In order to partially mitigate the full effects of the monetary crisis, the European Central Bank (ECB) has decided to lend as much as it can to the affected countries in, well, Europe. The ECB flooded borrowers quite literally with money to withstand the blow of the crisis, conducting what could be the most massive money-lending spree to date. It was so massive, some analysts consider it massive to a fault; after all, too much lending is risky business; what if the ECB runs out? This is pure and unadulterated doom to our European friends.
Still, the ECB couldn't stand idly while debt-stricken countries teeter on the edge of bankruptcy. the central bank boldly conducted two long-term refinancing operations to support the ailing nations. However, the future seems bleaker and bleaker.
THE high is over. The European Central Bank’s two long-term refinancing operations (LTROs) in December and February saw commercial banks borrow over €1 trillion ($1.3 trillion) of three-year money at the ECB’s main interest rate, which it had cut to 1%. Ostensibly a scheme to keep euro-area banks afloat, the LTROs also boosted flagging public-debt markets in the zone’s southern periphery, as banks used some of the cash to buy high-yielding bonds. That effect has faded.
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The good news; the European bonds are steadily yielding. We turn our attention to how Spain is holding up.
Spain’s ten-year government-bond yield has been rising since the second tranche of three-year ECB cash was doled out. This week it reached almost 6%, the highest level since November (see chart 1). The U-turn owes a lot to the shifting dynamics of the euro-zone bond markets, which have also affected Italy.
The bad news; time is running out. First, we have the delicate bond market:
Start with the bond-market dynamics. With tacit support from regulators, the stock of government bonds held by Spanish and Italian banks rose by €122 billion between November and February. Prices surged and yields fell. Hedge funds which had sold borrowed bonds in the hope that prices would fall were forced to buy them back. The rally lured others in.
Coupled with the futile attempts of hedge fund managers to mitigate inflation in bonds is a horrific revelation; the ECB may not be able to lend again.
“The minute the ECB says ‘no more,’ the bank bidder is lost,” says a hedge-fund manager.
So far, the bond market is riddled with anxieties about buying and selling.
Brokers are less willing to take bonds off sellers’ hands in the hope that buyers eventually turn up, says Andrew Balls of PIMCO, a fund manager. In thinly traded markets, bond prices can suddenly shoot up if only a few investors take fright and start selling.
Despite the possibility of salvaging the bond markets in a quicker time, brokers, bond sellers and buyers, as well as investors are afraid to take the risk in fear of losing more than what they can afford. This does not help the case of Spain, especially when Spain is so dependent on bond yielding to get by its huge debt. To make things worse, however, the government isn't exactly up to the task of keeping Spain together.
The clumsy handling of Spain’s 2012 budget may have persuaded some to sell. The newish Spanish government delayed it until after local elections in March; it also announced that its deficit target would be 5.8% of GDP, not the 4.4% agreed with European leaders (the compromise was a goal of 5.3%). The budget minister, Cristóbal Montoro, and the economy minister, Luis de Guindos, “contradict each other all the time”, complains a Spanish economist.
Yet Spain has deeper problems than muddled messages. The 2011 budget deficit was 8.5% of GDP, not the goal of 6%, in large part because of overspending by Spain’s autonomous regions. The economy is in recession—industry shrank by 5.1% in the year to February according to figures released on April 11th. Attempts to cut the deficit by 3.2% of GDP in a year will make things worse. Reforms to the jobs market, making it cheaper to fire workers and easier to set pay locally, will benefit Spain’s economy in time but not now.
Yet Spain has deeper problems than muddled messages. The 2011 budget deficit was 8.5% of GDP, not the goal of 6%, in large part because of overspending by Spain’s autonomous regions. The economy is in recession—industry shrank by 5.1% in the year to February according to figures released on April 11th. Attempts to cut the deficit by 3.2% of GDP in a year will make things worse. Reforms to the jobs market, making it cheaper to fire workers and easier to set pay locally, will benefit Spain’s economy in time but not now.
The Spanish government just can't stop overspending which adds extra debt on the huge one they owe already. Aside from internal conflicts between politicians, the key sectors in the Spanish economy are starting to dwindle, with the hopes of reaching the target deficit percentage getting slimmer and slimmer. It can be argued that the government might be responsible for wasting the money lent by the ECB, forcing the Spanish economy to race against time; bond yields versus increasing debt, with the possible inclusion of interest rates from creditors.
As if things couldn't get any worse, it was discovered that Spain's net investment deficit, comprises 93% of its Gross Domestic Product (GDP).
To complicate matters, much of Spain’s huge private debt is owed indirectly to foreigners via its banks. Spain’s net investment deficit—the sums owed to foreigners by firms, householders and the government, less the foreign assets they own—comes to 93% of GDP, the cumulation of a long series of current-account deficits.
This seems to be a perfect storm of debt for Spain, something that can seriously hurt the credibility of the said country in repaying what is due. In all likelihood, Spain couldn't hold up on its own, and so several economic figures came up with suggestions.
Spain and Italy could not live with today’s borrowing costs for long unless the outlook for their economies were to improve dramatically. So they may have to look to outside help. But it would be hard for the ECB to sanction another LTRO so soon, reckons Laurence Boone of Bank of America. The ECB could restart direct bond purchases: Benoît Cœuré, a member of the bank’s six-strong executive board, suggested on April 11th that it might, which helped push Spain’s bond yields down a bit. But that would make existing investors worry more about subordination to the ECB in the event of a restructuring. In any case Mario Draghi, the bank’s president, has recently said high yields are the bond markets’ way of asking governments to implement promised reforms.
