Why Spain’s in worse shape than Greece

By Felix Salmon
May 19, 2010
Martin Wolf's latest column:

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Note the circular reasoning in Martin Wolf’s latest column:

Greece is likely to restructure its debt at some point, as John Dizard has argued in the FT. That would not be the worst outcome. Once a country is in the “junk bond” category, no reputation is left.

Or, to put it another way, Greece got downgraded because it is likely to default, and it is likely to default because it got downgraded. This is yet another reason to start ignoring credit ratings.

The main point of Wolf’s column is a very good one:

European orthodoxy is that the crisis is, at root, fiscal. Marco Annunziata of UniCredit summarises it in a recent note: “In hindsight, it seems obvious that the flaw in the eurozone’s institutional setup is both extremely serious and extremely simple: first, a currency union cannot work without sufficient fiscal convergence or integration; second, the eurozone has been unable to create incentives for fiscal discipline.” Mr Annunziata’s chart shows that this view is wrong. Just consider the frequency of breaches of the rules requiring fiscal deficits of less than 3 per cent of gross domestic product. Greece is a bad boy. But Italy, France and Germany had far more breaches than Ireland and Spain. Yet it is the latter that are now in huge fiscal difficulties.

The fiscal rules failed to pick up the risks. This is no surprise. Asset price bubbles and associated financial excesses drove the Irish and Spanish economies. The collapse of the bubble economies then left fiscal ruins behind it.

It was the bubbles, stupid: in retrospect, the creation of the eurozone allowed a once-in-a-generation party.

This, in hindsight, was the biggest weakness of the Maastricht rules, capping debt at 60% of GDP and deficits at 3%. It’s not that the rules were broken: it’s that they were insufficient to prevent the kind of debt-fueled boom which leads inevitably to a fiscal crisis. As Wolf points out, the countries in fiscal trouble, like Spain, aren’t necessarily the ones with the highest sovereign debt ratios: they’re the ones with the highest debt ratios overall, including private debt. (Spain’s public debt is just 56% of GDP; its private debt, however, is 178% of GDP.) And private debt was never included in the Maastricht rules.

In a way, Greece has it easy: a sovereign default and devaluation solves a lot of its problems at a stroke. Spain, on the other hand, has a much tougher task ahead of it, since private-sector defaults won’t make the country any more competitive. And it’s already got unemployment over 20%. Only tough structural reforms have any chance of working, and those will take a long time, and face enormous political opposition. As Andrew Eatwell says:

Having squandered the opportunity to embark on unpopular economic, labour and pension reforms when his popularity ratings were relatively high after the 2008 general election –a period in which he fervently denied that Spain was facing an economic crisis– Zapatero now faces the prospect of tackling those issues while trailing the main opposition centre-right Popular Party in the polls and with a string of potentially tight regional elections around the corner. Necessary but unpopular measures may therefore be put on the backburner or at least kept to a minimum for fear of a voter backlash that could cost the governing Socialist Party dearly in regions such as Catalonia, where the Socialists lead a coalition government and elections are due this autumn. Zapatero also faces a general election in early 2012.

With regional governments accounting for 57 percent of total public spending in Spain, there is a serious risk that national interests and the economy as a whole may find itself subordinated to entrenched regional interests, crowd-pleasing promises and partisan politics.

All of which is different only in degree, not in kind, to what we’re seeing in the US right now.


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If only Milton Friedman were alive today.

He would be shouting from the rooftops that we (the world) need Friedmanite helicopter drops and tax cuts financed out of printed money.

Moving debt from one place to another just cannot work any longer. Sovereigns need to delever. The private sector needs to delever.

The only was for this to happen is for the monetary base to increase dramatically.

It won’t be inflationary because the debt overhang is gigantic all over the world.

Posted by DanHess | Report as abusive


You mean like this? Page 10 (Monetary Base Growth Rate and Inflation)
http://research.stlouisfed.org/publicati ons/mt/20100501/mtpub.pdf

How do you get velocity to pick up? The rate is still declining in the U.S.

The recent PPI and CPI figures suggest even this mammoth increase in the monetary base may not be enough to prevent deflation.

Posted by david3 | Report as abusive

@David3 –

We have to look at the dollar velocity in a global context.

The world is aging rapidly and this is particularly true in the wealthier countries.

In young societies the natural money velocity is higher as new households are ramping up their borrowing for houses, educations and so forth. In older societies, the natural money velocity is lower as mature households are not borrowing and are instead paying off debts and saving for retirement. In a mature society, the average desire to borrow will be much less, naturally.

The solution should not be to try to get velocity / leverage higher. Simply accept that in a mature older society, it will be lower. Consequently, the monetary base will have to be much higher to avoid deflation.

