Facebook Blogging

Edward Hugh has a lively and enjoyable Facebook community where he publishes frequent breaking news economics links and short updates. If you would like to receive these updates on a regular basis and join the debate please invite Edward as a friend by clicking the Facebook link at the top of the right sidebar.

Tuesday, June 24, 2008

The ECB - All Talk, No Walk?

by Claus Vistesen Copenhagen

A good relationship need not, at each and every moment in time, be characterised by passion and desire. In fact the relationships which best endure the relentless erosion of time are often those where mutual respect and acceptance of difference form the cornerstones. Although I am, I have to admit, by no means an expert on this topic I would imagine that some such rule of thumb is embedded at the heart of many a marriage councilors' cookbook of fundamentals. Every chain has its breaking point however, and it seems that the central bankers' hitherto passionate love affair with inflation targeting is beginning to suffer the unforgiving attrition of time as the chill winds of the global credit crunch and rising inflation start to make the going rougher. At least it is hard to avoid the impression that certain that as some of the key components of the global economy are now noticeably losing momentum, our central banks have begun to diverge on a number of crucial issues, and in particular on the key question of the day: how to break lose from the growing yoke of stagflation.

In an immediate market context there can be little doubt that the dominant discourse amongst market participants - and at a second order level amongst monetary policy makers - has shifted sharply of late from how to sustain growth to how to contain inflation. As I argue in more detail here, this is the context in which the hawkish message which has been emanating from recent ECB meetings should be seen. Yet, I also think that the ECB is acting as the proverbial marriage councilor here by attempting to solidify the bonds between central banks and a nominal inflation target. There certainly would seem to be a need for such an arbiter.

Regular readers of the RGE blogs (and in particular the Latin American vintage) will already be pretty familiar with the comings and goings of Brazilian monetary policy and the ongoing search for an adequate output gap with which to steer the setting of nominal interest rates. In Turkey, on the other hand, monetary policy makers have simply opted for an upward adjustment of the inflation target whereas others have headed off in the opposite direction and decided to simply jettison some variants of core inflation as formal policy targets. Generally speaking, the ECB seems to have decided to situate itself in poll position in its attempt to stand its ground on the inflation issue, with Fed chairman Ben Bernanke moving in with a much more hawkish tone hot on the heels of the ECB rate hike threat, whilethe Bank of Canada also decided to shelve what was otherwise thought to be a done-deal of a rate cut (see Morgan Stanley's Joachim Fels and Manoj Pradhan for a neat overview).

Astute watchers of global monetary policy will already be experiencing more than a faint whiff of deja vu here, since it was only as recently as the start of 2006 that global central banks decided to embark on what was then widely held to be a joint hiking exercise to try to soak up all the "excess liquidity" which seemed to be in danger of flooding the global coffers.

Yet, strong head winds in some key economies - and in particular the emergence of the sub-prime crisis last August - effectively prevented that particular monetary policy expedition from getting too far beyond basecamp, and since August 2007 the Fed has been heading full speed reverse gear down towards sea level, while the BOJ was never really able made it off dry land. Only the ECB has not (yet) opted to yield to the inclement weather and head back down the mountain. In fact, and as per my earlier reference to recent events, the ECB is now trying to re-muster the forces, and animate its peers to make one more attempt to scale the north face of the mountain, and most notably in this regard seeking a tandem assault in association with its erstwhile colleagues over at the US Fed.

However, a strange bout of amnesia seems now to have many pundits and analysts in its grip. In particular, the Federal Reserve has been taking a lot of flack for being so aggressive in lowering interest rates, in turn fueling and, according to many, unduly fomenting an "undesireable" appreciation of the Euro, not to speak of throwing more fuel on the fire of those global inflationary pressures. In fact, the Fed has been coming under more or less constant criticism since the start of the current easing cycle for acting recklessly in the face of mounting food and energy price rises which threaten to take us all back to that illusive 70s show we all so dearly wish to avoid attending.

The funny thing here is that if the US is now getting flack for pouring too much liquidity into the global economy few seem to be mentioning the real ultimate liquidity provider; Japan. What is most noticeable here is the speed with which one scapegoat for excess liquidity (Japan) has been traded for another (the US). You really don't need any kind of ultra sophistocated time machine to work yourself back the mere 18 months or so which now separate us from the days when G8 statements were focusing most of their attention on the Yen and when it was the BOJ's near ZIRP which was under permanent scrutiny.

At the present time the global economy needs and wants a strong USD, or at least this is the message which has emerged from recent G8 meetings. However, if this is the objective then the G8 discourse on the USD has not exactly been effective, and could almost be termed counter productive. Indeed, if a stronger dollar was what you were looking for, it might be thought that stern talking from Bernanke before Trichet started mentioning rate hikes might have been a better way of playing it.

Of course, things are never that simple, and G8 statements should never be taken at their face value, since in the context of the current global imbalances the argument for a weaker USD is pretty overwhelming. The main issue is really that the argument for this weakening being largely vis-a-vis the Euro is a lot less convincing. Thus, for as long as China and the Petroexporters remain ardent in continuing with their pegs it is hard to see how the USD can fall without some currency (in this case the Euro) or currencies (a basket perhaps) taking up the baton from the US by providing some sort of additional external deficit cushion with which to suck up all that excess liquidity. Indeed it could be argued that the US, by not (in any practical sense) giving a damn about the USD, is precisely trying to ease itself out from beneath the yoke of global consumer of last resort under which it has been labouring.

The reason I am emphasising the above point is simply that I think excess liquidity has deeper structural roots than simply the presence of low interest rates. More specifically; I think that there are reasons that run well beyond mercantilism why some countries (e.g. Japan) simply cannot muster the strength to raise interest rates. Indeed, in a world of excess liquidity where money goes for yield raising interest rates is not a straightforward remedy (as Stephen Jen nicely argues in this timely piece).

If you add to this new global dimesion in regional monetary policy the fact that price pressures are largely of a cost-push headline nature (domestic demand in the Eurozone has been weakening steadily for six months now) inflation targeting clearly becomes a difficult stunt to pull off. Nowhere is this truer than in the Eurozone where inflation targeting has also, since the Fed decided to let go of the reigns, been associated with a marked appreciation of the Euro in the expectation of a tectonic shift whereby (at least in the eyes of one group of analysts) the Eurozone could take over the US role as the counterweight in a revamped version of Bretton Woods II. This old narrative of decoupling was of course, from the start, on shaky grounds.

