Monday, November 29, 2010

Zapatero gets the message

If he means what he says (a big if since he is a politician) it seems like the Spanish PM, Jose Zapatero, has finally got the message. At a meeting with business leaders to discuss reforms this week he said all the right things:

He's talking about reforming pensions by February and restructuring the weakest savings banks by Christmas. In addition he says that regional governments, who account for about half of Spain's public spending, must start reporting their deficit-cutting progress every quarter.

Up until now he has dragged his feet on reforms, mindful of how unpopular they are on the left of his party and indeed with the electorate as a whole who I suspect mostly don't accept that things need to change if Spain is going to survive and compete. Now Zapatero talks about "accelerating reforms to the max" ... "whatever the personal cost". His new-found zeal as a reformer presumably owes its origin to the Irish crisis and the widespread view that Spain could go the same way ("The difference between Spain and Ireland is timing").

Another reason for urgency is the need to restore some credibility ahead of the first 4 months of 2011 when, according to Barclays, Spain and its banks need to raise 70bn€ in the bond markets, which they think will lead it to ask for a bail-out next Spring. Sounds plausible if you think Zapatero' reforms are too little too late, the Spanish banks are in worse shape than they admit and that austerity measures announced so far will push the economy back into recession. In this case now would be a good time to reduce your exposure to the Euro (or even short it if you are feeling brave) because this will be a calamitous bail-out too far for the currency to bear. On the other hand European leaders know this and may have a few tricks up their sleeves to ensure Spain pulls through e.g. I could easily see the ECB printing money to buy Spanish government or bank debt. Whatever happens it's going to be an interesting 2011.

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Monday, November 22, 2010

The difference between Spain and Ireland is timing

So Ireland finally caved in and went to the EU and the IMF for a loan. The point for Spain though, is will they eventually be brought down by the same pressures that did for the Irish?

The consensus appears to be no it won't. The markets and most commentators seem to accept that Spain is a different proposition and can pay its way. At an important bond auction last week, in the midst of the Irish uncertainty, Spain did manage to sell its latest batch of debt for an acceptable yield (10 year funding cost them 4.6%). There are good reasons to think that Spain is in a much stronger position:

Ireland's economy has shrunk more than any other in the EU economy during the crisis, shows no sign of recovering and the fiscal position of the government (excluding bank bail outs) is getting worse. Spain's economy has at least stabilised in 2010 and is at least not shrinking (Q3 GDP Spanish growth was 0%). The government's deficit as a % of GDP is narrowing to single figures and the government has set up major public spending cuts and tax rises to bring it down further.

Ireland was sunk by its banking sector more so than its public sector debt. In 2007 the Irish public sector deficit was the lowest in the EU at 25% of GDP and even with the crisis had only risen to just over 60% this year. However in 2010 the Irish deficit has ballooned to a remarkable 32% mainly as a result of the cost of bank bailouts, principally the AIB and the Bank of Ireland.

The markets just did not accept that the Irish could afford the guarantees given to these banks - the government had guaranteed 100% of their deposits and made some commitments to the bondholders of backing these bank. Ireland could not afford a bank bailout and get its deficit under control at the same time.

So, Spain in the clear? Not quite. There are some worrying similarities between Spain and Ireland's predicament:

- both economies are stagnating even before austerity cuts and tax rises have started to bite. Neither have the option of devaluing their currency to boost exports as they are stuck in the Euro.

- both not only had massive house price booms and bust they are both (unlike say the UK) still suffering the aftermath in terms of mountains of unsold properties dragging down prices

- Spain has its bank problems too. See Spain's economic crisis turns nasty

- Spain and Ireland have both lost control of their monetary policy so cannot engage in Quantitative Easing policies like the UK and US have done

- Spain is struggling to make its budget deficit-narrowing plans work (partly because tax revenues are stagnating and partly because the autonomous regions are not cutting spending to plan)

- if it were to suffer a double dip Spain would have nowhere to turn. In 2008/9 the government was able to spend its way to prevent the worst of the recession and even then it was pretty awful.

So if both economies are in the same predicament - deficits, austerity, stagnation, stuck in a Euro straitjacket - what sets Spain apart? The markets seems to accept that the scale of the Irish banks' problem set it apart. But I have my suspicions that Spain is more vulnerable than it appears on this front. The banks avoided much of the pain of the housing market crash by dodgy accounting and putting off foreclosures. They have in any case become the most reliant in Europe on borrowing cheaply from the European Central Bank. Another spiral down in house properties and an increase in repossessions - hardly outlying propositions - and the game could be up. Ireland today, Spain tomorrow? Watch the housing market.

