Spain's Manufacturing Contraction Accelerates in September

By Edward Hugh: Barcelona

Well here's the first BIG news from yesterday's global manufacting PMI reports - Spain's manufacturing contraction accelerated in September. Of course, how could it be otherwise. But I do wish all those people who are still in denial on what is now an all too evident reality would finally come out of the woodwork and do something. If Spain really goes down, it will drag the rest of the Eurozone with it, like Moby Dick, taking Ahab Trichet and his crew careering down to the murky bottom with him. Brussels, Frankfurt, you need to react. Zapatero has to go, and he has to go now. Spain needs a set of rational policies to deal with the crisis, before things really get out of hand.


Spain's September PMI

Key points:
- The Rate of output contraction accelerated.
- First reduction of new orders in three months.
- Job shedding intensified.



September data pointed to another deterioration of operating conditions in the Spanish manufacturing sector. Both output and employment fell at faster rates, while new business decreased for the first time in three months. The seasonally adjusted Markit Purchasing Managers’ Index® (PMI®) – a composite indicator designed to measure the performance of the manufacturing economy – dropped to 45.8 in September, representing a marked deterioration of business conditions. Moreover, the pace of decline accelerated to the fastest since June. Output contracted solidly in September, and at a sharper rate than in the previous month as demand in the sector decreased. Production has now fallen in nineteen of the past twenty months.

Falling demand was also a key factor in the twenty-fifth consecutive fall in employment as firms adjusted their staffing levels accordingly. Moreover, the rate of job cuts accelerated to its fastest since June. The lack of demand within the sector led to a further shortening of supplier lead times as pressures on vendors continued to ease.

Commenting on the Spanish Manufacturing survey data, Andrew Harker, economist at Markit, said:

“The latest Spanish manufacturing PMI data make sorry reading as the sector took a turn for the worse. With firms unable to pass on rising raw material costs to clients due to a lack of demand, manufacturers’ profit margins are likely to come under increased pressure in the coming months. The labour market shows little sign of recovery as firms continue to cut jobs at a sharp pace.”

Demand Deficiency in Spain

Spain is now suffering from an acute deficiency in internal demand. The latest retail sales figures (July) continue to confirm the ongoing decline, with sales down 1.2% month on month over June, and 6.47% over July 2008. Sales are now down 10.11% over their November 2007 peak. Spanish construction fell again between May and June, despite the omnipresent plan E, falling 0.2% on the month. Year on year figures are now virtually meaningless for an industry which had been contracting for three years as of last July, but from the peak activity is now down by around 30 - that is it is the industry is now roughly 70% of what it used to be, and there is still a lot further to go. Industrial output continued to fall in July, and was down 17.4% year on year, which means it has now fallen nearly 35% % from the June 2007 peak.


With the collapse in internal demand Spain's government has been compelled to come in to support the economy. Such intervention is entirely justified, since without it Spanish living standards would be falling dramatically, but behind the spending there should be a plan, and this is really what is missing in the Spanish case. Spain's economy has become demand deficient because all the main groups of domestic economic agents are steadily trying to cut back on spending and debt, and the export oriented sector, after years of neglect and internal price inflation, is now just not competitive enough to make up for the gap. Worse, given this, investors are not exactly queueing up to put money into new export capacity, which would be about the only other source of growth the Spanish could look for at this point.

The Unemployment Just Climbs And Climbs

Spain's unemployment hit 18.9% in August - the highest in the whole EU - according to the latest Eurostat data. According to Eurostat there were 4.348 million unemployed in Spain in August. This means the country should pass the 20% on the wy up around November, and of course it will simply keep on heading up and up until someone finally does something. I guess we could pass 5 million around February perhaps, if there aren't any accidents on the way, that is.




Europe Must React

Decision making in modern Europe stands on two legs. On the one hand, as far as fiscal decisions go we have the European Commission whose powers are shortly due to be extended by the all important Lisbon Treaty. Even this rather modest step forward, however, remains bogged down in dispute. On the other hand when it comes to monetary policy the powers of the central bank (the ECB) are severely restrained (at least in theory) by the terms of the Maastricht Treaty which as well as creating the bank also established the EU itself as a legal entity. The present Spanish government is - like all EU governments - being given a wide margin of manoeuvre in how it handles the crisis by both the long suffering EU Commission and by the ECB - there is scarcely an option given the degree of sovereignty the member states still retain - but this degree of tolerance cannot last for ever, and the present increase in the Spanish debt will surely not be allowed to survive unchecked into 2010 and beyond. So push is steadily coming to shove. Yet meanwhile, from their ivory Towers in Brussels and Frankfurt those who are really responsible for Europe's decision taking are relegated to the frustrating position of being mere spectators, forced to come in after the horse has bolted and extinguish the fire but without real access to the direct policy levers which would have enabled them to put the blaze out before it got out of hand. Would somebody please like to do something here, before we pass the point of no return. Hello-o, anyone there?