Stepping out for a moment from our brief helicopter tour of global monetary policy, where does all of this leave the ECB's present policy decisions, and what are the challenges these are likely to meet going forward?

Certainly the ECB is expected to raise rates come next meeting. Anything else would be a mistake in terms of continuing to nurture the still fragile credibility of the institution. We should remember here that the last time the ECB all but pre-committed to a rate hike back in September 2007, they had to abandon. Save for a financial market meltdown I don't think the ECB will be deterred this time around. The question really is how far the ECB will dare to take the hiking process and, crucially, whether the ECB will continue to raise into what is now clearly becoming a German slowdown (and this, and this)? What we do know is that so far the ECB has not been moved by the unfolding economic problems which beset two of the Eurozones "big four": Italy and Spain. Consequently, and as the Italian statistical office manged to wind itself back up to start delivering timely data, we recently learnt how Italy just managed to avoid a recession (for now) with flat lining growth rates over the last two quarters. As regards to Spain I don't think I need to say much but to point to Edward's elaborate piece posted at this space. The situation is grim indeed and Spain has without a doubt suffered a structural break and what awaits now is a long grind to rebalance the economy.

This brings us to another of the ECB's problems; internal Eurozone imbalances. This has been the subject of a whole series of posts and already a considerable amount of ink has been spilt scrutinising these issues. Contrary to what many think the problem is not so much the business cycle itself which is fairly synchronized (yep, Germany will fall too). Rather it is the level of growth as well as the divergence in external balances which is the problem. These imbalances or rather the perception of them is creating all kinds of kinds of issues; some taking the form of theatricals and some are more serious. In the first category voices have been reporting how German consumers were reluctant to receive and hold Euro notes from Spain, Greece and Portugal. Chuckling now are we? Well, you shouldn't. More seriously then was the recent news that the Spanish treasury announced that it would no longer accept Italian government paper as backing for short term loans. Arguably this could resort under the theatricals label too but it does latch on to the specific problem with Italy, that of the +100% debt to GDP ratio which, with the current and indeed potential growth rate, and the liabilities entailed by having a rapidly ageing population, looks set to climb and climb, recent promises to the contrary by the newly elected Italian government notwithstanding.

Imbalances or not the Eurozone is now decisively slowing and the ECB should be happy that the next interest rate meeting is not far away. Moreover, the most recent commentary from ECB VIPs appear decidedly out of touch with the underlying reality. In this way, council member Lorenzo Bini Smaghi was quoted saying that a hike of 0.25% would be just what was needed to bring inflation back into check within a period of about 2 years. The idea that a 25 basis point hike would constitute the holy grail to bring balance and prosperity back to the Eurozone economy is highly questionable I think, and in fact is almost laughable in its "political correctness". In fact, one can only interpret such comments as a sign that the ECB won't raise beyond the pre-committed hike come next meeting, which really adds a dimension of farce to the whole sabre rattling process. How can you possibly hope to steer expectations towards the idea that you will do whatever is necessary to bring inflation under control, if some of your key actors are stressing that what you are really doing is going through the motions? Don't threaten to go to work on those pumping irons if you haven't been to the gym of late would be my advice.

In a more immediate context the ECB's timing seems, being rather tongue in cheek for once, to be quite impeccable. The latest indicators from the Royal Bank of Scotland showed that manufacturing activity in France, Italy and Spain contracted in June. Only in Germany did the manufactures manage to eek out a small increase. Furthermore, the latest GFK consumer confidence reading from Germany also showed decline. Lastly, and to top off the cake with the proverbial cherry official German authorities predicted recently that the economy would mostly likely contract in Q1. In itself, this is not so strange after the bumper reading of 1.5% q-o-q in Q1. However, it does also represent and interesting factoid in the sense that the ECB will now have to decide whether to raise rates into what is obviously becoming a German slowdown too. In Germany's case the export link with Eastern Europe is particularly important. Any problems in Eastern Europe which go beyond the simply trivial and the German export machine will have to wind down, and wind down significantly.

Walking the Walk?

It is very difficult to see how the ECB can (or would want to) avoid raising rates at this week's meeting. Even though virtually all the incoming data since the last meeting has been pretty abysmal and despite the dovish hints from Bini Smaghi and others, I don't think the ECB will ditch a pre-commitment again. This is far from certain however. The most recent remarks from Trichet have pundits scrambling for a foothold; did he downplay the hawkish stance or reinvigorate it? In general, investors seem to be smelling a rat when it comes to an ECB raising more than once. Needless to say I also think that this a dangerous road to take. The point here is not simply a result of the fact that the raise comes at a time when the cycle has most decidedly turned, but because the ECB may well end up with a lot of egg in the face for what comes next. Essentially, I don't think the ECB can do much to halt the inflation currently rolling (or more aptly sailing in?) but one of the longer term consequences of this weeks decision may well bethat the ECB is forced to keep rates much lower for much longer on the back of the mess which is about to unfold.

As I noted after the last ECB meeting I actually respect the ECB for trying to steer global monetary policy makers to stand up to inflation. Yet, the world is not as simple as the ECB sees it I think, and most emphatically, in a stagflationary environment with wide global interest rates pursuing an inflation target may end up being counterproductive. More specifically, the risk is that the stick is bent too far, and the danger is that the end result may be to push an economy like Italy (and perhaps Spain) into outright deflation, in which case all sorts of ghosts about the Eurozone's viability will emerge. Ultimately, the ECB's task is not an easy one and the principal reason is that the bank is not presiding over one homogenous economy; the sooner this fact is incorporated into the policy process, and tools are designed to handle it, the better.

Friday, June 20, 2008

GEM Working Paper: Carry Trades, Risk Aversion, and Negative Betas

By Claus Vistesen Copenhagen

[Update: We have had to remove the paper since the (few I imagine) downloads ate up the bandwith too quickly; email this site if you want a copy]

Here at Global Economy Matters we also aim to present research of a more academic nature. This post and the subsequent paper it refers to is an example of this. In general and because the paper is presented openly you are free to use it as you see fit but I would of course appreciate a backline and -link if and when you decide to plug it. Considerable work is needed before it can be submitted anywhere but it is a good first take I think. I should also note, although it is pretty clear in the paper itself, that all disclaimers apply regarding the use of the paper's findings for trading purposes. In short; don't be knocking down my door when you get your margin calls.

What is it about then?

