Archive for April, 2012

EU slams governments for not enacting growth laws

BRUSSELS  — The 27 member countries of the European Union have been slammed for not implementing laws designed to boost growth on the crisis-hit continent.

The President of the European commission Jose Manuel Barroso delivers his statement on how to combat the economic crisis, at the European Parliament Wednesday, April 18, 2012 in Strasbourg, eastern France.

The criticism, from the president of the European Union’s executive Commission, comes as the EU finds itself increasingly under pressure to do more to get its economy growing again as many of its members slash government spending, pushing some states into recession.

International bodies like the Organization for Economic Cooperation and Development have long pointed out that the EU’s internal market — which in theory should allow people and businesses to move as freely in Europe as they can in the U.S. — often falls short in practice.

“It is incomprehensible that member states are still not fully implementing growth-friendly legislation we have in place,” European Commission President Jose Manuel Barroso told the European Parliament in Strasbourg, France.

The European Commission for years has been pushing states to remove administrative barriers that prevent workers from taking jobs and companies from offering services in other EU countries.

The EU’s internal market “is probably the largest engine for growth within the European Union,” Barroso said. “It gives European business unfettered access to other companies and half a billion consumers and allows them to develop the scale to compete globally.”

Barroso spoke after the Commission approved a series of initiatives to boost jobs and growth in the crisis-hit bloc. Many of the proposals in the 27-page plan have been made before but have failed to overcome resistance by governments.

The push to free up jobs has become increasingly urgent as unemployment in Europe has jumped to more than 10 percent as the continent struggles with a series of debt crises that have caused Greece, Ireland and Portugal to seek a bailout .

Joblessness varies widely from country to country, however. In Spain and Greece, unemployment stands above 20 percent and among young people almost one out of two is looking for a job. In rich countries like Germany, Austria or the Netherlands the unemployment rate is below 6 percent.

But getting a job in Germany or Austria is difficult for a Greek or Spaniard. Not only do most jobs require workers to speak the local language, there are also practical and administrative barriers.

The Commission called Wednesday for an easier way to transfer a worker’s pensions from country to country and the way cross-border workers are taxed to be simplified. Job seekers should be able to receive their unemployment benefits for up to six months while they are looking for work in another country and non-nationals should be hired for jobs in a country’s public sector, it added.

Getting governments to implement such initiatives is not easy. Citizens are often wary of foreign workers — even in countries with relatively low unemployment — and some rich states have seen nationalistic parties rise in the polls.

The EU has also come under fire from unions for its push to make the labor market more flexible — making it, they argue, easier to fire workers. The Commission argues that knowing they can easily get rid of workers during a slump would encourage businesses to hire more in good times. However implementing the reforms in the middle of an economic crisis can create more pain in the short-run. Critics also warn that shifting taxes away from income to consumption on things like energy — as the Commission has long favored — will effectively leaves workers with less money as their bills rise.

Laszlor Andor, the EU’s commissioner for employment and an outspoken critic of the focus on austerity, said governments needed to do more to ensure people who work full-time make enough money to live.

Even when adjusted for varying price levels, minimum wages range for less than €300 a month in countries like Bulgaria to almost €1,500 in rich states like Luxembourg — leaving many workers below the poverty line. Some countries, such as Germany, don’t have a minimum wage at all.

While low wages can make country’s exports more competitive, they also hurt consumption in rich states.

In addition to strengthening its internal markets, Barroso said the EU should try to improve its trade relations with non-European countries, including the United States.

“The United States is our largest economic partner,” Barroso said, adding that trade between the EU and the U.S. was worth almost €450 billion last year and that they had invested more than €1 trillion in each others’ economies.

“Any further gains, including through reducing non-tariff barriers, would be significant for both sides,” Barroso said. “We are exploring ways in which to broaden and deepen these ties.”

