Spain’s Capital Flight Intensifies

In Spain, political solutions have been prompting for a deepening crisis.

From the New York Times,

“The macro situation in Spain is getting worse and worse,” Mr. Vildosola, 38, said last week just hours before boarding a plane to London with his wife and two small children. “There is just too much risk. Spain is going to be next after Greece, and I just don’t want to end up holding devalued pesetas.”

Mr. Vildosola is among many who worry that Spain’s economic tailspin could eventually force the country’s withdrawal from the euro and a return to its former currency, the peseta. That dire outcome is still considered a long shot, even if Spain might eventually require a Greek-style bailout. But there is no doubt that many of those in a position to do so are taking their money — and in some cases themselves — out of Spain.

In July, Spaniards withdrew a record 75 billion euros, or $94 billion, from their banks — an amount equal to 7 percent of the country’s overall economic output — as doubts grew about the durability of Spain’s financial system.

The deposit outflow in Spain reflects a broader capital flight problem that is by far the most serious in the euro zone. According to a recent research note from Nomura, capital departing the country equaled a startling 50 percent of gross domestic product over the past three months — driven largely by foreigners unloading stocks and bonds but also by Spaniards transferring their savings to foreign banks.

The withdrawals accelerated a trend that began in the middle of last year, and came despite a European commitment to pump up to 100 billion euros into the Spanish banking system. Analysts will be watching to see whether the August data, when available, shows an even faster rate of capital flight.

More disturbing for Spain is that the flight is starting to include members of its educated and entrepreneurial elite who are fed up with the lack of job opportunities in a country where the unemployment rate touches 25 percent.

According to official statistics, 30,000 Spaniards registered to work in Britain in the last year, and analysts say that this figure would be many multiples higher if workers without documents were counted. That is a 25 percent increase from a year earlier.

“No doubt there is a little bit of panic,” said José García Montalvo, an economist at Pompeu Fabra University in Barcelona. “The wealthy people have already taken their money out. Now it’s the professionals and midrange people who are moving their money to Germany and London. The mood is very, very bad.”

It is possible that the outlook could improve if the European Central Bank’s governing council, which meets Thursday, signals a plan to help shore up the finances of Spain and other euro zone laggards by intervening in the bond markets.

Spain’s capital flight dilemma has mainly been symptoms from fears of devaluation (or rampant inflationism) from the possible reinstitution of the peseta. Such actions to preserve savings flies in the face of those who argue for the devaluation snake oil fixes.

And where “members of its educated and entrepreneurial elite” shifts money out of the system, Spain’s economic recovery will remain dim as productive capital seek refuge or allocate savings elsewhere.

Moreover, the political solution of perpetual bailouts [“plan to help shore up the finances of Spain and other euro zone laggards by intervening in the bond markets”], accounts for as doing the same thing over and over and expecting different results, have only been intensifying the predicament

Yet the above account represents as another sign where ground economic activities have been moving in the opposite direction relative to the actions of financial markets.

Eventually reality will be priced in.

Dealing with Spain’s Labor Rigidities

The Wall Street Journal editorial has some interesting insights, particularly facts (marked by bullets) and micro based recommendations in resolving Spain’s rigid labor markets.

[bold emphasis mne]

• After Cyprus, Spain ties with Malta for the most public holidays (14) in Europe. The Spanish Workers' Statute also guarantees 22 days of paid vacation annually, 15 days to get married and two to four days when anyone in an employee's family has a wedding, birth, hospitalization or death.

Mr. Rajoy has tried, with only moderate success, to tweak the public-holiday schedule and discourage "bridge" weeks—when, say, the Assumption of Mary falls on Wednesday and your entire staff takes off Thursday and Friday too. But if Mr. Rajoy wants a reform that would also be popular, why not ditch the statute's clause that bars employees from trading vacation time for extra pay? If Spaniards could earn greater rewards for taking fewer holidays, they might eventually want to scrap state-mandated vacations.