Spain's Current Account Deficit Folds In On Itself

by Edward Hugh: Barcelona

Spain's current account deficit fell to 2.064 billion euros in July from 7.752 billion euros a year earlier as imports tumbled, according to the latest Bank of Spain data. This is a very sharp and dramatic fall, and my guess is that at this rate the gap will close in six months or so, which will be a very strong correction, and potentially very painful for Spanish living standards.




In fact the Spanish current account deficit ballooned in the "good years" - from around 3% of GDP at the turn of the century, to around 10% in 2008 on the back of large external borrowing to acquire housing units and land, and the inevitable imports which were sucked in to fuel the consumption boom.




The main reason for the fall was the reduction in the trade deficit, as imports plummeted an annual 29.5 percent amid weak domestic demand, while exports fell a lesser 15.8 percent. As Dominic Bryant, Chief European Economist at PNB Paribas puts it - "The 4.2% fall in GDP tells only half the story. Final domestic demand has dropped by about 7.5% – the only reason GDP held up was because the collapse in domestic demand led to a 22.3% fall in imports" (Quarterly data from Q2) . That is, the drop in living standrads is actually much sharper than headline GDP numbers actually show. And this is with a government running a fiscal deficit of 10% of GDP plus this year. Heaven knows what the fall would have been without this.









The figure compared with a 4.2 billion euro current account deficit as recently as May.


Also included in this series is one of the key charts of the present spanish crisis, gross external debt - now at roughly 158% of GDP, and of course rising as GDP falls.






But the really important data point is net external debt which is currently around 83% of GDP, and again rising.





The net debt chart illustrates quite clearly why the ability to issue debt denominated in your own currency is one of the most treasured possesions of any sovereign state. Basically Spain's debt is in euros, and since the Spanish treasury and central bank have no capacity to create euros, or to devalue the currency, the only way to correct Spain's distortions is via and long slow and hard process of ideflation (also known by the more politically correct title of internal devaluation, which doesn't make it any easier or less painful as we can see now in Latvia).

But this is just the problem, since with deflation the external debt to GDP ratio will rise - that is Spain will become MORE indebted, and this is just one of the unfortunate consequences of having gotten to where Spain has now arrived.

I estimate this internal devaluation can be in the order of 20% (see Real Effective Exchange Rate chart and the comparison with Germany).




Basically, as the trade deficit has persisted and the current account deficit has grown so the financing to square the account, which was basically the funds needed to fuel the mortgages, also grew. Of course, now that Spanish people are saving rather than borrowing, there is no accounting item to offset the negative CA balance, the external position becomes unsustainable, and the whole Spanish economy folds in on itself, valiantly as the government may try to keep the bicycle moving by borrowing and borrowing.

Also of note here is the way the deficit on the income account has simply grown. This is the outflow of interest on all the borrowing, and now runs at nearly 3 billion euros a month, although it has been falling slightly as interest rates have come down. This item is the first thing that will need covering once Spain has a trade surplus. And of course the cost of servicing the debt will go up, as interest rates rise, which is one of the reasons that the greatest threat to the Spanish economy comes at the moment from a recovery elsewhere which leads to a sharp rise in interest rates. Remember also that over 85% of Spanish mortgages are variable, so the cost of servicing these will rise, even as salaries and the capital values of the homes which go with them fall.

What a total, complete, utter and absolute mess!

Chief IMF Economist Oliver Blanchard said yesterday that the Fund now expect Spain to return to growth in 2011. I'd like to know where he thinks the growth is going to come from, quite frankly I really would. I don't see any sustainable return to growth till Spain's export industries become competitive again. In the best of cases we will simply sink to the bottom, and stay there in an "L" shaped recovery, while the banks steadily blow up one after another under the weight of the mounting pile of non performing loans.

And of course, we may not get the best of cases, since the worst thing about a financial crisis, is that when a country enters one the cost of servicing the debt (interest payments) also rises, as credit downgrades come, and investors demand more risk premium. This is what normally sends a country spiralling out of control once a critical threshold has been triggered. Spain, of course, can't be that far from this threshold at this point, which is why it would be better that those in Brussels and Frankfurt who can see this should be doing something now to grab Spain's administration firmly by the scruff of the neck in order to move things in another direction before the inevitable happens. Or does the ECB plan to keep vitual quantitative easing - Japan style - running as far ahead as the eye can see?