The Hollow Men of the EU

Here we go round the prickly pear
Prickly pear prickly pear
Here we go round the prickly pear
At five o'clock in the morning.

Between the idea
And the reality
Between the motion
And the act
Falls the Shadow


This section of T.S. Eliot's poem 'The Hollow Men' just popped into my head whilst thinking about the latest chapter in the Euro crisis, but other parts of the poem also seem oddly appropriate.  The prompt for thinking about the poem was the ongoing woes of Spain and the reporting about the Spanish budget, and the wider concerns about the Euro. Reuters gives a good overview of the budget:

Ministry budgets were slashed by 8.9 percent for next year and public sector wages frozen for a third year as Prime Minister Mariano Rajoy battles to trim one of the euro zone's biggest deficits.

"This is a crisis budget aimed at emerging from the crisis ... In this budget there is a larger adjustment of spending than revenue," Deputy Prime Minister Soraya Saenz de Santamaria told a news conference after a marathon six-hour cabinet meeting.

Beset by anti-austerity protests and threats of secession by the wealthy northwestern region of Catalonia, Rajoy is resisting market and diplomatic pressure to apply for a rescue, partly out of concern for national sovereignty but also because European Union paymaster Germany insists Spain doesn't need help.

The central government sees budget savings of 13 billion euros in 2013, with spending down 7.3 percent -- not including social security and interest payments -- and income rising 4 percent thanks to a 15 percent leap in value-added tax take.

The budget goes to parliament on Saturday and debates could last weeks. The country's 17 autonomous regions still must present budgets and find an additional 5 billion euros in adjustments to meet overall public deficit reduction goals.

Apparently, the budget was well received with the Euro gaining against the $US, and stock markets rising in response.  As I have mentioned in an earlier post, there was also an audit of the Spanish banks, with the following finding:

Spain's banks need €53.75 billion ($69.23 billion) in new capital, an independent audit showed, a figure below initial estimates that provides a benchmark for the cleanup cost of the ailing sector, the government and the Bank of Spain said Friday.

The number was lower than an €62 billion estimate Spain gave in June, providing some welcome news to the government of Primer Minister Mariano Rajoy which this week announced a series of spending cuts and tax increases in an effort to stabilize the economy amid protests and political challenges from the country's richest autonomous region.

In my last post on the Spanish crisis, I questioned whether the audit would genuinely reveal the true extent of the losses, and that more toxic debt would be revealed at a later date. I am still of that view and, as I stated before, I suspect that we will see further requests for bailouts in the future. In short, I suspect that the requests for bailout money will be given in 'bite-sized' chunks. The disclaimer of liability at the start of the report and the explanation that the report 'methodology and process' was agreed with the Spanish Government and Banco de Espana might be seen as indicative of the reliability of the report.

The devil is in the detail, of course, and a quick look through the report and raised concerns in my mind, such as the limited sample size used for the assesment due to time constraints (p.13), and crucially, the audit assumes that 2014 is the date of sale of real estate assets, but I found no real clarity on how the values were projected, and it makes heroic assumptions that the assets will sell at all. However, I have only briefly glanced through the report and may have missed details or misunderstood sections, and I am not an expert. In other words, I just looked at the report to get a 'flavour' of the approach.

The point is this; it is not the initial positive market reaction that matters, but the reaction once experts have dissected the detail and methodology. It is then that the quieter shifts in markets will take place, and at which time the real judgement on the report will be felt. In many cases, those assessments will not be make public, but will remain proprietary. An article in the FT, before the audit publication, captures the pressures for positive results from the audit:

This time, it has to work. This is the view of senior bankers in Madrid as Spain prepares to unveil on Friday the results of an audit of its financial sector. Many now consider it the Spanish government’s last chance to convince the world that it has the banking crisis under control.

[and]

The investors and analysts that Madrid is anxious to convince, however, are already questioning the integrity of the latest review, with some arguing it is likely to resemble a stage-managed announcement with few surprises.

Mr Guindos has said that the final amount of total capital required is likely to come in at about €60bn, which is close to a provisional estimate of between €51bn and €62bn made by Oliver Wyman and fellow consultant Roland Berger in June.

In what he labels “the Don Quixote approach to valuation”, Santiago López, an analyst at Exane BNP Paribas, has said it is not credible that the Ministry of Finance has already indicated no listed bank, aside from Bankia, will need new capital under the tests, even though they use aggressive economic assumptions.

[and]

“Spanish banks are not giants but windmills,” Mr López says. “The assumptions of the tests seem reasonable but the conclusion is not credible.”

We have seen plenty of similar bank reviews in the past, and the pursuit of confidence over clarity seems to be the real purpose in many cases, such at the EU bank 'stress tests' that found Dexia to need no additional capital just a few months before it ran into trouble. In summary, perhaps I am wrong about the audit but I do not believe that this is the end of this story. My own view is that it is now just a question of 'when' the next bad news will arrive as the hollow men continue to seek that the crisis resolves, Not with a bang but a whimper.

Added Just after Publication:

German Wages

I just thought I would add a quick note. I stumbled on an article in Slate which grumbles that the low unemployment of Germany is based upon wage stagnation, and could not resist mentioning it.

The real secret to Germany's job market success, though perhaps in some ways related to the labor market regulations, seems to be simpler—don't give the workers any raises:

Now you look at this and you can see why Germans aren't chomping at the bit to offer bailouts to their southern cousins. But by the same token, you can see why the rest of Europe isn't rushing to embrace this model. The pitch for more flexible labor markets is supposed to be that you'll earn higher wages if employers have more freedom to organize work relationships to maximize productivity. Less job security and lower pay is not a great slogan. It is, however, a huge exporting success story. Germany has completely reoriented its political economy around the needs of its export industries which is nice except that just like in all other rich countries the majority of Germans work in non-tradable services.

My central thesis proposes that the shock of oversupply of labour sits underneath the economic crisis. That Germany has followed the logic of this position to its conclusion might be seen as explaining why German workers are still employed. I suspect that, given a choice, many unemployed workers would be pleased to turn back the clock and follow a similar path if it was to keep them in employment. However, before we get carried away with the German success story, it should be remembered that the fallout from the wider crisis may yet pull Germany down. Nevertheless, it is interesting that the German model was the correct response; with the labour supply shock, German workers allowed their compensation to drift down such that their value remained aligned with changing circumstance. And that value still remains high, perhaps reflecting the quality of the German workforce overall.

Another addition Just After Publication:

 I nearly forgot, but there have been several people who have used the Paypal donate button, including some fairly large sums. I just thought I would express my appreciation. In particular, although traffic has remained relatively high (it dropped off during the period when I stopped posting but is climbing again), there is less commentary than before. As such, it is good to know that the blog is appreciated. Thanks!