and Spain now face (alongside Ireland, Hungary, Latvia etc) is an internal devaluation which has to serve as the only means of adjustment since, as is evidently clearly, the nominal exchange rate is bound by the gravitional laws of the Eurozone. Now, I am not making an argument about the virtues of devaluation versus a domestic structural correction since it will often be a combination of the two (i.e. as in Hungary). What I am trying to emphasize is simply two things; firstly, the danger of imposing internal devaluations in economies whose demographic structure resemble that of Greece and Spain and secondly, whether it can actually be done within the confines of the current political and economic setup in the Eurozone.
On the last question I personally adamant that it has to since failure would mean the end of the Eurozone as we know it but this is also why I am quite worried, and intrigued as an economist, on the first question. Specifically and as Edward and myself have been at pains to point out (and to test and verify) this medicine while certainly viable in theory has three principal problems. Firstly, it takes time and may thus amount to too little too late in the face of an immediate threat of economic collapse. Secondly, an ageing population spiralling into deflation may have great problems escaping its claws, and thirdly, because of the pains associated with the medicine the patient may be very reluctant to acccept the treatment. Especially, the last point is very important to note from a policy perspective and was made abundantly clear recently in the context of Latvia where The Constitutional Court ruled that the very reforms demanded in the context of the IMF program to reign in costs through cutting pensions would violate the Latvian constitution. And as Edward further points out, the situation is the same in Hungary where voters recently (and quite understandably one could say) decided to reject a set of health charges that were exactly proposed as part of a reform program designed to reign in public spending. We are about to see just how willing Spain and Greece are in the context of accepting the austerity measures that must come, but similar dynamics are not alltogther impossible.
Consequently, and while I agree with Edward as he turns his focus on the inadequacy of the political system in Spain and Greece to realize the severity of the mess; it remains an inbuilt feature of imposition of internal devaluations through sharp expenditure cuts that they are very difficult to sustain given the political dynamics. This is then a question of a careful calibration of the stick and carrot where the former especially in the initial phases of an internal devaluation process is wielded with great force.
Internal Devaluation, What is it All About Then?
If the technical aspects of an internal devaluation have so far escaped you it is actually quite simple. Absent, a nominal exchange depreciation to help restore competitiveness the entire burden of adjustment must now fall on the real effective exchange rate and thus the domestic economy. The only way that this can happen is through price deflation and, going back to my point above, the only way this can meaningfully happen is through a sharp correction in public expenditure accompanied with painful reforms to dismantle or change some of the most expensive social security schemes. This is naturally all the more presicient and controversial as both Spain and Greece are stoking large budget deficits to help combat the very crisis from which they must now try to escape. Positive productivity shocks here à la Solow’s mana that fall from the sky may indeed help , but in the middle of the worst crisis since the 1930s it is difficult to see where this should come from. Moreover, with a rapidly ageing population it becomes more difficult to foster such productivity shocks through what we could call “endogenous” growth (or so at least I would argue).
With this point in mind, let us look at some empirical evidence for the process of internal devaluation so far.
In order to establish some kind of reference point for analysis I am going to compare Greece and Spain with Germany. This is not because Germany, in any sense of the words, stands out as an example of solid economic performance as the burden of demographics is clearly visible here too. However, for Spain and Greece to recover they must claw back some of the lost ground on competitiveness relative to Germany. This highlights another and very important part of the internal devaluation process. Spain, Greece etc will not only be fighting their own imbalances; they will also fight a moving target since they may not be the only economies who face deflation or near zero inflation as we move forward.
Beginning with the simple overall inflation rate measured by the CPI we see that the level of prices (100=2005) has risen much faster in Greece and Spain than in Germany. Compared to 2005 the price level in Germany stood 7.1% higher in Q3-09 which compares to corresponding figures for Spain and Greece at 11.5% and 10.3% respectively. However, this does not tell the whole story about the build up of imbalances since the inception of the Eurozone. Consequently, since Q1-00 the price index has increased some 15% in Germany whereas it has increased a healthy 29.3% and 27.2% in Greece and Spain respectively.