Well, the story begins back when I wrote a piece on the USD/JPY and how I related daily movements in the currency pair with movements in equities. More specifically, the piece homed in on the idea of carry trading currencies as so-called risk sentiment gauges in financial markets; especially since the credit turmoil began. The idea here is very simple in the sense that more than notional evidence suggests how the JPY (and indeed carry trade crosses in general) exhibit negative correlations and betas with risky assets.

Over the course of the past couple of months this story has also brewed elsewhere. In particular, the point about how the JPY is negatively correlated to equities was taken a step further when Greg Mankiw suggested (here too) that the Yen in fact is a negative beta asset. As per usual when Mankiw massages a topic it prompted many responses (e.g. here) but more importantly it alerted me to a more general inquiry in to what it actually means that this 'carry trade' behavior is embedded in the market. In short, this is the topic of my working paper entitled: Of Low Yielders and Carry Trading – the JPY and CHF as Market Risk Sentiment Gauges. (.doc)

Here is the abstract and conclusion:

Ever since the credit turmoil took hold in the summer 2007 financial markets have been on the brink. On this background, strong evidence is provided for the idea of carry trading currencies as risk sentiment gauges in the market. Using daily returns from 2006 to May 2008 this paper shows how traditional carry trading currency crosses (mainly JPY and CHF crosses) exhibit strong negative correlation and beta values with three key equity markets (SP500, Nikkei 225 and DAX 30). This paper also shows how this relationship, in relation to specific currency pairs, has been particularly strong since the advent of the credit crisis. This paper also homes in on the idea of carry trading currencies as means of hedging equity returns and fluctuations on a daily basis. At an initial glance such relationships are however bound to be highly spurious. As such, this paper also attempts to qualify its findings in a more general and solid empirical context.


The principles of carry trading and how to bet against the patchy theory of uncovered interest rate parity are well known. However, carry trading and the effect of investors pursuing it have almost turned in to an urban legend on financial markets where many derivative effects of ‘carry trading behavior’ are cited. This paper has attempted to scrutinize one of the most widespread of these. It has consequently been shown how the JPY and CHF, often cited as the traditional funding currencies in carry trades, exhibit strong negative correlations and beta values to equities. This lends evidence to the idea of the CHF and JPY as risk sentiment gauges in the market. A conclusion important to this argument was also that the negative beta values and their explanatory power increase in the context of an exogenous event which brings volatility and uncertainty to the market.

Regarding the potential for investors to use carry trade crosses to hedge equity positions the evidence appears strong. An initial glance will thus reveal that most currency pairs not only exhibit negative correlations with equities but also how they posses significant, in statistical terms, negative beta values. This suggests that investors can indeed cover equity positions by buying low yielding currencies in times of volatility. Yet, these conclusions need to be taken with a pinch of salt. First of all, the study is based on daily returns which means that only investors of a certain pedigree would be able to benefit from these correlations (i.e. investors trading on a daily basis). Moreover, it is not certain that such correlations can be assumed to persist. In this regard it is important to watch the currency pairs with significant negative beta values and relatively high coefficients of determinations across the two periods (GBP/JPY and GBP/CHF to the DAX 30 and EUR/CHF and AUD/JPY to the Nikkei 225).

Further studies on this topic should attempt to widen the time span of the sample to gauge the general validity of the results as well as attempt to make forecasts of daily exchange rate returns based on the relationships cited above.

Now, the conclusions are operationalized through regression analysis and correlations and I would not consider the paper heavy in quantitative terms. However, these things are always subjective since academic economists will probably find it too light on the math (I should have used GARCH, tested for unequal variance in the context of the Chow Test etc, I know :)) whereas others will shun it because of the statistical operationalization of the argument. More interesting is the validity of the results. I mean, it was only a few days ago when Macro Man smugly noted how bad hedges were falling apart for good people citing the exact same relationship (or more aptly its spuriousness) which I attempt to formalize in my paper. So it could seem as if I am too late with my findings in that the horse has already bolted across the meadows; or perhaps, to stay in Macro Man territory, it was always a pink flamingo? I will let our astute readers figure that one out for themselves.

Lastly, and specifically in the context of the JPY the paper also has implications for the conceptualization of those famous fundamentals driving the JPY. On the one hand we have the steady and relentless decline in Japanese investors' home bias and subsequent outflow of funds (remember to read Stephen Jen here too). Just this week JPMorgan's chief currency strategist noted how the Yen could decline to 114 against the USD on outflows alone. On the other hand there is the effect I latch onto in my paper by which risk sentiment and risk aversion drives the movements of funding carry trade currencies. When the first effect stops and the other takes over (and vice versa) is difficult to say but for investors it is important know them both.

All tables and results are available in the paper which can be downloaded above. If you want the actual spreadsheet(s) drop me a line and I will ship them over. Remember also that this is a first draft which basically means "not finished" and lots of typos. I will probably go over it in a month or so and refine it. Also, my impression is that a similar study has to exist within the vaults of some of the IB's or hedge funds' research edifices or is this just too common knowledge to jot down?

Sunday, June 8, 2008

Trichet Turns up the Heat

By Claus Vistesen: Copenhagen

Well, well, the plot thickens does it not? Certainly yesterday's more than strong hint (introductory statement and Q&A session here) that the ECB will raise rates come July is a clear sign that central banks are not at all sure about what to do. Some are revising up their inflation targets, some are searching for an output gap to justify why rates should be kept lower than the current and rising double digit chiffre, and some again are contemplating whether in fact a strong currency is the right remedy in the current context of stagflation. Ah yes, the wonders or more precisely perils of inflation targeting in a world of stagflation and excess liquidity on a relentless hunt for yield.

Within this patchwork of central bank decisions you could argue with some reason that the ECB, of all the rugged participants and tarnished knights, have managed to steer clear of dragons and ghosts with more elegance than its peers (I still think that a behemoth lures around the next corner though). The market discourse certainly seems to be riding this wave at the moment or at least some parts of the punditry is. Consequently, Trichet was branded with the label of 'leading the shift from growth to inflation' amongst global monetary policy makers in a piece by Bloomberg Friday morning. I am not sure the ECB and its governing council would admit to be leading anyone or anything but it is undoubtedly true that the market focus, as of late, has shifted from growth and credit turmoil to inflation. And within this shift the ECB's hawkish stance has clearly been solidified. Ultimately and initially it is in this light that I think the ECB's decision to dip its toe at Thursday's meeting should be seen.

However, as a dear econblogger of mine likes to point out; history does not repeat itself but it rhymes.