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Debate Grows as Europe Fears Return of a Crisis

Angela Merkel, the Chancellor of Germany

Angela Merkel, the Chancellor of Germany (Photo credit: Wikipedia)

BERLIN — The European financial crisis has shown signs of reigniting in recent days, sharpening the debate between the champions of austerity and a growing chorus urging more expansionary policies to promote growth.

Even the traditionally hard-line International Monetary Fund called on Tuesday for stronger European nations to ease the fiscal brakes by stretching out budget cuts over a longer period. But if that message was intended foremost for Germany, it seemed destined to fall on deaf ears: with two state elections coming up next month, Chancellor Angela Merkel is unlikely to shift her position, popular with voters, against additional help for the economies of struggling European partners.

“We don’t see the need that perhaps other countries see to boost growth through additional increases in expenditures,” said a senior official in the German Finance Ministry, speaking on the condition of anonymity.

“Instead, we see quite clearly, and will remind our partners about their responsibilities from Toronto,” the official said, referring to commitments made at the Group of 20 summit meeting in June 2010, “to cut their deficits in half and stabilize their debt levels.” At the same time, the official said that Germany hoped other countries would join in increasing the International Monetary Fund’s resources to help it combat the crisis.

Politics as much as economics is adding to the sense of uncertainty in Europe. President Nicolas Sarkozy of France, who is trailing the Socialist candidate François Hollande in the polls before the first round of the presidential election on Sunday, has joined his opponent in promoting pro-growth policies. In Greece, nationalist anti-German fringe parties are gaining strength ahead of next month’s parliamentary election.

The German state elections may not directly affect the federal government in Berlin, but they distract from Continent-wide concerns and crisis management while thrusting parochial issues to the forefront. The German government does not have a mandate to share further the burden of the common currency on less competitive economies like those of Greece, Portugal, Ireland and, increasingly, Spain and Italy.

What seems certain, however, is that the crisis will continue to fester until new measures are taken to address its root causes. Borrowing costs for struggling southern European countries like Spain and Italy have begun to rise again as the effect of the European Central Bank’s injection of about $1.3 trillion in cheap loans into the banking system in December and March has faded much faster than expected. The three-year loans were meant to buy time for struggling governments and financial institutions, but the breathing room appears likely to be measured in months rather than in years.

The recent shift has underscored that there have been no substantive fixes beyond promises by countries to reduce their budget deficits. “It looks like it’s coming back with a vengeance, largely because none of the underlying problems have been solved,” said Philip Whyte, a senior research fellow at the Center for European Reform.

Mr. Whyte said that despite two years of crisis management, the fundamental structure of the euro zone remained intact, with lower-productivity economies in the south yoked to higher-productivity economies in the north, which prevents the laggards from competing through a currency devaluation.

“The E.C.B. bought time, but what it ended up doing was simply tightening the link between national banks and their sovereigns,” Mr. Whyte said. “They made the system more vulnerable if markets started losing faith in debt sustainability in countries like Spain.”

Yields on Spain’s 10-year bonds climbed above 6 percent on Monday, though they fell slightly on Tuesday after a successful auction of short-term debt by Spain’s treasury. Spain has emerged as the central test this year after missing its deficit targets as it slips back into recession. The government in Madrid has had a difficult time reining in spending by the 17 regional governments.

A bailout of Spain would be much costlier than one for smaller economies like those of Greece, Portugal or Ireland, testing the resources of the euro zone countries. Many economists, particularly in the United States, have argued that Spain has to stimulate its economy with additional spending if it hopes to return to economic growth, an argument rejected by the German government.

In an interview with the German newspaper Frankfurter Allgemeine Zeitung on Tuesday, Christine Lagarde, the managing director of the International Monetary Fund, said she was concerned about the health of Spanish banks and warned against slashing spending too quickly. It is not a view shared here in the German capital.

