Arnold Kling  

Thoughts on Spain

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1. The Washington Post pushes the "austerity" narrative.


The economic debate consuming Europe comes down to the question of whether struggling countries should choose austerity by clamping down on government spending to rein in unsustainable deficits or pursue growth stimulated by more spending.

From that perspective, who would cut government spending? Ever?

2. Sober Look writes,


one of the major reasons the banking system is in trouble has to do with an unparalleled bubble that existed (and to some extent still does) in Spain's real estate markets. Spanish banks continued to fund developers to a much higher extent than other nations that also experienced a housing bust, namely Ireland and the US - even after 2009.

Pointer from Tyler Cowen. I can recall (no specific link, but you can Google Spain countercyclical capital requirements banks) that Spain was once thought to be a good example, because its bank capital requirements were counter-cyclical. Thus, capital requirements go up when times are good, which should be a source of restraint. There were economists proposing such a scheme for the U.S. My guess is that you won't hear much about that now.

3. John Mauldin writes,


the cajas, or Spanish regional banks, are worse than bankrupt. US banks are shut down when their nonperforming loans are at 5% of their capital. Spanish banks are at 20% and rising rapidly...This week the Spanish government basically nationalized Bankia, the nation's 4th largest bank, which had been cobbled together from seven failed cajas and given a large government guarantee and a €3 billion public-offering equity infusion. Only roughly half of its real estate loans are generating returns, and that is the number for public consumption.

Read the whole thing (requires free registration).

Mauldin's claim is that we are in what he calls the "endgame," meaning that the Keynesian option of increasing government borrowing is no longer available to European countries. The only willing lenders are banks, which in turn need to be propped up, and ultimately they can only be propped up by printing money.

My take-away from Mauldin is that, contra the mainstream media narrative, the real dilemma in Europe is not fiscal--deciding whether to maintain government spending or not. The real dilemma is financial--whether to recognize losses and absorb defaults (by both governments and banks) or turn loose the monetary printing presses.

What will happen to inflation under the faster-printing scenario?

a) nothing. High unemployment will hold down inflation no matter what. Monetary theories of inflation will be shown to be wrong.

b) miracle cure. Yes, there will be inflation, but it will solve all of Europe's problems. Real wages will fall, and full employment will ensue. Debt will be inflated away, restoring solvency to governments.

c) disaster. Inflation will rise without restoring full employment. Debt will be inflated away, but by the same token household savings will be inflated away. Europeans who see their wealth and incomes eroded will be bitter and resentful. Politics will turn really ugly. It will be less violent than in Germany circa 1930 only because the population has a much lower proportion of people under thirty.

Wouldn't you say that (c) has at least as high a probability as (a) or (b)?

Mauldin has another piece (link may or may not take you to the correct article--look for "Clash of Generations") where he quotes from Scott Burns, who co-wrote a book with Laurence Kotlikoff. He gives a fictional disaster scenario.


A major U.S. oil company had publicly called it quits on the greenback.

America's economic death was quick and painful.

In short order, the dollar plunged. Interest rates soared. Bond and stock markets vaporized. Towns, cities, states, and businesses--large and small--started declaring bankruptcy.

Can you go from stagnation to hyperinflation that quickly? I have a hard time envisioning it. I guess if Greece goes off the euro, we'll be able to see.

And then there's this:


The U.S. fiscal gap now stands at fourteen times U.S. GDP. For Greece, this figure is roughly twelve times GDP. Compare the two numbers and you see the naked emperor: on a fiscal gap basis, the United States is in worse fiscal shape than Greece even though its ratio of official debt to GDP is roughly half that of Greece.

Have a nice day.


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CATEGORIES: Eurozone crisis



COMMENTS (12 to date)
CKE writes:

What is the opportunity cost of a bailout or a recapitalization?

Isn't the damage already done on the day one recognizes that a bank (or any institution) is insolvent?

Where is the discussion or debate about the alternative uses of the resources being pulled to make whole a failed bank?

It is past time to cut losses, shareholders, taxpayers and depositors need to recognize the losses that have already occurred (it is a sunk cost). Stealing to make someone's losses whole just digs the hole deeper.

Pat writes:

According to the Wapo, you're either for growth or you're for austerity. It doesn't occur them that unsustainable deficits from government spending might hurt growth.

John Wilkins writes:

The reason Greece is in trouble is because it uses a foreign currency which does not have a floating exchange rate relative to other euro nations. Greece can "run out of money." Greece is a currency "user." The United States (and Japan, Canada, the UK, Australia, et al) are all monopoly producers of their own fiat currencies with floating exchange rates. Therefore, these nations cannot "run out of money" because they are currency "issuers". Greece and the other euro nations are comparable to households, states, and cities wh have no ability to issue currency. There is no comparison between Greece and the United States until Greece goes back on the Drachma and has a sovereign currency once again. That is why Japan can have 2.5x the debt of the United States yet have interest rates almost zero. The only limitation to a currency issuer issuing currency is inflation. And certainly in the United States, with unemployment and underemployment very high, a huge economic output gap, and real wages which are stagnant, there is little concern of inflation.