It would thus be a good idea to step back and look how we actually got to where we are today. This is obviously a rather open and cryptic question but in this context I am specifically talking about the Spring of 2006. Back then it was widely held in the market place that the G3 central banks led by Greenspan, Trichet, and Fukui would embark on a joint hiking trip to mop up excess liquidity. And so they did. The BOJ ended ZIRP and both the ECB and the Fed also commenced a tightening cycle in an attempt to normalise interest rates. Yet, the rest as they say is history and whatever we think would be a 'normal' interest rate it did not really go as expected. In Japan the continuation of deflation has kept the BOJ from raising more than 50 basis points, in the US a housing crash prevented the Fed from keeping interest rates at 5.25% for long before they were slashed and in the Eurozone the ECB's tightening cycle ground to a hold. One reference frame in which to slot the current situation would then be to ask whether in fact the ECB is trying to recall its peers to the hiking trail and whether it will be successful?

In this regard, one thing is certain; the ECB is not leaning so much against the wind this time around in its adamant and lingering focus on inflation. What the ECB is leaning on however is a rapidly slowing economic edifice which is only brightened by an outlier in the form of the Q1 GDP figures. Other than that, the economic news from the Eurozone leading up to Thursday's pre-announcement of a July raise has not made for pretty reading. For a complete overview I am directing you to me and Edward's aggregate Eurozone Watch blog as well as Edward's latest post on Spain over at GEM. But do take a look at the following list of news points and; German industrial production down in April, Eurozone retail sales down, aggregate services indices recording stall speed etc. On this background the ECB is obviously playing tough in its focus on inflation over economic fundamentals and once again trying to emphasise the need to get inflation back in check regardless the collateral damage.

I have argued several times that it is far from certain the higher interest rates can quell inflation in a world where excess liquidity goes for top line yield. Moreover, and as Macro Man is bend hell on hammering down lately the exercise of inflation targeting itself may essentially be impossible or in fact counter productive since raising nominal interest rates will only suck up even more purchasing power and as such act as a magnet for the global flow of funds. Yet, this need not be a problem for the ECB as such (for the countries in EMU perhaps?) but it requires that others are in on the idea that rates should go up. Otherwise you end up with a lot of action but very little effect which may even end up being counter productive. Remember please here that if the ECB is serious here it could with all likelihood take the EUR/USD upwards towards 1.70 and this is not accommodative for easing inflationary pressures. The point here is that even if imported inflation goes down oil, energy, and food will still rise much faster given the current market dynamics. In this light alone I do think that the ECB is playing a very high stakes game here.

Another theme I have been following is the distinction between core and headline inflation. Interestingly, it is precisely this distinction which has grown quite unfashionable as of late and which recently prompted the Fed chairman Bernanke to voice concern about rising headline inflation not to mention the flurry in Eastern Europe about revaluation, a Brazilian rate moving towards 15% and now an ECB reverting to its hitherto hawkish path.

I still think the graphs tell an important story. First of all it goes without saying that inflation indeed is far above the 2% threshold set by the ECB although the increase seems to be reaching one of those famous plateaus. The increase in core inflation however is coming down across all big four Eurozone countries and the 1.1% estimated in Germany for April is not exactly wheelbarrow territory I would think. In fact, the evolution in Germany is beginning to look curiously like the one in Japan with core inflation heading towards deflation and headline creeping ever upwards. Nothing 'unexpected' (you gotta love those Bloomberg headlines) here however since if we think about the demographics of these two countries it is not so difficult to understand which also means that when exports falter in Germany the real action begins and in this light I am waiting with much excitement to see how credible the ECB's commitment, not to mention our dear Mr. Weber's, really is.

I continue to hold the position that the ECB is embarking on a very dangerous path here since what goes up usually comes down. Here I am not talking about headline inflation in particular but rather about the dynamic by which the ECB may be forced, on the backside, to hold interest rates much lower for much longer to accommodate the mess which is about to unfold in the Eurozone. Of course, such a strategy might not be chosen but I just don't see anyway out of the fact that EU27 now is slowing considerably both in real and potential figures. In general, it now seems that with Spain falling the only real domestically driven economy in the zone is France with the rest of the gang either already, in the context of Germany, or attempting to become, in Italy and Spain, export driven. In such a context it does not exactly make sense to raise rates to become the new global consumer of last resort which I think we can all agree is quite out at this point. Another point I have been emphasising is the Eastern European connection. Admittedly, this is not something which the ECB is forced to, let alone obliged, to take into account but it is nevertheless important. Basically, we need to understand that at the moment Eastern European countries are not only struggling with rapidly overheating but also slowing economies all at the same time as many are nominally pegged to the Euro. Any hiking campaign by the ECB is likely to further put the squeeze on CEE economies and not only the peggers since one can easily concur, I think, that if the ECB hikes countries such as Hungary and Ukraine who recently loosened their pegs will have to follow the ECB if their currencies are not to plummet. If we think about this for a moment I actually do not think it would be entirely uncalled for that the ECB take this into account or at least that it came out with a clear message to those Euro members in spe still struggling to keep up with the yoke of convergence demands.

A Credible Threat?

So, where the hell do we go from here? In my Industrial Organization installment at the Copenhagen Business School they tried to teach something about credible commitments in the context of game theory (you know, those decision trees). I think it is reasonable to ask whether in fact the ECB is serious here? It would serve us to remember that last time we got a pre announced raise back in August 2007 it was shelved due to the breakout of the subprime crisis. In the current market context it is not difficult to imagine that such an event may occur yet again. However, somehow the ECB remains more sturdy this time around and it would be unwise not to expect a raise come July. There are many ways in which to see the ECB's sudden reversal. Personally, I actually do think that the ECB is trying to steer global monetary policy makers and not least the Fed into re-igniting the hiking trip which was begun back in 2006. In this context of course there is the little problem in Japan where I feel rather certain that the new governor would be more than a little bit weary to re-embark on such a trip at this point. Moreover, we also have the small detail of who exactly is going to shoulder the new Bretton Woods II (or III?) edifice if China and the petroexporters do not budge. Surely, India, Turkey and Brazil are doing their part but a stronger USD at this point would also increase the purchasing power of US consumers thus risking to bring us right back into the mess.

No easy solutions here it seems and consequently I remain skeptical of the ECB's ability to follow through here. The key for me is the extent to which the ECB will raise into what is now obviously becoming a German slowdown too. How will Weber for example act when it becomes clear that the German growth spurt for all intent and purposes ended in Q1. This also brings us to a wider question which I have asked on may occasions. How much should the ECB raise here? Clearly, a 25 basis point token move only to see the economic edifice crumble around it would leave the ECB rather pathetic I think. Is the ECB really serious here then? Over at Eurointelligence a move to 4.5% is being pencilled in but clearly that would not be enough, now would it? And while I know that we are still missing those markets I suggest that we go about and find them or more appropriately realise that inflation targeting is not as effective as the textbooks prescribe.

