Central bank have distorted markets around the world by their endless money printing. Spain has just changed covenants on its sovereign debt so that it may force all bondholders to participate in any potential restructuring. The country’s fiscal position has also continued to deteriorate since its benchmark 10 year bond yielded 7.74% on July 25, 2o12.
Both of these facts indicate an increase of risk in holding Spanish government bonds, which should translate to a rise in yield. Yet, yields have actually decreased to just over 5%. The coordinated money printing by the world’s central banks and specifically the ECB has made this possible.
Spain is issuing very rosy fiscal and economic forecasts for 2013. It will continue to underperform, but this should not affect its bond yields much. Allow me to update this post
on Spain’s fiscal condition with new information that I learned from the articles above.
If the ECB was not ready to fire up the printing press at a moment’s notice, the information that I am sharing with you would be sufficient to roil markets. If I am aware of the true Spanish situation, then financial professionals most certainly are, and they are happily gorging themselves on all the bonds Spain puts on the table.
If you have been reading my posts on Spain, you know that I am about to prove that the fiscal numbers its government is disseminating are inaccurate. What bothers me most is that under current market and central bank conditions Spain could actually tell the truth and still sell bonds for about the same price. In fact, increased bond supply may even be viewed as great news by the markets because they have more 5% paper to buy. Why do its officials continue to lie?
The BBG article above repeats a Spanish official’s claims that gross bond issuance will be between €215-230bn with net issuance of €59bn. From the Finance Pong article above, I learned that Spain has €159.2bn in maturing obligations for 2013, which includes the regions.
Gross bond issuance covers these maturing obligations and the budget deficit. Subtracting €159.2 from €215 and €230, we see that the budget deficit is projected to be between €55.8 and €70.8bn, 5% to 6.3% of GDP. Either figure is ludicrous. The consensus of economists is that Spain will have an 8% budget deficit this year amidst a 1.4% decrease in GDP. An anonymous source in the Spanish government leaked that the number is closer to 9%.
In 2013, Spain is forecast to endure another 1.4% decrease in GDP, and it expects its budget deficit to narrow from between 8% and 9% to between 5% and 6.3.%. That implies a combined increase in revenue and decrease in spending of at least €20bn. That number will be impossible to achieve during an ongoing depression.
If Spain is lucky, the budget deficit will remain at 8% and its gross bond issuance will be about €250bn, which includes maturing obligations and a €90bn budget deficit. Net bond issuance will also be higher.
Spain’s financing needs for 2013 are close to a quarter of its GDP, and we have not even included the electricity system deficit, future bank bailouts, this year’s financing shortfall, off the balance sheet guarantees or any surprise in store for 2013.
If this same fact pattern materialized just a decade ago, Spain would be ready for a default and IMF intervention. Under the new normal, Spain is the beneficiary of central bank largesse and watches its financing rate drop 50%.
This is not surprising. The Cantillon Effect holds that cheap money enriches those closest to it. The first in line for cheap, European money are the banks. They get these loans at 1%. Now, they have to do something with it, so they purchase PIIGS debt virtually guaranteed by the ECB. Spain receives the proceeds from issuing bonds and has money to pay its suppliers (businesses) and people (welfare, pensions).
The banks make riskless profits on their bond purchases, Spain pays a lower interest rate than it deserves, businesses continue to make money from government contracts and the people get their transfer payments. What’s the problem?
Well, banks have no incentive to lend to the business sector for expansion, and growth is what is needed to pull Spain out of recession. When banks can get 5% for loaning money to the Spanish government for 10 years with a virtual guarantee from the ECB, they will have to charge much more for a riskier business loan. The business now needs to earn a larger profit on a project in order to justify the higher interest rate. Hence, neither lending nor expansion take place.
Whenever the central banks print money, the biggest winners will be the banks who receive the cheap funds, the entities to which they loan the money, and then the people who benefit from those entities having cash. Workers are last in line, and they do not profit nearly as much as the larger entities closest to the money tap. Worse yet, the workers as taxpayers are on the hook for all of these cheap, ECB loans.
My thinking used to be that central banks were creating the next crisis with their interventions. While a collapse is still a plausible scenario, perhaps the real problem is the stagnation that the monetary easing is causing. As long as the ECB is willing to print, Spain will not default. However, cheap money ensures that business lending will not occur, and without new funds for expansion there will be no growth in the economy.
Spain’s situation is dismal. It can go two ways. Low interest rates combined with large government borrowing needs will continue to decrease lending to businesses with a requisite decrease in economic growth. Spain will become a zombie country muddling along for years.
The better scenario would be a collapse and a default. Spain will get out from under all this debt, the economy will bottom out, and Spain will begin growing again.
It appears to me that the first scenario is more likely. Japan has tried for twenty years to grow its economy with cheap money, and it has endured twenty years of economic stagnation. This will be Spain’s fate, and any other country that travels along the easy money path.