 
Turning to the bottom chart which plots the annual quarterly inflation rate a similar picture reveals itself with a high degree of cross-correlation between the yearly CPI prints, but where the German inflation rate has been persistently lower than that of Greece and Spain. The average inflation rate in Germany from Q1-1997 to Q3-2009 was 1.6% and 3.5% and 2.8% for Greece and Spain respectively. It is important to understand the cumulative nature of the consistent divergence in inflation rate since it is exactly this feature that contributes to the build-up of the external debt imbalance. From 2000-2009(Q3) the accumulated annual increases in the CPI was 57% for Germany versus 109.4% and 104% for Greece and Spain respectively. Assuming that Germany remains on its historic path of annual CPI readings (which is highly dubious in fact), this gives a very clear image of the kind of correction Greece and Spain needs to undertake in order to move the net external borrowing back on a sustainable path which in this case means that these two economies are now effectively dependent on exports to grow.
If the divergence in Eurozone CPI represents a general measure of the built-up of external imbalances and the need for an internal devaluation through price deflation two other measures provide more direct proxies. These two are unit labour costs and the producer price index (PPI) which are both key determinants for the competitiveness of domestic companies on international markets. Intuitively one would expect unit labour costs as an important input cost to drive the PPI which measures the price companies receive for their output. Yet this is only going to be the case if the companies in question have market power on the domestic market. Consequently, if you regress the quarterly change of the PPI on the quarterly change on unit labour costs you get a negative coefficient in Germany and a positive coefficient in Greece and Spain (highly significant for Spain and not so for Greece). This is exactly what one would expect since German companies are highly exposed to the external environment (where they enjoy no market power) and thus has to suffer any increase in the cost of labour input through a decline in their output price. Conversely in Spain, the connection between an increase in unit labour costs and the PPI is strongly positive which suggest that Spanish companies has enjoyed considerable market power due to a vibrant domestic economy [1]. It is exactly this that must now change.
 
If we look at unit labour costs and abstract for a minute from the increase in German unit labour costs from Q2-08 to Q2-09 in Germany [2], both Greece and Spain have seen their labour cost surge relative to Germany since the inception of the Eurozone. Since Q1-00 the accumulated change in the German index has consequently been 15.2% which compares to 97.7% and 105.6% for Greece and Spain respectively. More demonstratively however is the fact that since the second half of 2006 the labour cost index of Spain and Greece have been above the Germany relative to 2005 which is the base year. Consider consequently that the labour cost index in Greece and Spain was 13.3% and 16.4% below the German ditto in Q1-2000 and now (even with the recent surge in German labour costs), the Greek and Spanish labour cost index stands 7.2% and 5.2% above the German index.
Turning finally to producer prices the similarity between the three countries in question are somewhat restored which goes some way to support the notion of persistent lower labour cost growth relative to fellow Eurozone members as the main source of the build-up of Germany’s “competitive advantage” and in some way the build-up of intra Eurozone imbalances.
 
Essentially, and while definitely noticeable the divergence between Greece/Spain and Germany on the PPI is less wide than in the context of unit labour costs and the CPI. Consequently, and if we look at the index, the divergence which saw Spanish and Greek producer prices increase beyond those of Germany came very late in the end of 2007. Moreover, the correction so far has been quite sharp in both Greece and Spain relative to Germany with the PPI falling 14.8%, 5.7% and 2.8% (yoy) in Q2-09 and Q3-09 in Greece, Spain and Germany. The accumulated increase however, in the PPI, from 2000 to Q3-09 has been 85% in Germany and 136% and 101.7% in the Greece and Spain respectively.
If the numbers above indicates the extent to which intra Eurozone imbalances have manifested themselves in divergent price levels and rates of inflation, the concept of internal devaluation concerns the net effect on the prices in Greece and Spain relative to, in this case, Germany. On this account, and if we put the beginning of the financial crisis as Q3-07 (i.e. when BNP Paribas posted sub-prime related losses) the butcher’s bill look as follows.
From Q3-07 to Q3-09 and in relation to the CPI the average quarterly inflation rate in Greece in Spain has been 1% and 0.66% higher than in Germany. The accumulated excess inflation rate over the German inflation has been 8% in Greece and 5.29% in Spain. Only in the context of Spain do we observe some indication of the initial phases of a relative internal devaluation as Spain has seen an accumulated inflation rate lower than that of Germany to the tune of 1.28%.