Ultimately, I respect the ECB for its attempt to steer markets more than the note above implies. However, given that the only policy tool at its disposal is the nominal interest rates and given the global economy with its carry trade driven/excess liquidity driven nature I think it is a very dangerous road to take. Sometimes bold decisions are needed and I sure hope that the ECB knows what it is doing but I have my sincere doubts.

Thursday, June 5, 2008

Spain Unemployment May 2008 and the Worsening Real Economy

by Edward Hugh: Barcelona

Unemployment rose in Spain last month for the first time in the month of May since 1979. The Spanish newspaper ABC notes in passing that the Spanish Economy Minister Pedro Solbes has finally managed to describe the situation as ‘serious’.

The number of people unemployed in Spain increased by 15,058 in May to a total of 2,353,575, according to the Spanish labour office INEM yesterday. The number of registered unemployed at the end of May was thus up by 0.6% from the previous month.

By sector, unemployment in the services sector was down 0.2% and also dropped 0.1% in agriculture. On the other hand, unemployment in construction was up 4.6% and was also up 0.8% in industry.

Year on year the rate of increase has been rising steadily, and was up 19.38% in May 2008 over May 2007.

OECD Outlook

The OECD also forecast that Spanish growth will more than halve to 1.6 percent this year and fall to 1.1 percent in 2009 as Spaniards cut spending and public accounts fall into deficit, the OECD said on Wednesday. I think from everything we are seeing these numbers are too high, and I think if you look at the very serious outlook for the financial sector in the second half of this year (see this accompanying post here) it is very hard to be so optimistic about short term stabilisation. This is going to get worse, a lot worse, before it starts to get better.

The OECD also forecast that the knock on effects of the abrupt fall in house building will send 2009 unemployment to 10.7 percent from 9.7 in 2008. Again this is begining to look very optimistic from today's data. Unemployment on the EU harmonised methodology is already up around 9.6% and seems set to continue to rise.

Also, perhaps here it is just as important to consider total employment as it is to think about unemployment, since so much of Spain's GDP growth in recent years has been labour input driven and not productivity driven. In fact total employment seems to have peaked in Q3 2007 at 20.511 million. The question is now just how far and just how fast is this going to come down. To get an idea the rate of increase has been dropping by the quarter since the maximum rate of acceleration with seemed to be a year on year 4.91% in Q1 2006. By Q1 2008 we were at a y-o-y increase of 1.66% and we are of course dropping. Since there is very little productivity change going on here the rate of change in the employed population will probably constitute a pretty good proxy for the rate of GDP growth.

The OECD also forecast that Spain's public sector budget will fall into a deficit and be equal to approximately 0.3 percent of GDP in 2009, following five years of surpluses, due to a 10 billion euro economic stimulus package, lower tax receipts and higher infrastructure spending. They anticipate the economy will be sluggish for 18 months (I think we are into something much longer term than this).

Spain's inflation, which is currently among the highest in the euro zone at 4.7 percent, should finish 2008 at 4.6 percent before easing to 3 percent in 2009, the OECD said (this may well be much more realistic).

The OECD also expect credit growth to ease as Spanish banks, especially small savings banks or cajas, struggle to raise external capital (and of course this is already happening to some consderable extent). House prices will feel downward pressure as more new homes enter the market with construction firms finishing off the large number of housing projects begun in 2007. Investment in machinery and equipment, one of the most robust areas of the Spanish economy, is expected to contract on weaker demand, waning confidence and more restrictive financial conditions the OECD said.

The OECD also expect Spain's current account deficit, the world's second largest (after the US) in absolute terms in 2007, to remain around 10 percent of GDP over the next two years as higher import prices and external debt service payments offset a fall in imports and slightly stronger exports.

Consumer Confidence Hits New Low

Spain's consumer confidence index fell again sharply to 56.4 in May from 63.8 in April, the lowest level since the indicator began in September 2004, the state financing agency Instituto de Credito Official (ICO) said.

The indicator looks at consumer confidence in the current economic situation and future economy in terms of the country, the home and employment.

The index May figure reflects declines in all categories from April, with sentiment on Spain's economy down 6.7 points, on employment down 2.8 points and on household economy down 6.2 points.

Consumer confidence was 39.3 points lower in May from a year earlier, when the consumer sentiment index stood at 93.0.

There is also increasing evidence of a widening divergence between the big four economies in the 15-nation eurozone with Germany and France continuing to prop-up a contracting Italy and a Spain which is in "free fall". This divergence is only going to add to the headaches over at the European Central Bank, which continues to be worried about the ongoing high inflation. After a drop in April, the Business Climate Indicator (BCI) stabilised in May, with the Economic Sentiment Indicator (ESI) remaining unchanged in the Eurozone at 97.1. But as we can see from the chart below, the picture is very different from one country to another.

Car Sales

Spanish car sales fell almost a quarter in May, offering further evidence the Spanish economy is cooling far faster than expected - Spanish dealers sold 116,108 units in May, 24.3 percent fewer than a year ago, the Spanish car industry association ANFAC said earlier this week. In the year to date, car sales were down 14.3 percent at 587,407 units, almost 100,000 less than a year ago and the lowest total since at least 2002.

Retail Sales

Spain's retail sales fell 3.4% in April and continue to fall.

Industrial Output

Spanish industrial output adjusted for calendar effects fell 2.6 percent in March from a year earlier, according to the latest data from the National Institute for Statistics (INE). INE also said consumer goods output fell 4.6 percent from a year earlier, while capital goods output was down 0.4 percent. Intermediate goods output fell 6.9 percent, while energy goods output rose 10.2 percent.


Spain's services sector shrank for the fifth month running in May, although the pace of contraction was slightly less than in April according to the May NTC Purchasing Managers Index. Staffing levels in the sector contracted at sharpest pace of the 9 year survey record and companies were pessimistic on the outlook for one-year ahead. The PMI for the Spanish service sector stood at 43.3 in May, compared with 42.5 in April and 56.2 in May 2007.

For the first time in the near 9-year survey history, companies in the Spanish services sector were pessimistic overall regarding the outlook for activity in a year's time. The Business Expectations Index registered 49.3 from 54.7 last month.