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Monday, November 15, 2010

Autonomos retain their expenses allowances

I spotted this news article in the Spanish press:

In essence the message is all in the title and the article doesn't add that much: the government keeps the 5% deduction for small and medium-sized enterprises (SMEs) and autonomos (self-employed) for 2011. This refers to a rule that can save autonomos money if they do their quarterly "modelos" correctly i.e. return a simplified "objective" declaration of their business profits rather than the full version. This allows them to report a taxable profit equal to income minus allowable expenses minus a further 5% of net income as an additional expense allowance. The idea is that the small business will have expenses which they cannot easily claim because of a lack of receipts or justification and this allowance makes up for it.

In a sense it is more than necessary because otherwise the system of what is and what is not deductible in terms of business expenses is quite harsh particularly when compared to the UK. There is a full guide on our website (autonomo expenses guide) but as examples :

- if a self employed businessman flies to London on business the flight can only be claimed as an expense if it is demonstrably 100% business-related. If the spouse travels or there is any day spent away from business then the whole cost of the trip is disallowed. The assumption is that the trip has been at least in part for pleasure.

- it is routine in the UK to claim for business lunches and entertaining but practically verboten in Spain

Reading the article, the authorities are making it sound like retention of the 5% deduction is a temporary measure because of the crisis. It could be removed when (if) things pick up for the Spanish small business sector. With Spanish GDP growth coming in at an invisible 0% for Q3 it looks like business needs all the help it can get.

Monday, November 8, 2010

QE2 and the soaring cost of fine wine

If you think that the US Federal Reserve's announcement of a $600bn second slug of quantitative easing (QE2 as it has been dubbed) is just what the US and World economies need right now, think again. It is rare that mere monetary manipulation is the springboard for a solid and lasting cycle of productive economic activity. I will allow that an economy that has suffered a shock fall in its money supply, because of major banks going under say and taking depositors's cash with them, could do with an infusion of cash from the central bank. But the US and most of the World is not in such a position.

Bank bail outs and the last lot of QE have stabilised the banking system, at least for now. No depositor in the US or UK lost a penny. Money supply and the velocity with which it has been circulating round the economy, have been growing briskly on both sides of the Atlantic after an understandable slow down in the aftermath of the crisis, caused by a reluctance to lend, borrow, invest and consume in the private sector. Retail price inflation is positive and rising in the US (about 1%, much higher in the UK). The economic recovery is slow but what would you expect if the private sector is working off its excessive debts and banks rebuilding their capital?

So the new money is not filling a hole in the money supply, or warding off the supposed horrors of deflation or needed to refloat the financial system. The Fed chairman justified the extraordinary move by claiming prices are not high enough - he wants high consumer inflation and higher share prices.

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending," Ben Bernanke

So the Fed is printing 600 billion to buy US government debt on top of the 1,700 billion it has already printed to make sure its citizens pay more for what they need to live on and in the hope of a trickledown effect from booming stock markets. But what will happen in practice?

A clue was to be found this week in news reports of a boom in fine wine prices and a new world record for a single bottle:

An 1869 vintage wine of Chateau Lafite-Rothschild was recently sold at auction in Hong Kong for a record 147,020 pounds, leading experts to warn that fine wines could soon become unaffordable. (CityAM)

And this is before QE2. The free money, printing press economics that are being followed by our monetary masters around the globe are predictably fuelling inflation, even though the main consumer indices are reasonably becalmed. The money is finding its way through to speculative property deals, emerging markets, takeovers, precious metals, rents, commodities, luxuries, art - the price of anything that isn't being held down by the deadweight of unemployment misery and industrial ruin.

A tidal wave of money has been unleashed supposedly because we are all suffering from low prices at a time when energy prices are rising sharply and food basics like rice, sugar and wheat are soaring in price. The fact that emerging markets and speculative investments are booming suggests that the excess liquidity is not being invested in real investment in the Western economies but is simply flowing abroad, jacking up the prices of essentials and causing chaos.

I think there is some sort of recovery taking hold in some of the Western countries and am not unrelentingly doom and gloom, but this latest piece of economic policy making beggars belief. I hope the UK doesn't follow suit. And I certainly don't expect a healthy round of balanced economic growth any time soon.

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