Turning to unit labour costs the picture changes quite a lot depending on the time horizon. Using the same period as above, the average quarterly excess increase in unit labour costs of Greece and Spain relative to Germany has been 1.75% and 0.3% in Greece and Spain respectively. The accumulated increase in unit labour costs has consequently been a full 14% and 2.8% higher in Greece and Spain relative to Germany. However, if we focus the attention on the period from Q4-08 to Q2-09 and due to the fact that labour hours in Germany have gone down further than in Greece and Spain, labour costs have corrected sharply in Greece and Spain relative to in Germany to the tune of -5.2% and 13.7% (accumulated) and -1.7% and -4.6% respectively. The fact that German producers have so far cut down sharply on labour hours could mean that Germany should claw back some of the lost ground vis-a-vis Greece and Spain if and when these two economies follow suit.
Finally, in relation to producer prices the picture is very much the same as in the context of unit labour costs with the notable qualifier that the relative excess deflation observed in Greece and Spain from Q4-08 and onwards is likely to be less “technical” and thus more “real” than in the case of labour costs. In this way the period Q3-07 to Q3-09 saw the excess rate of produce price inflation reach 14.8% and 6.8% (accumulated) and 1.8% and 0.8% (quarterly average) in Greece and Spain respectively. However, if we focus the attention on Q4-08 to Q3-09 the picture reverses and reveals a substantial degree of excess deflation over the Germany PPI in Greece and Spain to the tune of 16.1% and 5.2% (accumulated) and 5.4% and 1.7% (quarterly average) for Greece and Spain respectively.
The End of the Beginning
As we exit 2009 it is quite unlikely that we will also be able to leave behind the effects of the economic and financial crisis and this is not about me being persistently negative or even a perma-bear. Things have definitely improve and much of this improvement owes itself to rapid, bold, and efficient policy measures. However, some economies are in a tighter spot than others and this most decisively goes for Spain and Greece who now have to correct to the fundamentals of their economies with rapidly ageing populations.
As this correction largely has to come in the form of an internal devaluation the following conclusions are possible going into 2010.
- The extent, so far, of the internal devaluation process depends on the time period used for analysis. Using Q3-2007 as the beginning of the economic crisis suggest that Greece and Spain have not corrected relative to Germany as a benchmark. However, if we look entirely at the worldin a post-Lehmann context the picture is different with Greece and Spain having observed excess deflation relative to Germany to the tune of -1.7% and -4.5% respectively for unit labour costs and -5.4% and -1.7% respectively for the PPI.
- The correction observed in the context of unit labour costs appears technical as German unit labour costs have increased sharply since Q4-2008 due to a large reduction in working hours and an increase in short time work. In comparison, the relative correction in the PPI looks more solid.
- The internal devaluation has not yet trickled down into the overall price level represented by the CPI. Both using the period Q3-07 to Q3-09 and Q4-08 to Q3-09 as the relevant time horizon reveals that there has been no meaningful internal devaluation in Greece and Spain measured on the CPI.
- While the analysis presented here may go some way to quantify the intra-Eurozone imbalances and the course of the internal devaluation so far it is impossible to say precisely how far (and for how long) Greece and Spain (and indeed Latvia, Hungary etc) have to go here. More importantly, it is impossible to say exactly which measures that must be taken albeit that they have to be severe in the context of reigning in public spending and, ultimately, the public debt and ongoing deficit. Likewise, it is difficult to quantity just how high unemployment should drift and for how long it should stay there in order to grind down past excess.
In this sense, 2009 will not go down as the end in any sense of the word, but more likely as the end of the beginning.
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[1] – Naturally, this argument assumes non-sticky prices and thus a 1-to-1 relationship in time between a change in input costs and output prices of companies. Since contractual arrangements are likely to make both sticky in the short run and likely with divergent time paths too, the quantitative results are not robust. The results for Germany are significant at 10% whereas those for Spain are significant at 1%. Mail me for the estimated equations if you really want to see the results.
[2] – The index rose 7.8% over the course of the year ending Q2-2009 which is way above 3 standard deviations of the “normal” annual change in the index from 1997 to 2009. The explanation is really quite simple and relates to the fact that German manufactures (in particular) has sharply cut overtime work and short time work has been rapidly extended (see e.g. this from Q2-09) which is obviously not the case in Greece and Spain. The fact that German producers have so far cut down sharply on labour hours means that Germany should claw back some of the lost ground vis-a-vis Greece and Spain if and when these two economies follow suit.
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By Claus Vistesen, on December 15th, 2009
If Friday was the day Macro Man had to pay for a wet evening in the company of alcoholic beverages, it was my turn yesterday as I spent the day trying to recover from a night where the amount of alcohol consumed had been beyond excessive. Thus, as I woke up, in agony, some time in the early Sunday afternoon feeling like the bloke below, I was initially filled with self-pity which gradually gave way to the realization that I had it coming [1].