• Sick employees can get most or all of their wages for 18 consecutive months if they have a doctor's note. An employer could opt to fire chronically ill employees—and pay up to 24 months of guaranteed severance. That's excessive. Then again, the mandatory national insurance to cover sick wages, severance pay, health care and so forth takes 39.9% from the gross average Spanish wage.

Mr. Rajoy has trimmed unemployment benefits and pledged to reduce compulsory "social contributions" by one percentage point next year and another in 2014. He could do much better by letting Spaniards opt out of some entitlements entirely, such as paternity pay or child-care coverage. Spain would be a far better place to work and hire if its laborers and businesses could choose how to spend more of what they earn.

• Spain's 52% youth unemployment remains the subject of countless government training programs and tax exemptions for businesses hiring those under age 30. The programs don't work but they are expensive.

A free alternative: Repeal the Workers' Statute clauses that forbid most trainees and apprentices from earning less than 60% of the wages of full employees and from working more than 85% of a regular shift. It's harder to hire young people if you know you'll get much less work out of them for not much less pay.

Mr. Rajoy could also expand the one-year period during which businesses may dismiss new employees without severance. This only applies to firms with fewer than 50 workers, which helps explain why 99% of Spanish companies have no more than 49 employees of any age.

• Once a Spanish business reaches 50 employees, its workers must also elect five workplace reps to bargain on wages and conditions. These delegates must each receive at least 15 paid hours off monthly for their duties, and the quotas rise as companies grow. By the time a business hires its 751st staffer, it must have at least 21 workplace reps, each getting a minimum of 40 paid hours off per month.

Eliminating these costly sops and letting workers negotiate individually would no doubt provoke a declaration of war from labor bosses. So what? Fewer than 16% of Spaniards today opt to unionize, and far fewer than that join in already-frequent union demonstrations.

Read the rest here

From the above, one can see that the predicament of Spain’s competitiveness has scarcely been about the adverse effects of a “strong” currency, but because of the compounded negative side-effects of suffocating regulations, the barnacles of bureaucracy and the unwieldy welfare state.

Why Spain’s Bailout may NOT Work

Author and derivatives analyst Satyajit Das at the Minyanville.com has an insightful dissection of why Spain’s bailout will not likely succeed (all bold emphasis mine)

1. Spain’s bailout package overlooks the requirements of larger banks

The amount -- 100 billion euros or more depending on the independent assessment of the needs of Spanish banks -- may not be enough. On the surface, the amount appears around three times the 37 billion euros the International Monetary Fund says is needed. The capital requirements of Spanish banks may turn out to much higher -- as much as 200 billion to 300 billion euros.

The IMF assumes only the smaller Spanish savings banks (the Cajas) will need help. In reality, the larger Spanish banks may also require capital.

Spain’s banks have over 300 billion euros in exposure to the real estate sector, mostly through loans to developers. Around 180 billion euros of this exposure is considered “problematic” by Spain’s central bank.

Estimates suggest that there are about 700,000 vacant newly built homes, but including repossessed properties the total could be as high as 1 million or even higher. At current sales levels, it will take many years to clear the backlog, which will be compounded by more properties being completed and coming onto the market. Housing prices have fallen by 15% to 20% but are forecast to fall eventually by as much as 50% to 60%. A severe recession and unemployment of 25% means that losses on Spain’s over 600 billion euros of home mortgages loans are likely to also rise.

2. The bailout excludes sovereign debts

The proposed amount also does not include any provision for write-downs on holding of sovereign debt. Local banks are estimated to hold over 60% of outstanding Spanish government bonds.

3. The conditions of Spain’s bailout may prompt for a domino effect or demand for changes in the conditions or covenants of existing bailouts by other crisis affected EU nations.

The bailout will be provided with no conditions, which creates its own problems. The lack of conditions may lead to Greece, Ireland, and Portugal seeking relaxation of the terms of their assistance packages. The lack of conditions also prevented the IMF from contributing.

4. The bailout lacks the discipline of keeping the house in order, unlike crisis affected Asian economies during the 1997 Asian Crisis.