What I think we are seeing is the cumulative effect of millions of rational older people all over the world trying to simultaneously hold a lot of cash for their retirement. There isn’t enough cash to go around for this purpose.

Posted by DanHess | Report as abusive


Your understanding of credit ratings relationship to the market is wrong. First the market treated Greece as AAA for many years even though it rated A by the three agencies. Now the market is more bearish than the agencies as only one agency has it in speculative grade.

Also I am having a hard time following criticism of agencies. You think it will default and blame the one agency for thinking the same thing you do. They just cant win with you, now can they? In fact you seem to be completely ignorant of the fact any rating, anywhere can be criticised like any editorial can be criticized. It can be too high, too low, too volatile, too slow, too quantitative and too subjective. Rarely though do I see criticism that takes both sides of these dichotomies and not even notice the contradiction. Bravo, that takes chutzpa.

Second, if ratings had no impact on the market than , you could argue they are useless. Of course you took the other side of the argument and said since they impacted the market, they are dangerous. I bet you, if there was no market reaction to the Greek downgrade, you would have ran a piece arguing the other side without any intellectual qualms about it.

Third, simultaneous causation around ratings is a problem if agencies were not aware of it and downgraded it several times in a week. That is not case with Greece. If S&P was wrong then speculators would have driven the spreads back to where they should be. Not all serious money is constrained by ratings. A constraint that the agencies themselves do not like either by the way and is not their fault.

Look Felix, if wondering why agencies have so much power, its because unlike the rest of the media, we have criteria to make our opinions. When we perform an analysis we stick to the criteria. We have a track record which we publish. You on the other hand pull it out of your ass. And I bet you if we were to create a track record for the media, I am sure it would perform worse than rating agencies. The media can easily run agencies out business if they did these things, but they wont because its boring and bruising on their egos. Your entertainers, not analysts.

Also Felix your piece Re-REMICs singled out the wrong analysts. If you, Bloomberge and Calculated Risk wish poor opprobrium, rightfully so in this case, on the analysts, you should have done it on the New Issue Analysts. The Surveillance Analysis, the people you singled out, were doing their job. In fact you would not even know about this if did not tell you, you should be thanking them. What you should have done was singled out the ratings you thought were wrong and then found the New Issue Analyst who made that rating and embarrassed them. Preferably with some analysis of your own.

Posted by RHS | Report as abusive


Older folks aren’t the only ones holding cash.
Excess bank reserves are extemely high.
http://research.stlouisfed.org/fred2/ser ies/EXCRESNS
Depository institutions are doing this with a good reason. They cannot afford to make consumer loans in a probable deflationary enviroment and many B/S items have not be marked down.

All this expansion in the currency base (which I would agree seems necessary) only has brought about flat-flation.

A system built on credit, needs an expansion of credit. Hence, we need a pick up in velocity.

Posted by david3 | Report as abusive

Felix, did you suddenly forget the existence of feedback loops?

Circular reasoning isn’t a problem when describing feedback loops. An increased liklihood of default should lower a credit rating, and the lower rating feeds back and further increases the liklihood of default. Yes, there are also other factors at play. Did you want to see an exhaustive list?

Posted by crazynutjob | Report as abusive

Along these lines, I kind of found it odd that Enron was ever downgraded to BB (if I remember correctly) when I thought it was fairly well known that a downgrade to junk would trigger all kinds of solvency demands that they couldn’t meet. If you’re a rating agency and know this, don’t you just go straight to C?

Posted by dWj | Report as abusive


It seems there is an economy-wide distaste for leverage right now. Is there anything wrong with that? For most of American history, growth was gangbusters and leverage was less.

It seems that the big losers if the economy was less levered (balanced by a bigger monetary base) would be banks that profit from lending.

Some new currency base need to get straight into the hands of consumers (i.e. money-financed tax cuts and helicopter drops). Suddenly delinquincies would go down, impaired assets of banks would heal. Indeed banks would be able to start lending again.

This western standoff is silly and getting old.

Posted by DanHess | Report as abusive

Well, the Economist blog Charlemagne totally busted you as a doomsayer.

I think you may be one of Taleb’s empty suit economist who thinks he knows the future.

Posted by lubumbashi | Report as abusive


Indeed, rating agencies have a record, and it’s hard to imagine a more dubious one, as these organizations failed totally.

The problem is neither Greece nor Spain: It’s the very economic, political and social fabric of the EU as an organization, and of its member countries on an individual basis.
Everyone’s intentions were good, and the vision was beautiful and exciting, but they no longer can be sustained economically, unfortunately.
The European system is neither productive nor competitive enough for today’s world. The European way of life and standard of living are unrealistic.
Euro socialism should evolve rapidly into a more competitive form, or the union would disintegrate.

Posted by yr2009 | Report as abusive