"Cost pressures and faltering demand led many firms to believe that conditions could worsen in the year ahead," said Nathan Carroll, economist at NTC Economics.

Prices charged by the Spanish service providers fell in May, in a positive sign for Spanish inflation - the highest in the euro-zone - as companies slashed margins in an attempt to re-ignite demand. But this squeezed profit margins further for companies already crushed by higher input prices led by soaring energy costs.

Brazil Central Bank Raises Interest Rates to 12.25%

by Edward Hugh: Barcelona

Brazilian central bank President Henrique Meirelles and the other seven members of the central bank board raised the benchmark lending rate a half percentage point yesterday to curb accelerating inflation fueled by higher food costs and record consumer demand. The central bank increased rates to 12.25 percent from 11.75 percent.

"Continuing the adjustment process of the benchmark interest rate, which was initiated at the April meeting, the Copom decided unanimously to raise the Selic rate to 12.25 percent a year without bias" the bank said in a statement.

Henrique Meirelles also indicated policy makers are very likely to raise the benchmark lending rate further to contain inflation. The bank removed language from its April 16 statement saying it had carried out a ``significant part'' of the tightening process and in that sense the `rocess is much more ``open-ended.'' and the tightening cycle may well be longer than the previous statement indicated. The central bank are effectively going to increase the rate as much as they feel is needed.

Meirelles told the Brazilian parliament at the end of May that the bank will act to prevent rising wholesale industrial and agricultural costs from spreading to consumers as household demand expands at a record pace. The IGP-M inflation index, which has a 60 percent weighting in wholesale prices, rose to a three-year high of 11.53 percent in May.

Consumer prices had their biggest increase in four months in April on the back of of higher food costs. Consumer prices, as measured by the government's benchmark IPCA index, climbed 0.55 percent In April - up from 0.48 percent in March. Brazil's inflation rate in the 12 months to April was 5.04 percent.

Most of the macro economic indicators are showing signs of strong demand. Lending by banks has climbed at least 20 percent in each of the past three years. Retail sales jumped 11.4 percent in March, capping the strongest quarter on record. Industrial production jumped 10.1 percent in April from a year earlier, the highest in six months.

This picture is only completed when you think about the large inflows of funds Brazil is receiving at the present time. Brazil received $37.2 billion of foreign direct investment in the 12 months through April, a record annual inflow, and foreign exchange reserves were up to $195 billion in March 2008.

The half-point rate increase pushes Brazil's real interest rate, which is the rate after adjusting for inflation, to 7 percent, the highest among the world's leading economies.

Meirelles is also receiving significant backing from Brazil's President Luiz Inacio Lula da Silva who, after being re-elected to a second term in 2006, vowed to accelerate growth to a 5 percent annual pace through 2010. Economic growth accelerated last year to 5.4 percent and Brazil's economy grew at a 6.2 percent rate in the fourth quarter, more than twice the average pace of the past decade.

The principal problem facing monetary policy is that as interest rates rise external funds are attracted by the yield differential which can be obtained and this only adds to internal inflationary pressure.

The only real tools left to the government are institutional reforms to increase capacity and fiscal surpluses to drain some of the excess internal demand. Allowing the currency to rise further can also help, but again there is a delicate balance to be struck here between soaking up imported inflation and creating structural distortions in the development of the economy such that industrial growth is curtailed by problems created for manufactured exports by a strong currency and the excessive growth of financial services and construction fuelled by the availability of cheap borrowing (made possible by the achievement of investment grade) and the consequent acceleration of internal demand. Obviously we have just seen some of the difficulties presented by the end point to which this process can lead in the case of the US and we are currently witnessing an extreme case scenario in the case of Spain's current slowdown. Brazil needs to try to learn some lessons from what we have just seen. Attracting cheap finance on the back of "investment grade" securities is excellent if the underlying assets are "reasonably priced" - this is the hard part.

There is a real Scylla and Charybdis to be steered here between being export driven and excessive dependence on domestic demand, and I don't think anyone has found the "best path" here yet, but we do need to realise - as my colleague Claus Vistesen keeps emphasising (and see here for the Japanese case) - that someone needs to soak up the world's growing surpluses somewhere, and Brazil certainly seems to be one of the stronger candidates in the short term.

Brazil's politicians do seem to be on a learning curve here, and Finance Minister Guido Mantega, who only last February was questioning the need for more rate increases, this month reversed course and decided to cut the fiscal deficit at a faster pace to help rein in inflation. Yielding to calls by Meirelles, Mantega announced last week the government would cut spending by an additional 13 billion reais this year, boosting the budget surplus before interest payments to 4.3 percent of gross domestic product from 3.8 percent.

Monday, June 2, 2008

Japan's Savings - Going for Yield

by Claus Vistesen: Copenhagen

The idea of having a large pool of funds to place on the world's asset markets in order to livf off of the derived income seems alluring to most I think. In fact, you could argue that it is precisely this allure and many an economy's pursuit of it that is causing much of the current debacle in the global economy. In Japan's case we are arguing as a part of our ongoing observations that Japan is now dependent on exports. In reality Japan has been dependent on external demand to grow for some time now. More specifically we have, here at JEW, argued why we should look at Japan's age structure to find the principal reason as to why Japan has the growth profile it has. The point is simply that when the labouring cohorts of the economy are declining in number with such a pace as we are seeing in Japan domestic production and productivity will have to be channeled towards external demand. I see no coincidence in all this but a quite natural consequence of the fact that domestic capacity in Japan is now declining and will continue to do so for the immediate future. As such, if Japan is ever to keep the ratings agencies at bay and if Japan is ever going to have hope, even a fool's hope, of servicing the pension demands of her citizens it is necessary for the economy to be biased the way it is. Of course, and this I have been pointing out extensively, the problem is that Japan is not the only ageing economy and in fact if we extrapolate the demographic developments a bit we are going to end up with a lot of exporters and no one willing to run a respectable external deficit. This global bias towards one end of the intertemporal spectrum of the current account is a very interesting theoretical theme which I intend on investigating further as I go along. In a recent post I elaborate further on this topic and especially the following rather lenghty quote is important to take away in terms of my main argument.

