Contraction 'Worse than Expected'

Once again economic forecasters are 'surprised' by the depths of Spain's recession. They really shouldn't be. After all, one of the most egregious housing bubbles of all time has burst in Spain. The bubble has produced malinvestment on a truly breathtaking scale. Moreover, it has left the banking system in tatters. If not for the doctrine that all banks including their shareholders and bondholders must be bailed out (to be fair, the MoU regarding the ESM bailout of Spain's banking system does contain provisions that losses have to be taken by these groups), a large part of Spain's banking system would likely have collapsed.

The banking system is now on artificial life support, but effectively the events have left it 'zombified'. It is too busy trying to survive to be able to extend credit. To the extent that such credit is created ex nihilo that is actually a good thing, but the ongoing liquidation of malinvested capital is of course mirrored as weakness in the official economic data until a stable situation has been attained, markets have reached clearing levels and consumption, savings and investment are back in a sustainable relation with each other. Given the numerous interventions designed to forestall liquidation and keeping the size of the State untouched while 'fixing' its debt problems, it takes much longer than would otherwise be necessary to get the economy back to a sustainable configuration. It is of course clear that the process is very painful; one cannot expect one of the biggest real estate bubbles in history to unwind painlessly. What is at issue is only how to best achieve the best outcome as quickly as possible.

Bloomberg reports:

“Spain’s recession deepened more than economists forecast in the fourth quarter as the government’s struggle to rein in the euro region’s second-largest budget deficit weighed on domestic demand.

Gross domestic product fell 0.7 percent in the three months through December from the previous quarter, when it declined 0.3 percent, the Madrid-based National Statistics Institute said today. That’s more than the 0.6 percent contraction the Bank of Spain predicted on Jan. 23. GDP dropped 1.8 percent in the fourth quarter from a year earlier and 1.37 percent in the full year from 2011, INE said.

The European Commission this week signaled it may recommend easing Spain’s budget goals for the fourth time in a year as unemployment in the euro region’s fourth-largest economy rose to a record 26 percent at the end of Prime Minister Mariano Rajoy’s first year in power.

“Risks on this number are clearly on the downside,” Ruben Segura-Cayuela and Laurence Boone, London-based Bank of America Merrill Lynch economists, wrote in a note after INE released GDP data. “The recent behavior of indicators would suggest a stronger impact than anticipated of tax increases on domestic demand.”

The yield on Spain’s 10-year benchmark rose one basis point to 5.17 percent at 10:42 a.m. in Madrid after a euro-era high of 7.75 percent in July. The spread with German borrowing costs has narrowed around 45 percent to 3.47 percentage points. Investors see bonds from so-called EU periphery countries offering even more gains than last year after European Central Bank President Mario Draghi pledged to do whatever is needed to save the 17- nation euro.

“We should be circumspect; the domestic demand contraction is severe and more of the same is likely in the first half of 2013,” said Guillaume Menuet, a senior economist at Citigroup Inc. in London. “The current market momentum is such that investors have to chase the rally, masking economic fundamentals to a large degree.”

(emphasis added)

We are not surprised to learn that the EU is contemplating to 'ease Spain's budget goals' for the fourth time in a year. There really is no choice: Spain's government cannot meet the originally agreed upon goals, in fact it is highly likely that it will miss the revised goals (whatever they will be) as well.

'Chasing the rally that masks economic fundamentals' – which is engendered solely by central bank intervention – doesn't exactly strike us as the brightest of all ideas.



10 year yield-Spain

Spain's ten year government bond yield, with lateral support indicated in red – click for better resolution.


Recently the rally in the IBEX has run out of steam – lateral support has (barely) held thus far, but the rally has topped with the typical RSI divergence appearing that traditionally tends to be seen near highs (a sign of waning momentum that warns of a trend change).




The IBEX with near term lateral support as well as the recent RSI divergence marked in red – click for better resolution.


A Worsening Political Scandal

In the meantime, prime minister Rajoy's government has been caught up in a bribery scandal that seems to become ever more serious, as new allegations emerge all the time. Recently they have ensnared Mr. Rajoy personally, but not only him – practically the entire ruling stratum of his party suddenly stands accused.

According to Reuters:


“Spain's ruling People's Party denied on Thursday that Prime Minister Mariano Rajoy and other leaders received payments from a slush fund after a newspaper published what it said were secret party accounts.

El Pais published images of excerpts of almost two decades of handwritten accounts that it said were maintained by People's Party treasurers. The newspaper said the accounts showed 11 years of payments to Rajoy of 25,200 euros ($34,200) a year.

The accounts – which El Pais said amounted to a parallel unofficial bookkeeping system – indicate donations from companies, mostly builders, and regular payments of thousands of euros to a number of party leaders. The report is the latest twist in a scandal that has damaged the credibility of 57-year-old Rajoy as he battles a deep recession and one of Europe's highest unemployment levels.

Rajoy – a longtime politician widely thought of as boring but honest – has demanded sacrifices of Spaniards as he slashed public spending to avert a fiscal crisis that could push Spain into an international bailout.

"The People's Party only has one set of accounts and it is clean, transparent and submitted to the official accounting authority," PP Secretary General Maria Dolores de Cospedal told a news conference, denying allegations of corruption in El Pais. "We have absolutely nothing to hide."

Hundreds of Spaniards gathered outside party headquarters in central Madrid on Thursday evening in peaceful protests, chanting 'Thieves!' and bearing placards reading 'Resign Now!'.

Cospedal was one of many top party officials, along with former Economy Minister and IMF chief Rodrigo Rato, named by El Pais as receiving secret payments. Rato did not immediately respond to a request for comment.

An earlier statement by the PP said the party's payments to its leaders and staff were always legal and followed tax rules. The party also denied there were systematic payments to people other than their official paychecks. A spokeswoman from Rajoy's office told Reuters the prime minister – who has been in office just over a year – stood by comments he has made recently that he has not engaged in improper conduct.

High Court Judge Pablo Ruz, who is investigating a four-year-old corruption case involving the PP, has asked prosecutors to look into the new allegations and could open another line of investigation, court sources told Reuters.


A recent poll by Metroscopia showed that 96 percent of Spaniards believe corruption is widespread in politics in Spain, after dozens of cases emerged in recent years, most notably an ongoing judicial investigation into alleged embezzlement of public funds by King Juan Carlos' son-in-law.

(emphasis added)

It has long been known that Spain's political class is e.g. using state-owned industries as a kind of personal demesne, a place where retired politicians go to get cushy and well-paid jobs. 96% of Spaniards are correct with their suspicions: their political class is thoroughly corrupt. This is the case with the political class almost everywhere, as there are very few jobs that at the same time offer so many opportunities for theft and corruption while keeping the perpetrators relatively safe from legal trouble. It is only when they fail to hide their tracks and something becomes publicly known that they have to fear consequences.

Anyway, the allegations made by El Pais sound quite serious to us. This could well end with bringing the government down, especially if the allegations turn out to be based on strong evidence (which is something we cannot judge from afar). Spain continues to experience 'interesting times'.


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