In an interview with Reuters on Tuesday, Germany’s finance minister, Wolfgang Schäuble, praised Spain for making difficult economic changes. “You don’t win back trust overnight,” Mr. Schäuble said, adding that Spain was following the right path by cutting spending. German officials have also recommended changes in labor markets as a longer-term strategy to promote growth.

As deficits balloon in countries across Europe, Germany continues to watch its deficits and financing costs fall. In another sign of Germany’s recent strength, the Bundesbank said on Tuesday that the country’s debt had fallen to 81.2 percent of gross domestic product in 2011, compared with 83 percent in 2010. That is still far above precrisis levels: in 2007, German debt was 65.2 percent of the size of the country’s economy.

“The problem with the crisis in Germany is that we know we have a crisis, but we don’t feel it,” said Eckart D. Stratenschulte, a political scientist and the director of the nonprofit European Academy Berlin.

Even as the European Central Bank loans improved market conditions, European leaders, including Ms. Merkel, were clear that they did not believe that the crisis was over. Many in Germany argue that a sense of crisis — and the elevated borrowing costs that come with it — is necessary to end out-of-control spending in the heavily indebted nations and to push through the economic liberalization they need to restore growth.

But the higher borrowing costs and austerity measures cut into growth, critics say, lowering government revenues in a self-defeating downward spiral and leading to higher interest rates and further budget cuts. “It’s concerning that the markets are again running out of patience and driving yields higher,” said Thomas Mayer, chief economist at Deutsche Bank in Frankfurt. “That creates further head winds.”

The I.M.F. on Tuesday raised its forecast for global growth slightly for the year. In Europe, the fund projected recovery in the second half of 2012, except for Spain, Italy, Greece and Portugal, where substantial improvement is not expected until next year.

The crisis, Mr. Mayer said, is like “a manic depressive moving between euphoria and worries, and now we’re in the valley of worries again.”

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Economic crisis, a failing political class and the spectre of 1930s-style extremism across Europe

History suggests that in dire economic times which offer  no hope of improvement, extreme parties of the Left and Right will spring up and  attract widespread popular support. That was what  happened in much of continental Europe in the Twenties and early Thirties, most notably in Germany.

This time, it is not in Germany that political extremism is gathering force, no doubt because that country is at least, for the moment, largely insulated from the cold economic winds blasting much of Europe. No, the first disturbing signs of parties of the  far-Right and Left entering the political mainstream are to be found in France and Greece.

To be sure, France already had an established record of extremism in the shape of the semi-fascist Front National, whose leader, Jean-Marie Le Pen, was actually runner-up (admittedly a distant one) in the 2002 presidential elections. The party’s current and only marginally more moderate leader, his daughter, Marine Le Pen, commands around 14 per cent in the opinion polls ahead of the first round of this year’s presidential election on April 22.

Phenomenal success: Jean-Luc Melenchon appeals particularly to the young, desperate and unemployed with his rousing rhetoric and extreme Left policies Phenomenal success: Jean-Luc Melenchon appeals particularly to the young, desperate and unemployed with his rousing rhetoric and extreme Left policies

More surprising, and in a way more shocking, is the phenomenal success of a far-Left candidate called Jean-Luc Melenchon, who is slightly in front of Marine Le Pen in most polls. Think of a Gallic, more intelligent Arthur Scargill and you would not be very far off beam. He advocates confiscating the incomes above a certain level of the rich, raising the minimum wage immediately by 20 per cent, and  banning profitable companies from laying off workers.

M Melenchon’s rhetoric is even more alarming than his policies. He speaks approvingly of ‘civil insurrection’ and  tells delirious crowds, largely made up  of desperate, unemployed young  people, that they ‘will have to be the crater from which the new flame of revolution erupts’.

This kind of far-Left incendiary language has not been listened to in Europe for more than 30 years. The fall of the Berlin Wall was thought to have put an end to it. The far-Left is back in France as a formidable force, and M Melenchon’s wild policies and wilder words — which only ten years ago would have seemed hopelessly anachronistic — are being taken seriously in a country where youth unemployment is at least 25 per cent.