"This 'crowding' of countries in one end of the intertemporal spectrum of savings/investment and consumption is not coincidental and perhaps most importantly it will result in important global externalities. The drivers of this tendency (to the extent that it exists) need to be found in terms of life cycle dynamics aggregated to population levels. At this point I feel that we are far away from really pinning this one down. However, one part of it is related to three potential hypotheses that I am working with in terms of consumers life cycle pattern. 1) people do not dissave to 0 since they do not know when they will end their existence. 2) Rising life expectancy will induce consumers to save more and longer during their life cycle. 3) Ageing societies are likely to, one way or the other, promote forced savings in order to ease the societal burden of the intergenerational skewness as the dependency ration rises. If we add this together with the decline in home bias currently observed in Japan (the oldest society on earth) we consequently run smack into the externalities I was talking about before. Consequently, if we go back to the point on intergenerational preference for spending we need to understand that ageing economies will indeed attempt to invest their accumulated savings. They have to in order to earn income but they cannot invest it in their domestic economies. Thus we have the externality in the sense that as the world ages we are likely to see a process by which more and more countries will develop a propensity to 'export' in order to sustain growth."

So, what does it mean to be dependant on external demand? Traditionally we think of Japan as being dependent on exports of tangibles but this does not represent the complete picture. To be sure Japan is extremely dependent on exports in the form of a trade surplus but on the margin another factor is important too; the income balance.

Whether the graphs above tell the story of an ageing economy is of course debatable. I clearly think it is and I believe that there are sound theoretical reasons back my thesis. This point notwithstanding we can clearly see how Japanese savers have stepped up their holdings of foreign assets and given the impressive growth of the global economy the income earned has certainly been quite respectable. However, why invest abroad when you can invest at home? Well, I have always answered that question above but two seperate headlines in Bloomberg very neatly sums up the situation. First, we learned from Bloomberg reporter Patrick Rial that Japanese companies lost investors a hefty $3.2 billion the fiscal year ending this April and secondly we got the news, referring to the charts above, that Japan was the largest holder of foreign assets in the world. I don't think it takes much of an economist to connect the dots here and if we accept the fact that Japan's deflation problem and its subsequent low interest rate are related to the country's demographic profile it should not be too difficult to see what is going on.

The graphs above will be familiar to many a financial trader as it shows the lingering negative trend in Japan's main stock index. Of course the second index could just as well have been made with 2003 as a starting point in which case we would be observing +100. In this light it will be interesting to see just how far the Nikkei will fall this time around as Japan enters yet another tough patch in terms of economic growth.

It is thus not so strange that Japanese savings are rather eager to go abroad and why we consequently have observed a very rapid decline of home bias amongst Japanese investors. However, this decline is not so much a story of equities but rather one of debt (0.5% interest rate remember) not least the samurai bonds; a topic which I have addressed on several occasions.

The graph above speaks a clear language I feel and even though the share of equities have nudged upwards recently the majority of Japanese portfolion investments still go into debt.
Lead by a suffering Citi Group in the wake of the credit turmoil the sale of yen denominated bonds is thus estimated to have tripled in 2007 from 2006. Part of this was no doubt due to the fact that spreads in Japan offered significantly more calm straits than the credit crunch ladden debt markets in Europe and the US but it is also a simple reflection of the fact that Japan has the spare capital. In this way and as a market mechanism Japan's role here is no different from when one of those much debated SWF dares to venture a stake in rebuilding the balance sheet of a tarnished knight from the US financial service sector. In the context of the credit turmoil Reuters also reported how market participants are well satisfied with the state of affairs;

Dealers in the Samurai market say investors remain keen to buy the bonds -- issued in Japan by foreign entities -- because of the higher yields they now offer and because they see little risk of big U.S. banks and investment banks defaulting.

We can always quibble about just how secure those US investment banks are (well, if Bear Stearns is anything to go by I would say very!) but from Japan's point of view and in the grand scheme of things with a debt/GDP ratio of 170% the income earned on these instruments are quite vital. In fact, notional evidence suggests that Japan may well be an asset managers wet dream in terms of securing funding. A Bloomberg piece fresh in off the wire consequently alerts us to the fact that hedge funds are also dotting down Japanese savings for a source of capital. Obviously, these money need to earn a return though and this is where it all gets very complicated since what happens when everybody wants to be Japan? Coupled with a reserves piling up in China and in the petroexporters' vaults hunt for yield and the subsequent low return and/or overheating are structural consequences for the growth path of the global economy.

A Tendency to Watch

I think that the points above represent important tendencies to watch for both theoretical economists and investors alike.

  • For acamedic wonks (such as myself in spe) I think that the idea of the intertemporal current account is important in terms of describing what is going on. More specifically I believe that the tendency of ageing economies to exhibit the same savings/consumption profile in terms of the trade-off between the two is important. If we look at the intertemporality as a spectrum we can say that as the global economy ages economies will tend to crowd in one end of the spectrum and I think that important externalities will arise as a result.
  • For investors and asset managers I don't think that the importance need much explanation. However, I do think it is important that investors think about narrating capacity and more importantly excess capacity in terms of demographic age structures. In the context of Japan it means that ageing economies can be a source of capital (hardly news at this point) but it also means that changing demographics in terms of age structure should be incorporated into the asset management framework.

Sunday, June 1, 2008

Are Spain's Bank's Facing A Short Term Liquidity Crunch?

by Edward Hugh: Barcelona

Last Monday morning when most of Spain's citizens were busy watch YouTube videos or TV coverage of Rodolfo Chiquilicuatre doing his buffoonery at the Eurovision Song Contest, many readers of the English speaking press were hard at it peering into another video, the one of the FT's Ralph Atkins interviewing Spain's representative on the ECB executive board José Manuel González-Páramo (transcript here, curiously whilst almost everyone in Spain seems to know who Chiquilicuatre is, almost no one has heard of González-Páramo).

The Spanish representative was busy trying to allay fears that European banks have become over-dependent on European Central Bank liquidity injections and in particular trying to deny that the Spanish banks are gearing their operations to take advantage of its extra help.(In other words while good Rodolfo was dando-nos a todos verguenza ajena, González-Páramo was simply doing his job, and dando la cara).

“I don’t think in any way the banking system is becoming addicted,” said José Manuel González-Páramo, ECB executive board member, in an interview with the Financial Times. “They are now behaving a little bit different than they were behaving before August 2007, but the reasons behind that are quite obvious to everyone.”
If González-Páramo was having to work hard to keep the Spanish end up, this was in part a response to the growing concern that Spanish banks are creating ever riskier collateral to swap with the ECB, far riskier collateral than the central bank ever envisaged (see below), that the ECB already holds too much risky collateral, and that the funding was being used to far to great an extent to keep "business as usual" going, rather than bridge finance to enable a sizeable restructuring of the Spanish economy. Just such a view was expressed earlier this month by Yves Mersch, Luxembourg’s central bank governor – who, like Mr González-Páramo, sits on the ECB’s governing council – when he indicated that the type of collateral now being accepted by the ECB was “a matter of high concern”.

