The Latest Euro-Zone Deal with Spain

reminiscences of a stock operator pdf

There is a rather good article in the Spanish El País

Where it might be worth the effort to muddle through it even if your Spanish is mediocre.

But in my dubious resume:

The inflations is predicted by the IMF to be below 2% in 2013 in the eurozone and stay there in 2014; but there is a considerable risk that it will change to negative rates – medium term.

The drop in consumption in 2009 coincided with lower oil prices. Consumer prices grew with 1.4%, but excluding oil and seasonal prices (vegetables); but the underlying development in prices stopped. Alarm is now sounded to avoid situations like the one in the USA in the 1930’ies and Japan in the 1990’ies.

One factor is that consumers expect further price drops (comment: Probably more to the point businesses make do with older equipment and repair what should have been replaced) that deminishes profits and employment. Simultaneously deflation increases debt in relation to other goods and services – which makes service on principal more difficult.

The ”Green Turnaround” and rising oil prices gave some inflation from the beginning of 2010.

The risk of deflation is relatively low in countries in the EU with good growth; but considerable in the periferi with low growth, where taxes camouflage a considerable pressure on prices.

The IMF report partly is a message to the ECB, that possibly should consider a further lowering of interest rates below .75%, partly countries with ”commercial surplus” (i.e. Germany) to allow rising wages that will allow easier adjustments in the southern counties. Chief economist in the IMF Olivier Blanchard advises a raising of the inflationary target in the Euro-zone from 2% to 3% and some economists like Paul Krugman or Kenneth have advocated larger inflation to ease the service of debt.


Four years ago an economist colleague Henrik Magnussen (you don’t know him either) pointed the imminent danger of DEFLATION out to me. He pointed out that all major consumption goods had a severe downward pressure that eventually – together with limited growth and overinvestment – would lead to deflation. I’ve never changed perspective quicker – because he was so obviously right (like shifting without a clutch).

That I disagree with Krugman et alia is not surprising (I do hang on to my pathetic fragments of sanity):

1) A further lowering of the official interest rate and increase in inflation will mean a still lower real interest rate will mean nothing, as an increase in employment is not likely to be to increasing salaries as there is considerable underemployment in most European countries: This will mean lower real wages – which makes it even more difficult to service private debt – not that it has been done debtors neither can nor intend to service debt.

2) You need a high power microscope to find an increase in inflation from 2% to 3% significant. There simply isn’t enough OOMPH in that to wave away the most arthritic fly.

3) While Germany is raising wages, is investing, is benefitting from the weakened EUR – Germany simply isn’t large enough to drag Europe’s southern countries up from the quack mire singlehandedly. Here the IMF is generous to all other “surplus” countries.

4) The IMF misses the point in the real economy that will help the southern countries as France, Spain and Italy (Greece is beyond redemption): Lower energy prices and rising agricultural prices. The structural unemployment in f.i. Spain can’t be helped with threateningly waving the magic wand: Spaniards are public employees, waiters and construction workers – where all possible needs have been overloaded for years. Only the autoworkers – selling into a tough market – have some growth potential.

With lower import prices, rising export prices (food) and lower wages there is a fair chance of real growth.

Now to the financial part:

The IMF annual newsletter to Spain is to a large part practical advice on how a Banking Union is achieved within the EU – something the IMF considers “a priority”. The June summits results are appreciated, because it opens the road to a common integrated bank inspection under the European Central Banks auspices. Furthermore it allows direct bank rescues without passing individual states [that the states will have to guarantee for losses is often forgotten – my remark].

The IMF maintains that a common bank inspection – for at least the major banks is necessary. Furthermore the must be common rules for the guarantee for all depositors in the Euro-zone. Thirdly a uniform model for resolution of banking crisis is recommended. In both cases a compatible evaluation of the individual bank must be enforced.

Proponents want to reserve these measure to ”critical situations” – with opening a credit line to the ECB and access to public funds.

Here the IMF’s suggestions split up:

Either make the rescue fund guarantee the depositors or opportunity for direct intervention into distressed banks. The other way is emission of common Eurobonds; but”limited and gradual”.

This will call for at change of the Treaty – at best a slow and tortuous route for the Euro-zone countries.


As already indicated there appears to be a split in how to deal with the large banks (“Systematically Important”) and Little Twittleton Savings and Loans.

There is a clear realisation that the larger banks simply are too big to be handled by the individual nation – the “too big to fail” is changed to “too big to live”. Clearly the large banks cannot be allowed to play one country against another. The direct intervention into a systematically important banks without messing with the local bunch of dim-witted politicians is controversial – but that is again not an IMF problem.

This is liable to cause German Finance Minister Schäuble to blow several gaskets (indeed an ugly sight), because the liability issue is central issue which up to now in the case of Spain has been sidestepped by only including the minor banks (or rather excluding the 3 large ones), where a the Spanish state guarantees as the trashcan entity (FROB) is directly owned by the Spanish state.

But these IMF recommendations are directly aimed at the larger banks where state guarantees are not realistic. We have seen cases where branches and subsidiaries in other countries have been told to “lump it”. I could mention the closing down of Danske Banks subsidiary National Irish Bank (the banks in Estonia and Finland could be next in line), even a pretentious hick ATM machine like Sydbank has been given to understand that their Swiss branch office is seriously surplus to the requirements the Danish bank inspection tells them they have.

But it gets more complicated than that: A Spanish bank like Santander has extensive interests (non-serviced loans) in South America: Try making Argentina liable! Other banks have considerable subsidiaries in other EU countries (in and out of the Euro-zone) shuffling bad loans to and fro.

Apparently a set procedure is not yet in force. Both HSBC Holdings plc (LON:HSBA) (NYSE:HBC) and Barclays’ PLC (LON:BARC) (NYSE:BCS)  are facing criminal charges: Drug money laundering and LIBOR-fraud respectively – the systematic decapitation of boards seem to indicate a clear lack of insight into the machinations. Presumably an extended period in a correctional facility could produce lead to a continued investigation – provided you can keep the dignitaries alive (bank managers in prison are a definite suicide risk).

The other point with a depositor guarantee is more immediately practical: During Q1 2012 about 100 bio. EUR. (haven’t seen later figures) fled Spain – reasonably directly into German bonds (sovereign and local).

A run on a bank is one thing; but when the run is on the country we are talking a different magnitude. What in effect happened was that Germany issued bonds and the interest dropped – the shorter maturity German Bonds has negative interest rate. There was nothing else to do but to lend the Spanish banks “their” money back at 3% for a 12½ year average maturity.

So some sort of guarantee must be found to avoid this seasonal migration of cash.

As to practical implementation the IMF take refuge into officialeese baby talk. Meaning they haven’t a clue either.

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About the Author

I have a degree in managerial economics from Aarhus University - specialising in strategy. Have been employed in various firms private, state and semi-state. Branches have been: Transport (rail and ferrylines), mashine industry, building, energy and university administration.

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