The idea of hangover as repayment is not, as it turns out, an entirely useless allegory in the context of the themes that dominate the discourse on global markets and the economy moving into 2010.
The Eurozone’s Cracking Periphery
Last week we consequently saw the issue of Greek sovereign debt race to the forefront of the agenda with Fitch handing the Greek government an early ill-wanted Christmas present in the form of a downgrade from A- to BBB+ which saw yields rise significantly as well as it brought all kinds of nasty (but important) questions in relation to the Eurosystem/ECB. Firstly, it essentially raised the question of who exactly is going to pay for Greece should push come to shove and secondly; it raised a more technical question of eligible collateral at the ECB and whether the downgrade could, in the event it was followed by the other rating agencies, mean that Greek government bonds would loose their formal standing as eligible collateral at the ECB.
(quote: Bloomberg)
Greek bonds plunged to their lowest in seven months on Dec. 9 and stocks slumped after Fitch Ratings cut Greece one step to BBB+, saying Papandreou’s two-month-old government isn’t doing enough to tame a deficit of 12.7 percent of output, the highest in the European Union. A day earlier, Standard & Poor’s put its A- rating on watch for downgrade.
The yield on Greece’s 2-year bond has surged 127 basis points to 3.15 percent this week, driving it above Turkey’s for the first time.
Edward has already discussed the significance of this Greek tragedy extensively and I really encourage you to carefully read his posts since I can say with the utmost objectivity that they offer the best current round-up of the flurry. Especially, the link between the ECB’s decision to withdraw enhanced credit support and the widening spreads in an intra-Eurozone context is absolutely crucial to understand in this case. The following is then a key point;
Well, using ECB facilities made sense for Greek banks for a number of reasons. In the first place, ECB funding is relatively cheaper for Greek banks than for their European peers since the ECB makes no adjustment to the rates charged for the perceived higher risk of the Greek banks. As Goldman Sachs point out a Greek bank operating in Greece pays the same price as a French bank in France, even though the French bank operates in a lower risk environment and should, in theory, be able to finance at lower rates in the market. But this is what enhanced liquidity support is all about, if only those responsible for the financial and economic administration of Greece understood the situation.
Secondly, the current spreads on Greek government bonds (around 200 base points over German 10 year equivalents) offer Greek banks an exceptional arbitrage opportunity, since by taking advantage of the uniform ECB liquidity rate Greek banks can buy higher Greek government bonds with a much higher yield than the government bonds which their French or German counterparts buy. Regardless of the risk implied through by the Greek CDS spread, Greek government bonds carry a zero risk weighting when calculating riskweighted assets for capital purposes. So for Greek banks this arbitrage carries no capital impact whatsoever. That is to say the Greek banks have been doing very nicely indeed out of the Greek sovereign embarassment, thank you very much. Hence it is not difficult to understand the ECB’s growing sense of outrage with the situation.
(…)
So to be absolutely clear, the Greek banks have been making money from arbitrage on ECB exceptional liquidity funding and in the proces financing the Greek government to carry out spending programmes while at the same time basically hoodwinking the European Commission about what it was they were actually up to. That is to say, the ECB has been effectively paying to lead the EU Commission straight down the garden path.
Needless to say, the ECB is not stupid and even if I, and others, have had hard time showing the direct link between ECB financing and government deficit spending, the situation described above is another matter. Yet, and for all the outrage the ECB and the commission must feel towards Greece (and perhaps Spain and Italy) the obvious problem is naturally what will happen to government yields in the Eurozone once Enhanced Credit Support is wound down.
Comments made last week by ECB Executive Board member Gertrude Tumpel-Gugerell suggest that while the ECB is indeed ready to play hard ball when it comes to normalization, it also looks with worry at the prospects of sharply rising bond yields going into 2010. It would then seem that normalization of monetary policy without a subsequent normalization of fiscal policies that would take the latter on to a more sustainable path entails huge risks for government finances. Moreover, and as Edward has already eloquently detailed, the ECB will not simply sit back and play ball through the continuation of liquidity provisions. And so, we end up with the overall problem with the Eurozone that one set of policy tools for a lot of diverse economies simply do not work and although the ECB may very well “agree”, they are not able nor willing to implement special policies for Spain or Greece.