Since the global financial market crisis erupted last year, finance houses have been able to fall back on the ECB’s liquidity operations, available to a large number of banks on the basis of a broad range of collateral, including some mortgage-backed securities. To address financial market tensions, the ECB has also altered the way it provides finance.

Slowdown in Bank Lending

Evidence of the difficulties that Spain's banks are having is everywhere. Take bank lending for example. According to the most recent data we have from the Bank of Spain, lending to Spanish households was up by 4.245 billion euros in March when compared with February, and year on year lending to households was up by only 10.6%.

I say "only" here since this rate of increase in lending is only about half what it was at the start of 2007, and as such it is only about half the rate of new mortgage generation that the extensive Spanish construction industry needs simply to keep turning over.

The reason for this decline in the rate of new lending creation is obvious: the liquidity crunch, which is now the principal reason why Spanish banks are steadily lending less and less extra money in new mortgages each month, although evidently since all of this is now producing a substantial slowdown in the real economy, with unemployment rising and take home pay under constant pressure from inflation we are steadily moving from a construction crisis fuelled by a lack of availability of funds for mortgages to one which will be increasingly driven by absence of demand for them as the "affordability" issue steadily locks-in on those who would like to buy their own home.

The fundamental situation is that since the Spanish banks are short of cash they are simply able to lend less. It is this, and not the 4% repo rate set by the ECB, which is the principal reason the value of mortgages created on urban buildings in Spain (at approximately 16,575 million euros) was down in March 2008 by 36.7% over March 2007. In housing, the capital loaned exceeded 9,975 million euros, 41.9% less than in March 2007. 105,608 properties were mortgaged in March 2008, a decrease of 37.77% over March 2007.

The Spanish banks are, of course, able to raise money, but much of this is on a short term basis, and not appropriate for long term lending on products such as mortgages. Moody's recently suggested that Spanish savings banks are trying to attract foreign investors (especially German pension and investment funds) with private placements of tailor-made securities. But such issues are typically in the 30 to 300 million euro range - a far cry from the earlier jumbo cedulas. In addition maturity on these securities is much shorter, typically three years. (To those readers who have no idea at this point what cedulas hipotecarias actually are, I would say fear not, since neither did I when I set out on this venture, but perhaps it is worth reading through my working notes on the topic since they may help you become just a bit more familiar with the meaning of an expression which is - unfortunately - only too likely to become as much a part of the 2008/09 economics lexicon as "sub-prime" was in the 2007 one).

Another strategy the banks have been using has been to issue short term (typically three month) paper, and there was roughly 90 billion euros worth of it outstanding at the end of March. Banks are also trying frantically to attract more deposits, and since the end of last year some 20 billion euros have been transferred out of investment funds into long term deposits. The however do not come cheap, and the price the banks are paying for this money is prohibitively expensive - some of it even pays 7% - for it to be used as a basis for mortgage finance, for mortgage finance since mortagages are still widely on offer for around 0.5% over 1 year euribor (or 5.25% or so).

Thus the problem for the banks is really how to find a stable long term source of finance for their mortgage business given the fact that the wholesale money markets have been virtually closed in their faces. In this connection the Financial Times's Leslie Crawford had a piece in the May Issue of Financial World which examined some of the funding problems the Spanish banks are having. As Crawford says "with every month that the capital markets remain closed to them, the problems of the Spanish banks grow more acute". And since we have no idea at the present time at what level Spanish property prices will finally settle (and thus what the true market value of the pool of mortgages which effectively backs the cedulas actually is) then it would seem that the day the doors will once more open again (at least at prices the Spanish banks would be interested in) is far from being at hand.

Crawford cites the Madrid based consultancy Analystas Financeros Internacionales (AFI) to the effect that during Spanish banks were raising approximately 40% of their funding requirements outside Spain at the height of the boom, as compared with only 15% in 2000-2001.

According to AFI foolowing the August blow-out the Spanish banks and savings banks did continue to issue residential mortgage backed securities (cedulas) in the second half of 2007 (to the tune of an estimated 50 billion euros, although this number seems rather high to me), but none of these were placed with external investors (since there were effectively no takers), but rather they were kept on the books for use in repo facilities with the ECB as needed.

Data from the Bank of Spain show that Spanish banks have doubled their share of the ECB's weekly funding auctions since August 2007 - up to 10% of the total from a previous 5% - and that in February Spanish banks borrowed 44 billion euro out of a total 442 billion euro.

The big issue is of course that there is now no market for the earlier jumbo bond offerings. Worse, many of the original jumbos were offered with maturities of between five and eight years. So these cedulas will effectively soon be coming up for rollover.

I would say that the greatest risk points for the Spanish economy at this stage are:

1/ the potential liquidity crisis which may be constituted by the need to refinance the cedulas.

2/ the potential increase in the quantity of bad debt provision which the Spanish banks may need to set aside as and when the builders themselves start going bankrupt in serious style. With anything up to an estimated 1 million unsold properties on the books in Spain at the moment, and with the banks being de facto owners of these properties through their financing of the builders, this avenue is the most important short term threat of debt delinquency, and not unpaid mortgages (IMHO). And the sums involved are by no means chickenfeed, and could well be very similar in magnitude to the quantities owing on the cedulas. ie the whole problem is very large indeed.

Of course later, as the financial problem ripples its way through the real economy, the ability of individual households to meet their mortgage obligations may well become a problem, but we are a long way from that at this point, and sufficient unto the day is the evil thereof is very much the case here I think.

AFI estimate that around 40 billion euros in cedulas and other bank debt come up for refinancing in the second half of 2008, that in 2009 this number will rise to around 80 billion euros, and that the number will remain high through 2010 and 2011. That is to say my rule of thumb guess that we may be facing around 300 billion euros in rollover issues (or around 25% of Spanish annual GDP) in the coming years does not seem to be too far off the mark. And as I say, we may need to make similar provision for equivalent exposure to bankrupt builders etc.

According to this report in El Economista the President of the Confederación Española de Cajas de Ahorro Juan Ramón Quintás has been in discussions with the Spanish government about the problems the regional savings banks are having and are going to have, and one of the solutions under discussion is that the fondo de Reserva de la Seguridad Social should buy bonos and cedulas to help with liquidity. Help! Well it's not my pension they may be about to start playing with, but still.