Authored by Michael Cembalest, JPMorgan CIO,
The Spanish Prisoner: why the adjustment in Spain looks like it will eventually fail
The people of Spain are prisoners of an economic adjustment that looks like something dreamed up by Torquemada. Let me explain. I was discussing Spain with a colleague, and I mentioned the ongoing collapse in Spanish labor compensation.
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He cheerfully connected the compensation decline with an improvement in Spain’s competitiveness, and offered the improvement in Spain’s trade balance as proof. A lot of the recent compensation decline had to do with public sector workers (who export nothing) and not private sector ones, but let’s assume he’s right that private sector wages are impacted as well. Is this a sustainable way to regain competitiveness? Historically, balance of payments crises brought on by competitiveness gaps were almost always addressed in part through currency devaluation, as shown in the table. Let’s go to the archives.
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The 2008-2012 recovery in Spain’s trade balance didn’t happen as quickly as the other episodes, but at least the gap closed, right? Not so fast. Spain’s exports have been growing, but its recovery is the worst of the bunch, indicating that trade improvement relies heavily on an import collapse and 25%+ unemployment. The last chart is the smoking gun: the growth dynamics of the current Spanish adjustment are nothing short of terrible in an historical context.
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One could also look the collapse in capital spending in Spain, down at a 28% annual rate in Q4 2012 even when excluding construction. Did inflation spike in prior episodes after devaluation? Yes, but real GDP measures improvement after taking inflation into account, which is why the last chart tells you most of what you need to know. Torquemada the Inquisitor would be impressed with the pain that Spain is inflicting on itself. The bad news for Spanish labor markets isn’t over: most measures of Spanish competitiveness show that only half the gap has been closed vs Germany. I don’t see how this can be sustained indefinitely, even with the rally in Spanish sovereign and bank spreads, and with looser fiscal policy sanctioned by the EU. Without a true fiscal transfer union in Europe, caveat emptor in its Periphery, unless prices for stocks, bank loans and real estate are sufficiently cheap.
Full cembalest letter [12] [12]