Thus and in my opinion it is, by now, really a question of whether the commission/EU has the needed force and will to force upon Spain and Greece what would effectively be extreme harsh policies in terms of fiscal austerity. Such drastic prospects handed to SSpain and Greece by part of their very own brethern could only work if they also came with some form of guarantee from Germany and France that they would help with “help” here being a very clear commitment to . What you need to understand here is then that if the for example Greece and Spain were forced (committed) to move just within the boundaries of the growth and stability pact that stipulates a running fiscal deficit of no more than 3% of GDP, the subsequent deflationary impact would be massive and destructive; and while this may indeed be the inevitable route we much travel here it would be best, I think, realizing that this is exactly the case in a transparent fashion. So far though, both in Spain/Greece and the EU itself the recovery is “on track” and the longer we continue to believe this to be the case the harder it will to reverse. In line with the theme cast above, rising bond yields in 2010 may prove a timely wakeup call.
And in Japan …
On the back of the BOJ’s emergency meeting which effectively re-instigated QE with the promise to provide funding to commercial banks and where the BOJ was also, more or less, arm-wrestled by the MOF into committing to buy additional government debt notes, it seems that the mounting debt is beginning to worry parts of the new government. Consequently, Japanese Finance Minister Hirohisa Fujii was quoted last week of saying that government should “cap” bond sales next year at 44 trillion yen ($495 billion);
(Quote Bloomberg)
Japanese Finance Minister Hirohisa Fujii said the government must cap bond sales at 44 trillion yen ($495 billion) next year, in contrast with Prime Minister Yukio Hatoyama, who indicated he is prepared to abandon the pledge.
“Such a figure doesn’t need to be seen as a big problem for the Cabinet,” Fujii said at a news conference in Tokyo today. “We have to do it,” he said of the bond limit, which was the amount that the previous government budgeted for the current fiscal year ending in March 2010.
Naturally and with some knowledge of the general government debt situation in Japan which will at some point result in a prolonged hangover in the form a debt restructuring, one finds it hard to see this talk of a cap as nothing more but a proverbial drop of water in the ocean. However, it does signify that Mr. Fujii is tuned in to the likelihood that governments will struggle to maintain the fiscal tap open throughout 2010 even if you, in the case of Japan, is likely to be shouldered by a BOJ that stands ready to print the JPYs necessary to soak up large parts of the nominal supply. The point here is simply that Japan won’t naturally be immune to a general tendency in which governments will stand to face an increase in their financing costs in 2010.
The 2010 Debt Hangover
Given my emphasis above, it should be no surprise that I agree, at least in part, with Morgan Stanley’s Joachim Fels, Manoj Pradhan and Spyros Andreopoulos who recently rolled out the banks’ 2010 themes of which the main points are posted over at the GEF. Especially, I like the idea that as exit from monetary QE measures will not be synchronous with the scaling back of fiscal deficit spending, bond yields (especially in key economies) are likely to react as they are no longer supported by the bid from central bank funded liquidity be it from direct or indirect demand. This is interesting since if the former is a prerequisite for the latter we are likely to observe a battle (like the one currently observed in the Eurozone) in which policy makers will be prone to pushing central bankers into supporting deficit spending through outright government bond purchases or other liquidity measures.
Morgan Stanley for their part focuses on the likelihood that QE exit strategies will exactly be halted in their tracks in this context, something which there is ample precedent for in e.g. Japan.
(…) markets are likely to increasingly worry about longer-term fiscal sustainability, and rightly so. Importantly, the issue is not really about potential sovereign defaults in advanced economies. These are extremely unlikely, for a simple reason: most of the government debt outstanding in advanced economies is in domestic currency, and in the (unlikely) case that governments cannot fund debt service payments through new debt issuance, tax increases or asset sales, they can instruct their central bank to print whatever is needed (call it quantitative easing). Thus, in the last analysis, sovereign risk translates into inflation risk rather than outright default risk. We expect markets to increasingly focus on these risks in the year ahead, pushing inflation premia and thus bond yields significantly higher. Put differently, the next crisis is likely to be a crisis of confidence in governments’ and central banks’ ability to shoulder the rising public sector debt burden without creating inflation.