In an opinion piece in the Financial Times, Jin Liqun, chairman of the supervisory board at the China Investment Corporation, pointedly noted the contrast between the treatment of European and Asian countries.

Viewed from China, the management of the eurozone debt crisis offers a stark contrast to the handling of the 1997-98 east Asian crisis. In that episode, Thailand, South Korea and Indonesia were all forced to implement tough austerity programmes imposed by the International Monetary Fund.... Unlike many of today’s Europeans, the people of east Asia did not have the luxury of large relief funds from outside their countries. The people had to tolerate hardship...In a poignant case, the Korean people contributed gold and household foreign exchanges to the government to help ease fiscal pressure.

Amen to that.

Western politicians think that they can elude the laws of nature. Markets will eventually prevail.

5. The bailout overestimates on the sources for funding.

Future international support, either bilateral or through the IMF, may be difficult.

The funds will come from either the European Financial Stability Fund or the still to be approved European Stability Mechanism. Since 2010, the eurozone has committed 386 billion euros to the bailout packages for Greece, Ireland, and Portugal. In theory, the EFSF and ESM can raise a further 500 billion euros, beyond the commitment to Greece, Ireland, and Portugal, allowing them to contribute the 100 billion euros for the recapitalisation of the Spanish banking system. The EFSF/ESM also assumes that it “can leverage resources." The reality may be different.

For a start, Finland has indicated that it may seek collateral for its commitment, an extension of its position on Greece which the European Union ill-advisedly agreed to.

As Spain could not presumably act as a guarantor of the EFSF once it asks for financing, Germany’s liability will increase further from 29% to 33%. France’s share also increases from 22% to 25%. The liability of Italy, which is in poor shape to assume any additional external financial burden, rises from 19% to 22%.

The EFSF’s AA+ credit rating may now be reduced. Irrespective of the rating, the EFSF and ESM will have to issue debt to finance the bailout. Support for any fund raising by these instrumentalities is uncertain.

Commercial lenders have been reducing European exposure. Emerging market members with investible funds lack enthusiasm for further European involvement. Lou Jiwei, the chairman of China Investment Corporation, the country’s sovereign wealth fund, has ruled out further purchases of European debt: “The risk is too big, and the return too low."

6. Spain’s bailout will worsen Spain’s financial ratios which could likely dissuade participation from the private sector.

The bailout also does not address fundamental issues.

The funds will be lent to the Spanish government, probably its bank recapitalisation agency Fondo de Reestructuracion Ordenada Bancaria (FROB), rather than supplied directly to the banks because of legal constraints. This will add 11% of GDP to Spain’s debt level. The transaction will do nothing to reduce the country’s overall debt level -- over 360% of GDP before this transaction.

Spain’s access to capital markets or its cost of debt is not addressed. The last auction of Spanish government bonds saw yield around 6.50% per annum with the bulk of bonds being purchased by local banks. Spain and its banks also face pressure on their own ratings, which are now perilously close to becoming non-investment grade.

The bailout may actually adversely affect the ability of Spain and its banks to funds. Commercial lenders are now subordinated to official lenders. Based on the precedent of Greece, this increases the risk significantly, discouraging investment.

The European Union has stated that it believes that these measures will help the supply of credit to the real economy and assist a return to growth. This optimism is unlikely to be realised.

Restoring the bank’s solvency will not result in an increase in credit. The capital will allow existing bank debts to be written off. Spanish banks have limited access to funding. They are heavily reliant on the European Central Bank for money, a position which the assistance does not address.

Interventionism begets more interventionism which substantially deepens the distortions of the markets, through more misallocations or malinvestments and which consequently aggravates the problems.

Policymakers do NOT have the KNOWLEDGE and the RESOURCES to deal with the worsening crisis.

The basic 'commonsense' solutions are to keep the proverbial house in order through fiscal discipline “austerity”, allow unsustainable institutions to fail or for the markets to clear and to induce competitiveness by removing structural political and regulatory obstacles (e.g. labor market reforms).

Yet commonsense has been disregarded for wishful thinking.

