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Politicians always appear to consider the cost of acting versus the
cost of inaction. As long as more money is lined up: be that from the central government for the regions; be that from a European stability fund for the government; or be it from the IMF, incentives for reforms are taken away. [Spain is a prime example of what is wrong with Europe – and much of the world. Let me explain why that is the case and how to benefit from the overall situation.] Words: 1174
So says Axel Merk (www.merkfunds.com) in edited excerpts from his original article* which Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
Merk goes on to say, in part:
Let’s highlight Spain…[where], if you run out of your own people’s money, there may always be other peoples’ money.
Regional Government Debt Problems
One of the major concerns is Spain’s regional government debt. Spain consists of 17 autonomous regions, whose total debt almost doubled in the past three years, due to economic recession and a housing market collapse. In many ways, Spain reflects a microcosm of how the Eurozone as a whole is structured:
- Spanish regions have the power to issue public debt. The central government has little ability to interfere with regional government spending and is prohibited by Spanish law to bailout regional governments.
- While regions enjoy high autonomy on spending, the central government retains effective control over regional government revenue.
- Spain has its own peripheral problems: the most indebted region, Catalonia, recorded 20.7% debt-to-regional-GDP ratio and 3.6% deficit-to-GDP ratio in 2011. Its 10-year bond yield recently breached 10%, far beyond the yield on 10-year Spanish government bonds, which yield around 6%. In 2011, the total debt of 17 regional governments rose to €140 billion, accounting for 13.1% of Spain’s GDP. This number is up from 6.7% by 2008.
- Spanish law forbids the central government from rescuing regional governments (in much the same way that the Maastricht Treaty prohibits bailouts of EU countries). In practice, the central government appears to have implicitly helped Valencia, Spain’s 2nd most indebted region, with a €123 million loan repayment to Deutsche Bank.
Banking Woes
More broadly known are Spain’s banking woes. Unlike much of Europe, a housing boom propelled much of Spain’s recent growth, causing Spain’s regional banks, in particular, to become overly exposed to the mortgage sector.
Spain’s banks are very dependent on liquidity provided by the European Central Bank (ECB). The recent 3 year long-term refinancing operation (LTRO) by the ECB at first took pressure [off] the Spanish banking system, but has since been seen more critically, as Spain’s banks may be using the liquidity to buy Spanish government debt, thus increasing inter-dependency and potentially making nationalization (read: the Spanish government taking on the obligations of its banks) of Spanish banks more, rather than less, likely.
It’s Still Business as Usual
The tensions between Spanish regions and its national government are nothing new and that’s really the main lesson here: it’s business as usual in Spain! As of late, Spain’s government appears to be reining in regional control over budgets in earnest. However,…the moment the pressure abates,…those promises are forgotten. Spain is proof that the only language policy makers may be listening to is that of the bond market.
As painful as it is, volatile markets are necessary to keep policy makers focused. Whenever Spanish bonds come under pressure, Spain moves further from talk and closer to action, with respect to implementation of more austerity measures, as well as the pursuit of structural reforms.
Spain – like so many developed countries – has rigid bureaucracies aimed at protecting the old (companies and employees) at the cost of preventing the new, stifling innovation and fostering massive youth unemployment. Structural reform is politically painful. What is striking about Spain is that it has an enviable position of a government with an absolute majority yet even such a seemingly strong government is dragging its feet in implementing reform. In the process, political support is eroding, thus making it increasingly difficult to pursue reforms as the economic environment worsens.
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Spain’s Problem Is a Global Problem
As Europeans have convinced themselves that they have done plenty of the heavy lifting, the next stop is the IMF, where member countries are expected to pledge billions more. The critics may be forgiven for pointing out that Europe could be doing more before tapping into purses of other, less affluent countries. Unfortunately, politicians treat this as politics rather than a serious debate about money.
The good news here, though, may be that we don’t think this is a European problem. The bad news is that this is a global problem. Spain is not unique. In the U.S., we have many of the same challenges, but we have a bond market that has allowed policy makers to get away with spending ever more money. Different from the Eurozone, the U.S. has a significant current account deficit and, as such, should the bond market impose austerity on U.S. policy makers, it may have far more negative implications on the U.S. dollar than it has had on the Euro to date.
Monetary Easing to Continue
In the meantime, as policy makers around the world continue to hope for the best, but plan for the worst, expect monetary policy to [continue to] be most accommodating. The U.S., the Eurozone, the U.K. and Japan all have eased in some form or another in recent months.
Beneficiaries of Inaction
Beneficiaries in the medium term may be:
- precious metals and
- commodity currencies.
For now, those currencies [think Canada, Australia, etc.] have been held back by a generally somber mood about global growth.
What has done well – and we expect will continue to do well – are the currencies of countries that realize such policies will foster inflationary pressures. Singapore should be praised in this context, as the Singapore Monetary Authority tightened monetary policy last week, allowing the Singapore Dollar to appreciate. Those countries that can afford to are taking note that all this easy money may have significant side effects and are taking action to combat it. However, such countries are few and far between.
We have long argued that there may not be such a thing anymore as a safe asset and investors may want to take a diversified approach to something as mundane as cash.
*http://www.merkfunds.com/merk-perspective/insights/2012-04-19.html (To access the article please copy the URL and paste it into your browser.)
Editor’s Note: The above article has been has edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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