The Economist speculated that Spain can turn to the benefits the other affected countries receive, but the bailouts might not able to cover another ailing country. The article ended with an ominous prediction.
A more likely outcome is that Spain is eventually forced to draw on the shared rescue fund to recapitalise its banks, which might in turn take pressure off its sovereign-borrowing costs. Meanwhile, some have turned to the next trouble spot. “France is our cheapest and biggest short,” says one hedge-fund manager.
The way I see it, the efforts of the government and key investors might not be enough; otherwise, it might take a long while for Spain to get back on its feet. The plausible choices of actions are quite limited, given the possible consequences of reckless decisions.
Perhaps it's time to let out the daredevil in the private sector. Right now, the best bet Spain has to stay upright is the yields from government bonds. However, the bond market isn't looking so pretty because people are afraid to take risks. However, if people just sit still, then Spain is left at the mercy of altruists willing to lend a hand. I believe the Spanish people can make a difference here. They can try purchasing bonds and holding on to them. The last thing the bond market needs is stagnancy. Even small bonds count; as long as many citizens are willing to participate. Make the bond market look healthy, and maybe, just maybe, more foreign investors might gain the incentive to join the fray.
I won't recommend that ECB conduct another LTRO. They should maintain their reputation as lender of last resort and so must recover for the time being. It can also participate in direct bond purchasing to pump oxygen to the gasping bond market. The private sector, with rational risk-taking, can turn out to be Spain's savior, and who knows, the rest of Europe.
Meanwhile, the Spanish government must ensure one thing, and it's quite obvious; they must do something about their overspending habits. There is a need to implement stricter auditing and sound fiscal policies to maximize what remains of the government funds while keeping borrowing at minimum. If the government is feeling up to it, it can apply its diplomatic skills and ask creditors to temporarily freeze the accumulation of interest rates as they accelerate the accumulation of bond yields. They can even go so far as to ask some creditors to cancel debt, but, given the dismal state of the affected parties, this scenario isn't likely to happen.
Undoubtedly, Spain, together with the rest of the world, is being haunted by the euro crisis. However, just like how lore has come up with weapons against ghosts and creepy crawlies, there are always solutions available if countries are willing to withstand this economic crisis, provided that they are willing to take a few risks every now and then.
As if things couldn't get any worse, it was discovered that Spain's net investment deficit, comprises 93% of its Gross Domestic Product (GDP).
To complicate matters, much of Spain’s huge private debt is owed indirectly to foreigners via its banks. Spain’s net investment deficit—the sums owed to foreigners by firms, householders and the government, less the foreign assets they own—comes to 93% of GDP, the cumulation of a long series of current-account deficits.
This seems to be a perfect storm of debt for Spain, something that can seriously hurt the credibility of the said country in repaying what is due. In all likelihood, Spain couldn't hold up on its own, and so several economic figures came up with suggestions.
Spain and Italy could not live with today’s borrowing costs for long unless the outlook for their economies were to improve dramatically. So they may have to look to outside help. But it would be hard for the ECB to sanction another LTRO so soon, reckons Laurence Boone of Bank of America. The ECB could restart direct bond purchases: Benoît Cœuré, a member of the bank’s six-strong executive board, suggested on April 11th that it might, which helped push Spain’s bond yields down a bit. But that would make existing investors worry more about subordination to the ECB in the event of a restructuring. In any case Mario Draghi, the bank’s president, has recently said high yields are the bond markets’ way of asking governments to implement promised reforms.
The Economist speculated that Spain can turn to the benefits the other affected countries receive, but the bailouts might not able to cover another ailing country. The article ended with an ominous prediction.
A more likely outcome is that Spain is eventually forced to draw on the shared rescue fund to recapitalise its banks, which might in turn take pressure off its sovereign-borrowing costs. Meanwhile, some have turned to the next trouble spot. “France is our cheapest and biggest short,” says one hedge-fund manager.
The way I see it, the efforts of the government and key investors might not be enough; otherwise, it might take a long while for Spain to get back on its feet. The plausible choices of actions are quite limited, given the possible consequences of reckless decisions.
Perhaps it's time to let out the daredevil in the private sector. Right now, the best bet Spain has to stay upright is the yields from government bonds. However, the bond market isn't looking so pretty because people are afraid to take risks. However, if people just sit still, then Spain is left at the mercy of altruists willing to lend a hand. I believe the Spanish people can make a difference here. They can try purchasing bonds and holding on to them. The last thing the bond market needs is stagnancy. Even small bonds count; as long as many citizens are willing to participate. Make the bond market look healthy, and maybe, just maybe, more foreign investors might gain the incentive to join the fray.
I won't recommend that ECB conduct another LTRO. They should maintain their reputation as lender of last resort and so must recover for the time being. It can also participate in direct bond purchasing to pump oxygen to the gasping bond market. The private sector, with rational risk-taking, can turn out to be Spain's savior, and who knows, the rest of Europe.
Meanwhile, the Spanish government must ensure one thing, and it's quite obvious; they must do something about their overspending habits. There is a need to implement stricter auditing and sound fiscal policies to maximize what remains of the government funds while keeping borrowing at minimum. If the government is feeling up to it, it can apply its diplomatic skills and ask creditors to temporarily freeze the accumulation of interest rates as they accelerate the accumulation of bond yields. They can even go so far as to ask some creditors to cancel debt, but, given the dismal state of the affected parties, this scenario isn't likely to happen.
Undoubtedly, Spain, together with the rest of the world, is being haunted by the euro crisis. However, just like how lore has come up with weapons against ghosts and creepy crawlies, there are always solutions available if countries are willing to withstand this economic crisis, provided that they are willing to take a few risks every now and then.
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