I agree that this would definitely imply an increase in the focus on government finances and most definitely provide a push to bond yields although I could easily imagine a situation in which bond yields of key economies were to rise regardless of the bid from central banks. Moreover, I have another rather large qualifier here. Consequently, and while I can see this kind of dynamics taking place in the UK, the US and especially in Japan (at least potentially), the Eurozone is an entirely different case. In fact, when MS notes that “they can instruct their central bank to print whatever is needed (call it quantitative easing)”, this categorically does not apply to the Eurozone where the ECB has pretty much made it clear that in terms of providing some form of “special” support to some economies this is not going to happen.
So what happens then? Well, we will see won’t we. One thing is for sure; just as I spent Sunday regretting decisions the night before, so will some economies likely face equal regrets in 2010.
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[1] – Pictures taken from http://im.rediff.com and http://abhishekkatiyar.files.wordpress.com
By Claus Vistesen, on October 16th, 2009
Who does not like a good argument? I for one do, especially when it comes to economics. A lot of water has already gone under the bridge relative to the note published a couple of weeks back by VariantPerception on the Spanish banking sector which provided a timely and, in my opinion, accurate analysis of the issues facing the Spanish banking and financial system as a function of the dire macroeconomic situation Spain finds itself with skyrocketing unemployment and lingering (and entrenching) deflation. Now, the reason that I point out how “a lot of water has gone under the bridge” is quite simply that I know the people at Variant and, as you know, I also know Edward Hugh who was very effective in dessimating the conclusions of the report across his (second) empire now growing on Facebook. As Edward noted here on A Fistful of Euros in the immediate aftermath of VariantPerception’s report, it quickly got a lot of attention.
Now, I wish that I could present PDFs of both reports here (i.e. the VP and Iberian Equity report), but I can’t due to the fact that such reports are usually behind the firewall. However, this first note by FT’s Alphaville on the VP report and the second note, just published, on the challenge by Iberian Equities are enough to get a sense of the argument.
I have seen VP’s rebuttal and I still square with their side of the fence. Especially, Iberia Equities make the following point in their report;
“Variant claims Spanish banks are not marking their loan books to market. Non-performing loans in Spain (4.6% of the system’s loans by the end of Jun’09) are marked-down according to different provisioning calendars set by the Central Bank. For non-mortgage loans, NPLs are provisioned at the end of year 2. The majority of mortgage loans (40% of loans or two thirds of mortgage loans) have been – until the BoS made changed the interpretation of the rule – also 100% provisioned by year 2. Only a small fraction of
low –risk mortgages (20% of loans) are provisioned according to a long calendar (100% provision by year 6). By international standards, Spain’s provisioning calendars are quite strict especially considering >60% of loans have a mortgage collateral”.
To which VP replies;
“Non-performing loans are being passed off as current, vacuumed up and rolled ito cedulas to deposit at the ECB’s repo window. (Incidentally, that is the only way many Spanish banks are finding any semblance of liquidity right now. Without the ECB, some Spanish banks would have the same liquidity problems that subprime mortgage originators had. The ECB is a mega warehouse, effectively, for the Spanish banking system. This is intimately tied in to the question of funding excess consumption in Spain, which we discussed.)”
In my opinion and apart from the glaring neglect, in the Iberian Equity report, on the macroeconomics of the situation this is the most important omission. This is to say, that had it not been possible (which it still is) for Spanish banks to park many of their assets at the ECB as collateral for funding, they would have effectively needed to mark to a non-existing market (i.e. write off the whole thing in one swoop in which case it would have been bye bye Sandy). I mean, this was what happended with Bear Stearns and Lehmann and then only afterwards did the Fed (and the “appointed” buyers) wade in to scoop up these assets which are now sitting and waiting for better times (presumably, I mean, I don’t know how quick they are ground down to reflect market fundamentals).
So, as you can see, I am still with VP here but not everyone may agree in which case it is naturally something which should be debated with facts and reason.
By Claus Vistesen, on October 6th, 2009
I am a sucker for a good argument presented with the correct dose of eloquence and cold facts, and John Hempton’s latest tour of the balance sheet of the Spanish bank BBVA is just that. Essentially, John sets out to address the question of whether Spanish banks are hiding their losses or, as John ultimately goes on to argue, frontloading their eventual losses by extending credit to bad debtors in stead of writing down on the balance sheet.
Of course, this is not only a question of the practices of BBVA and whether you buy John’s extrapolation from the case of BBVA to the case of the entire Spanish banking industry and on to the Spanish economy and the Eurozone itself, I believe the analysis and underlying points deserve a closer look. Personally, I do think that this is one of the most important questions we face in the context of the ongoing financial crisis, namely the extent to which the periphery of the Eurozone (and in particular Spain) harbour the ingredients to pull the whole edifice down or very close to the brink as a result of an unravelling which lies ahead in the beginning of 2010 as government and monetary stimulus begins to wane and/or the pressure from deleveraging and internal devaluation becomes too much.