The current path of policies of sustained bailouts only increases the risk of MORE inflationism which serves as the fundamental reasons to be bullish on gold and commodities.

Austerity in Spain?

Juan Carlos Hidalgo at the Cato Institute investigates claims that Spain has been suffering from “austerity”

Writes Mr. Hidalgo, (bold emphasis mine)

There is a wide consensus that Spain’s economic troubles are the result of an enormous housing bubble—even bigger than the one that hit the U.S.—that burst in 2008. Just the year before, Spain boasted healthy fiscal indicators: a general government budget surplus of 1.9% of GDP and a gross consolidated debt of just 36.2% of GDP. However, once the bubble burst, government revenues collapsed and stimulus spending was injected into the economy, resulting in a fiscal deficit of 11.2% in 2009 and a gross debt that has increased over 30 percentage points of GDP in just 4 years.

Paul Krugman and The Economist argue that this evidence shows that, unlike Greece, Spain wasn’t fiscally profligate. However, the devil is in the details. Spain did run budget surpluses prior to the crash, but those surpluses weren’t caused by restrained government spending, but by ballooning tax revenues (thanks to a growing housing bubble). If we look at total government spending in the last decade, we can see a steady and significant rise until 2009:

* Using GDP deflator.
Source: European Commission, Economic and Financial Affairs.

Government spending in nominal terms increased at an annual rate of 7.6% from 2000 to 2009. Ryan Avent at The Economist says that “the push for austerity began in 2010,” and thus we have to look at nominal spending after that year, when according to Avent, it fell “substantially” due to austerity measures. In reality, it went down by just 1% in 2010 and a further 3.6% in 2011. If these cuts seem “substantial” to Avent, then a yearly average increase of 7.6% for almost a decade must be staggering.

Moreover, if we look at spending in real terms, using constant euros from 2000, there hasn’t been any decrease in the level of government spending.

If we look at government spending as a share of the economy, Spain appears as fiscally prudent: Spending was 39.2% of GDP in 2000 and exactly the same figure in 2007. However, as has been noted by Juan Ramón Rallo, Ángel Martín Oro and Adrià Pérez Martí of the Juan de Mariana Institute in a recent Cato study, “the data should be interpreted with caution, given that the GDP was growing at an artificially high rate.” The point is proven by the fact that when the economy came to a halt in 2008 (it grew by just 0.9%), government spending as a share of GDP leapt 2.3 percentage points to 41.5% in just one year. Government spending as a share of the economy remained constant during much of the 2000’s not because the government was spending too little but because GDP was growing too fast.

Moreover, once the crisis kicked in, government spending as a share of GDP reached a peak at 46.3% in 2009 (due to a combination of still more stimulus spending and a contracting economy). It later fell to 43% in 2011, still a higher share than in 2008. Government spending in Spain has indeed come down in the last two years, but not in a dramatic fashion as some people would have us to believe.

What about taxes? As has been the case in Britain, France, Italy and Greece, in the last two years the Spanish government increased taxes to tackle the soaring deficit: personal income tax rates went up in 2010 and two new brackets of 44% and 45% were introduced for higher incomes. Tax credits to self-employed workers were revoked. The VAT rate went up from 16% to 18% and excise duties on tobacco and gasoline were also raised. All these tax increases took place before the large tax hike introduced this year by the conservative government of Mariano Rajoy, which turned Spain into one of the highest taxed countries in Europe (and explained at length in this Economic Development Bulletin).

In short, austerity in Spain, described by Paul Krugman as “insane,” consists mostly of significant tax increases and timid spending cuts.

So Spain’s economy has been enduring economic strains hardly from spending cuts but mainly from HEFTY TAX INCREASES, rigid labor regulations and the welfare state.

On asphyxiating labor environment the Economist noted last February,

Spain’s labour laws, which date back to the Franco era, have condemned half the workforce to unemployment or to temporary jobs while the rest enjoy ironclad contracts and huge redundancy pay-offs. The new law blurs this insider/outsider divide and may thus get more people into stable employment. The decree comes on top of a January agreement by unions and employers to limit pay rises over the next three years. Mr de Guindos thinks most Spaniards see the need for labour reform. But its success in terms of growth may depend on unions’ choice between protecting jobs and keeping up their members’ pay.

