The Pain in Spain

Forget the downgrading of Spanish sovereign debt by S&P in Friday’s U.S. session. And forget the generally downbeat day stocks in America and Europe had to close out last week. The big factor on Aussie shares today took place late Friday afternoon right here in Australia when the Federal government escalated its media war against the mining companies. How will that play with investors in Australian stocks today?

Back to that in a moment. But first, from the damned-no-matter what you do file is Spain. The Spanish government has announced austerity measures to bring its public debt and deficit into line. On Friday after European markets closed, ratings agency Fitch said those measures would damage Spanish growth prospects. The country’s credit rating was downgraded.

On the surface, Spain’s debt levels don’t look as scary as those in Greece. Spain’s debt-to-GDP ratio is 53% with a deficit-to-GDP ratio of 11.2%. Both measures are higher in Greece. But Spain’s economy is much larger, about $1.4 trillion in GDP. And there are two big other problems, both of which stem from the nature of Spain’s credit boom.

The first is that the unemployment rate is already 20% in Spain. The real estate boom supported heavy building and construction investment along with lots of employment. Much of that is going away. According to the Associated Press, the total number of unemployed in Spain leapt from 1.7 million in the first quarter of 2007 to 4.6 million in the first quarter of 2010. Needless to say, it’s hard to contribute to economic growth when you can’t find a job.

But the bigger problem is the collateral of the banking system. Granted, this is not just a Spanish problem. But Spain’s 45 big savings banks are chock full of housing-backed collateral. Spanish house prices were the asset class that benefitted most in the credit boom. And now, that bank collateral is under pressure, which puts a government with comparatively modest levels of debt under even more pressure.

Mind you this is not an example of contagion. The debt disease is everywhere, from Europe to America to Japan and even here in Australia at the household level. Sooner or later, its symptoms – deleveraging, lower household spending, falling asset prices – start to show up. They show up when the cost of servicing existing debt becomes unbearable and the prospect of borrowing even more can only be realised by debt monetisation (the central bank buying government bonds).

That, we think, is the big underlying story to Europe’s woes. And it raises a question our colleague Porter Stansberry asked late last week: “How long will the capital markets continue to finance government borrowings that may be refinanced but never repaid on reasonable terms? And second, to what extent can obligations that are not financed through traditional fiscal means be satisfied through central bank monetization of debts – that is, by the printing of money?”

The answers to those two questions determine in what sequence you will inflation and deflation. Our view is that you’ll see more asset deflation (falling house and stock prices) until the government (in various countries) is compelled to support banks and households by buying assets with new money. But over what time frame this all plays out is another matter.

Meanwhile, back here in Australia, something extraordinary happened on Friday afternoon. The Australian website reported that Treasurer Wayne Swan, earlier in the month, applied for and received a “special exemption under national emergency powers to waive the government’s own advertising rules for a campaign against the miners.”

If we understand it correctly, the exemption allows the government to mount its own swift, tax-payer funded counter-message to the miners. Cabinet Secretary and Senator Joe Ludwig apparently had authority to grant the exemption under a special national emergency powers basis. Ironically, or hypocritically, it allows the government to avoid its own advertising rules in which it must have its ads vetted by an independent communications committee.

The Senator granted the exemption with the following statement:

Given that co-ordinated misinformation about the changes is currently being promulgated in paid advertising, I accept the need for extremely urgent action to ensure the Australian community receive accurate advice about the nature and effect of the changes.

As the changes also affect the value of the capital assets and impact on financial markets, I am satisfied that a compelling reason for an exemption exists, particularly given the nature and extent of misinformation against a backdrop of continuing market volatility.

Hang on! We thought the government had claimed that the resource super profits tax was NOT responsible for the fall in the Aussie dollar or mining stocks. It was all Greece to them. But if Wayne Swan filed this request on May 11th on the basis that the alleged disinformation by the miners was already affecting asset values, why did the government spend all last week saying no such had happened?

But this is more than a “gotcha!” moment. It’s the government taking its very public spat with the miners to a new level. And what it reveals is a fundamental disrespect by the current government for the private sector. That’s not terribly unique to Australia. Cash-strapped governments everywhere are ransacking the economy for cash.

However…it’s going to be pretty interesting to see what happens to the dollar and stocks this week. Markets in London and New York are closed Monday. When they reopen, who are they going to sell?

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

Leave a Reply

2 Comments on "The Pain in Spain"

Notify of
Sort by:   newest | oldest | most voted

Seems to me that if the RSPT is as great as the Gov’t has cracked it up to be, there wouldn’t be a need for a $38M advertising campaign to covince everyday Aussies that the RSPT is a wonderful thing. And surely the mining companies would never be able to sway public opinion otherwise?



Suggestion is to overlay the past two weeks Spanish Bank shares vs our ASX XXJ vs AUD-USD cross. Symmetry. Thats what you get with an asset deflating house of cards with phoney balance sheets pumped up by funny money.

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to