Readers with a good memory or just a specific interest in this topic will remember the debate that arose in the context of the report by Variant Conception that essentially attempted to call the emperor, in the form of the Spanish banking industry, with not clothes. The VP report stirred up quite a flurry with for example an Iberian Equity piece that specifically targeted the arguments of Variant Perception. I have a good overview of the initial skirmish here if you want to read up on the background on this (although John draws up the playing field very nicely in his piece). As you will see, I am with the bears here, but I do think that we need to settle this with facts and good reason and to this end I would rate John’s piece very highly, even if it also tends to conform with my world view.
Now, the basic point made by Hempton is, as far as I can see, the following;
There is a time honoured way of hiding losses in banking – a method that Variant Perception suggests is being done on a breathtaking scale in Spain. The method is rather than call a bad loan bad – to just extend it a bit more credit. If the borrower can’t pay the interest give them a bigger loan or line of credit. They will use the loan to become current. The slogan is that a “rolling loan gathers no loss”. Even the most diabolical subprime mortgage book in the US showed only small losses until the market stopped rolling the loans.
Together with this qualifying comment at the end;
All these problems of the same type that Variant Perception alleges in Spain – but none are of the scale Variant Perception alleges in Spain. In other words I can unequivocally support the notion that the Spanish banks are hiding their losses – but support for the notion that these losses are so large that France and Germany will be left “holding the bag” is not to be found in the US data.
What the Spanish bankers have been telling us about their credit is – at least on the American data – easily shown to be lies. We just don’t know whether they are big lies.
For the sake of Europe I hope they are not.
This last point is naturally important and somehow goes to the heart of the problem at hand here. Are we dealing with one, or a few, rotten apples or is the whole plantation sour? At this point, we can only speculate on the basis of the facts that are on the table. For me personally, it is thoroughly outside my realm of analytical ability to say whether this is a widespread practice among Spanish banks although the extent to which it is, we should be very worried with respect to the Spanish macroeconomy which is alread, as Edward noted recently, in an exceptionally dire state.
But more importantly, the arrows of causation may run in both directions here. Specifically, (and I may be reading too much into Hempton’s analysis here but still), one important underlying current seems to be that with the absolute horrific situation in which the Spanish economy finds itself we should be seeing a lot more pain in the banking sector in the form of loan writedowns or simply deleveraging. And of course, the extent to which we aren’t suggests that Spanish banks are trying to frontload their inevitable losses and the further this goes on the more grim it will be when the penny drops. This, I should add, has been my colleague’s Edward Hugh’s point (and to some extent my own too) right back from the summer of 2007 when it became clear that the subprime crisis was not merely a US undertaking. Basically, better rattle the closet well and good in the beginning and face all the skeletons than have a bunch of them come knocking you out later on, when you have grown, potentially, complacent.
To finish off with my own, albeit modest, contribution to the discussion it is worthwhile taking a look at the chart I have prepared from ECB data on the aggregate balance sheets of monetary financial institutions in France and Spain, where the former is naturally present as a benchmark case.
Essentially the graph plots of a moving average of a weighted value [1] of loans to housholds, loans to non-financial corporations and loans for household purchases in France and Spain (stock value, end of period). The change is month on month and then smoothed with a 6 month moving average. On the basis of the my remarks above the hypothesis to test here would be the extent to which Spain has clearly had a larger boom and subsequent bust than France, the degree and pace of deleveraging should also be comparatively larger and faster in Spain. Clearly, and even though the process of deleveraging in Spain is moving faster than in France, it does not correspond to the macroeconomic differences between the two economies. Could then be evidence of a macroeconomic pendant to practices shown by Hempton to prevail at BBVA? This is to say, is the apparent lack of fastpaced deleveraging in Spain evidence by contraposition to the argument Hempton implies in his analysis?
This is difficult to say and clearly this is no smoking gun since we cannot see beyond, well, what we cannot see and thus Spain may just be about to hit sh’t in the second half of 2009. Also, a larger sample size would aid the hypothesis significnatly, but it does at least makes me think that there may be more to this than meets the eye.
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[1] I constructed this myself and it is NOT complicated. Mail me if you really want to know what I did.
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