JeffM writes:

I would not put much credence in anything Mauldin writes when he comes out with whoppers such as that US banks are shut down when they have non-performing loans reach 5% of capital.

That would in fact be idiotic. Suppose a bank has loans equal to 5% of its capital and loses 100 cents on the dollar on every non-performing loan (an extremely strong assumption). The bank would then lose 5% of its capital. If its pre-loss capital ratio was 10% (and if it had no loan loss reserves), its capital ratio would fall to about 9.5%. (It would actually be slightly above 9.5% because assets, the denominator in the ratio, would have fallen as well as capital, the numerator in the ratio. Do not get me started on why capital ratios SHOULD be based on liabilities.)

What Mauldin seems to have done was to misread a Bloomberg article that said regulators would be all over a bank that had non-performing loans that reached 5% of "holdings." The article is admittedly a bit fuzzy about what "holdings" are, and non-performing loans are sometimes measured against outstanding loans and sometimes against total assets. But it is quite clear from the article itself that "holdings" does not mean capital.

In fact, the entire US banking system had a non-performing loan ratio above 5% as recently as 2010 (according to the St. Louis Fed). Obviously that was an average with many banks far below 5% and others well above 5%, but quite clearly half the US banking system was not shut down in 2010.

In short, Mauldin may be quite right about the weakness of Spanish banks, but his general knowledge of banking seems shaky.

Arthur_500 writes:

Sticky Wages are the problem everywhere. In the United States we demand Davis-Bacon Wages so we still have the same limited number of employees. A Depression WPA program simply cannot exist.
In France the labor rules are so counter to hiring employees that no one wants to hire anyone.

Regardless of how the economy moves forward, unless individuals are able to work you will remain with high unemployment, desparate people clamoring for government help and a government system going broke as it is unable to afford its programs. So we get back to enabling the free market to run the programs and that floats the prices for services, materials and labor.

this isn't so much austerity as it is privatization of programs the government has no business of being involved in in the first place.

Saturos writes:

(c) Ever heard of something called the Fisher effect? And real rates should rise with higher growth expectations, as has been pointed out ad nauseam.

I won't even comment on the absurdity of (a). I thought only Dinosaur Keynesians thought like that.

James Oswald writes:

A Sumnerian rewrite:

What will happen to inflation under the faster-NGDP increasing scenario?
a) No inflation, all real growth.
b) A mix of inflation and real growth.
c) Inflation will rise without and real GDP increase.

What will the split be between real growth and inflation? If you think there is a lot of nominal rigidity holding up the labor market, etc, a fair bit of the increase in NGDP will be real growth. If you think the main problems in the economy are supply side, increasing NGDP will increase inflation. I don't know enough about Spain to take a side on this issue.

Europe is much messier than the U.S., because the ECB doesn't target NGDP or inflation for any one country, they target it for Europe as a whole (presumably). An incompetent central bank with a small currency area might achieve better outcomes than a competent one with a large area.

Jim Glass writes:

"The economic debate consuming Europe comes down to the question of whether struggling countries should choose austerity by clamping down on government spending to rein in unsustainable deficits or pursue growth stimulated by more spending."

If they decide to spend more and add to their unsustainable deficits, who is going to lend them the money to do it?

It's a sign of our times that so many people assume that there's automatically always going to be more money coming from somewhere to spend.

Greece should reject austerity! It can always borrow more money to spend from ... the Bank of the Underpants Gnomes?

Santcugat writes:

The real debate is which country pays the price for adjustment. Is it inflation in Germany or deflation in Spain?

ThomasH writes:

"The U.S. fiscal gap now stands at fourteen times U.S. GDP. For Greece, this figure is roughly twelve times GDP. Compare the two numbers and you see the naked emperor: on a fiscal gap basis, the United States is in worse fiscal shape than Greece even though its ratio of official debt to GDP is roughly half that of Greece."

I don't know what the "fiscal gap" means in this post but for comparing Greece and the US remember, "Quod licit Jovi, no licit bovi."

"The real debate is which country pays the price for adjustment. Is it inflation in Germany or deflation in Spain?"

An economist would ask which combination of price level changes and structural reforms will minimize gdp loss. Hard to see that low inflation in Germany is part of the best answer.

ThomasH writes:

"...Spain was once thought to be a good example, because its bank capital requirements were counter-cyclical. Thus, capital requirements go up when times are good, which should be a source of restraint. There were economists proposing such a scheme for the U.S. My guess is that you won't hear much about that now."

What was wrong with that policy except it was not strict enough to prevent Spain's price level from getting out of line?

Joe Cushing writes:

Why does nobody ever talk about growth stimulated by cuts in the burden of government?

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