The same statist FALSEHOODs have been thrown to Greece, where supposed “devaluation” from an “EU exit” would have posed as “elixir” to Greek economic woes.

Yet the ramifications from such absurd mainstream propaganda has been to SPUR a stampede out of the Greek banking system or systemic “bank run” or “capital flight” into safe havens as Germany and the US, as Greeks feared the loss of savings from forcible conversion of their euros to “drachmas”.

And the same tax hike prescriptions from statists has led Greeks to drastically avoid paying taxes.

In short, statist medicines have been blowing up right smack on their faces.

Yes, polls have it that 80% of Greeks want to stay in the Euro!!!

Statist imbeciles engage in deceptive phraseology to promote their political religion. As George Orwell once wrote,

In our time, political speech and writing are largely the defence of the indefensible... Thus political language has to consist largely of euphemism, question-begging and sheer cloudy vagueness… Such phraseology is needed if one wants to name things without calling up mental pictures of them…The inflated style itself is a kind of euphemism.

The great enemy of clear language is insincerity. When there is a gap between one's real and one's declared aims, one turns as it were instinctively to long words and exhausted idioms, like a cuttlefish spurting out ink. In our age there is no such thing as ‘keeping out of politics’. All issues are political issues, and politics itself is a mass of lies, evasions, folly, hatred, and schizophrenia. When the general atmosphere is bad, language must suffer.

False prophets, these statists, are.

Germany’s Competitive Advantage over Spain: Freer Labor Markets

When politics is involved, common sense is eschewed.

The vicious propaganda against “austerity” aims to paint the government as the only solution to the crisis, where the so-called “growth” can only be attained through additional government spending funded by more debt. Unfortunately, these politically confused people have forgotten that today’s crisis has been caused by the same factors which they have been prescribing: debt. In short, their answer to the problem of debt is to acquire more debt.

The same with clamors for crisis plagued nations to “exit” the Eurozone in order to devalue the currency. Inflating away standards of living, it is held, will miraculously solve the social problems caused by too much government interventionism that has led to inordinate debt loads.

Professor John Cochrane of the Chicago School nicely chaffs at statist overtures,

The supposed benefit of euro exit and swift devaluation is the belief that people will be fooled that the 10 Drachmas are not a "cut" like the 5 euros would be. Good luck with that.

Little has been given thought to what’s happening on the ground, particularly achieving genuine competitiveness by allowing entrepreneurs to prosper.

At the Mises Institute, Ms Carolina Carmenes and Professor Howden lucidly explains why Germany has been far more competitive than Spain, specifically in the labor markets .

Spain’s labor costs have been cheaper than Germany, yet the Germans get the jobs. Writes Ms. Carmenes and Prof Howden (bold emphasis added)

Spanish employment is now hovering around 23 percent, with over 50 percent of youths jobless. Only around 6 percent of Germans are without work, almost the lowest level in the country since reunification. This divide solidifies Spain's position among the worst-performing economies of the continent, and Germany's vaunted position as among the best.

Yet such a situation might seem paradoxical. One could, for example, look at the wage rates of the respective workers and find that low-cost Spaniards are much more affordable. Profit-maximizing businesses should be expanding their facilities to take advantage of the opportunity the Spanish crisis has provided and eschew higher-cost German labor.

While fixating on nominal labor costs might provide a compelling case for a bright Spanish future, delving into the details provides some darker figures.

Once again the German-Spain comparison shows of the myth of cheap labor

Little thought has also been given to the impact of minimum wage and excessive labor regulations which stifles investment and therefore adds to the pressures of unemployment

Again Ms. Carmenes and Prof Howden (bold emphasis added)

One of the main differences between Germany's and Spain's labor markets is their minimum-wage rates. A Spanish minimum-wage worker can expect to earn about €633 per month. Germany on the other hand enforces no across-the-board minimum wage except in isolated professions — construction workers, roofers, and electricians, as examples.

