Wednesday, 18 April 2012

Spain. IMF.

Mr Market has got something right
You will not often catch me saying something positive about the large majority of financial market participants. In the past couple of days, I have found several pieces that have left me thinking whether the markets are actually getting something right.

In Spain, all signs point to disaster. The story is well-known by now. A host of weakly banks have fuelled a housing boom. The growth falls, property prices begin to fall, banks end up in deep trouble, and that accelerates the economic downturn. Government finances deteriorate sharply. Add Spain’s notoriously ineffective labour market.

In Berlin, Paris, and Bruxelles, politicians are still shocked that Greece was “forced” into a de facto bankruptcy. The response is that the market “attacks” are best countered by draconian austerity measures.

The markets now appear a good deal more sophisticated than that. Bond markets are not afraid of government deficits as such. Bond markets are afraid of losing money. That leads to the critical point: Markets are not afraid of the Spanish budget deficit, but they rightfully fear that a German-style austerity policy will make things worse and lead to a “death spiral”, which eventually increases the default risk.

So far it appears that this analysis is better than the one made by the European politicians: in order to meet the EU demands to the budget deficit in 2013, the Spanish government introduces policies making it close to impossible to reach the goal.

Suddenly I find myself siding with the bond markets. Weird feeling, indeed.

Has adjusted its growth forecast for the EU-zone upwards. From -0.5% to -0.3% in 2012. Wow, let’s have a party! This is entirely for public consumption. No economist worth his salt believes that forecasts can be made that precise (and in 98% of the cases they are wrong anyway).

The most important is that IMF strongly pushes the European politicians to make it their “overarching priority” to prevent a renewed escalation of the debt and growth crisis. IMF also tells Europe to get more busy in resolving the problems in the banking sector. IMF identifies two major obstacles to a resumption of normal growth in the Western economies, fiscal consolidation and bank deleveraging. I totally agree.

In the cases of USA, UK, Spain, and Denmark another factor is at play, a heavy increase in household debt related to property investment, all happening while property prices were booming. That complicates the situation in those four countries. In the US there is no political consensus to fight the budget deficit and hence no austerity. In Denmark the government debt is sufficiently low that dramatic action can be postponed. But have a look at UK and Spain.

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