German employees are free to negotiate their salaries with their employers, without any price-fixing intervention by the government in the form of wage control. (This is not to imply that the German labor market is completely unhampered — jobs are cartelized by industry each with its own wage controls. While this cartelization is not perfect, it does at least recognize that a one-size-fits-all minimum-wage policy is not optimal for the whole country.)

As an example of the German approach to wages, consider the case of a construction worker. In eastern Germany this worker would make a minimum wage of around €9 per hour. His counterpart in western Germany would earn considerably more — almost €11 an hour. This difference allows for productivity differences to be priced separately or local supply-and-demand conditions to influence wages. Working for five days at eight hours a day would yield this German worker anywhere from €360 to €440.

It is obvious that the German weekly wage is almost as high as the monthly Spanish one. What is less obvious is why Germans do not move their facilities to lower-cost Spain.

As the old saying goes, "the more expensive you are to fire, the more expensive you are to hire." If a Spanish company decides to lay off an employee, the severance payment for most labor contracts (a finiquito in Spanish) will amount to 32 days for each year the employee has worked with the company. Although this process is not simple in Germany either, there is no legal severance requirement that companies must pay to redundant workers. The sole requirement is for ample notice to be given, sometimes up to six months in advance. If a Spanish company hires a worker who does not work out as intended, a substantial cost will be incurred in the future to offload the employee. Employers know this, and when hiring workers they exercise caution accordingly, lest this unfortunate and unplanned-for future materialize.

These factors make the perceived or expected cost of labor at times higher in Spain than in Germany, despite the actual monetary cost being lower in euro terms. This effect has been especially pronounced since the adoption of the common currency over a decade ago. As we can see below, the average cost of German labor is largely unmoved since 2000, while Spanish labor has increased about 25 percent over the same period.

When hiring a worker, the nominal wage is only half the story. The employer also needs to know how productive that worker will be. Even after we factor for the extra costs on Spanish labor, a German worker could be more costly. A firm would still choose to hire that worker if his or her productivity was greater.

As we can see in the two figures below, over the last decade a large divergence has emerged between the two countries. While German productivity has more or less kept pace with its small increases in wage rates, the Spanish story is remarkably different. Productivity has lagged, meaning that on a real basis Spanish laborers are much more costly today than they were just 10 years ago.

Of course, boom bust policies have also contributed to such imbalances. The EU integration which had the ECB inflating the system essentially pushed Spanish wages levels up substantially, thereby overvaluing Spanish labor relative to productivity and relative to the Germans and to other European nations…

In his book The Tragedy of the Euro, Philipp Bagus mentions a similar phenomenon. Bagus points to the combination of (1) the rising labor costs that result from eurozone inflation and (2) divergent productivity rates between the countries as a source of imbalance. Indeed, inflation has been one driver of rising (and destabilizing) wages in the periphery of Europe, and especially in Spain. Others include, as we have noted here, minimum wages, regulatory burdens, and severance packages that increase the potential cost of labor.

In either case the effect is the same: wage rates do not necessarily reflect the labor itself, but rather the regulation surrounding it. In Spain, this translates to noncompetitive wages. It is important to remember, though, that this does not imply that the labor itself is necessarily uncompetitive — it is price dependent after all.

Every good has its price, even labor. When prices are hindered from fluctuating to clear markets, imbalances occur. In labor markets those imbalances are unemployed people. Policies such as a one-size-fits-all minimum wage and high mandated severance packages keep the price of Spanish labor above what it needs to be to clear the market.

Until something is done to ease these policies, Spanish labor will remain uncompetitively priced. Until Spanish labor costs can be repriced competitively, Spain's masses will need to endure stifling levels of unemployment.

The only solution to the current crisis is to allow economic freedom to prevail. Of course, this means less power for the politicians and their allies which is why they won't resort to this. Their remedies will naturally be worst than the disease.