As is invariably the case with extreme Left-wing and extreme Right-wing politicians, Jean-Luc Melenchon and Marine Le Pen have much in common, railing against globalisation  and the European Union. Mme Le Pen has her own anti-immigration rhetoric, which speaks to the fears of many French people over the ‘Islamisation’  of France.

Neither of them will win this year’s presidential election, and both will almost certainly be knocked out in the first round. The ultimate victor will either be the present incumbent, the centre-Right Nicolas Sarkozy, or the Socialist Party candidate Francois Hollande, something of a Left-wing firebrand himself, whose policies put him to the Left of the British Labour Party.

But although neither of the extremist candidates will be president, they will together probably account for around 30 per cent of the vote on April  22. Moreover, their policies will influence the eventual winner. This is particularly likely if the socialist M Hollande emerges triumphant in the second round two weeks later, and there is talk of M Melenchon securing Cabinet seats or influencing policy if that happens.

In other words, extremism is becoming part of the mainstream. Who can say what will happen if the French economy continues to deteriorate? It is still a long way from the predicament of Greece, where draconian austerity measures demanded by the German government in the name of eurozone solidarity are provoking a deeply worrying political backlash.

According to opinion polls, the two established Greek parties may win less than 50 per cent of the vote in elections early next month. A majority  of voters seems likely to back  one of the small parties  which oppose the austerity measures, in particular the Greek Communist Party or  the far-Right Chrysi Avgi  (Golden Dawn).

Jean-Marie Le Pen and his daughter Marine Le Pen: Mme Le Pen has her own anti-immigration rhetoric, which speaks to the fears of many French people over the 'Islamisation' of FranceJean-Marie Le Pen and his daughter Marine Le Pen: Mme Le Pen has her own anti-immigration rhetoric, which speaks to the fears of many French people over the ‘Islamisation’ of France

As in France, though even more strikingly, many people are rejecting the failed orthodoxies of the mainstream in favour of the superficially alluring — though almost certainly impractical — quack remedies peddled by politicians who until recently would have been almost universally regarded as being beyond  the pale.

Of course, in Europe as a whole it would be silly to exaggerate a development that is still in its infancy, and is not bound to follow the pattern  of the Twenties and Thirties.  We are obviously still very far from the financial meltdown of the Weimar Republic which led to Hitler coming to power, trading as he did on the communist threat which terrified many middle-class Germans.

But it would be equally foolish to deny that recession and unemployment on a scale unknown since the end of World War II are helping to create the  conditions in which extremist parties can flourish. Nor should we be surprised that the movement is gaining traction  in France, cradle of revolutionary fervour.

Extremism reaches Britain? It is tempting to see the recent triumph of the populist Leftist George Galloway in the Bradford West by-election as a protest vote against mainstream orthodoxyExtremism reaches Britain? It is tempting to see the recent triumph of the populist Leftist George Galloway in the Bradford West by-election as a protest vote against mainstream orthodoxy

It is also tempting to see the recent triumph of the populist Leftist demagogue George Galloway in the Bradford West by-election as a similar protest vote against mainstream orthodoxy, though we can perhaps hope that this was a one-off victory that will not be repeated elsewhere. The British are not supposed to be drawn to political extremists.

If, like me, you think that the euro is the main — though not the only — cause of Europe’s woes, then there is at least a theoretical solution. The financial difficulties of  France, Spain, Italy, Portugal,  Ireland and Greece would be greatly ameliorated if they could be freed from the  uncompetitive exchange rate which membership of the euro imposes on them.

That, though, is not going to happen any time soon. Angela Merkel, Chancellor of Germany, is wedded to the notion that the future of a federal Europe and the survival of the euro are indivisible. The fear is that she could turn out to be entirely wrong, and the medicine being forced on Europe’s weaker economies could end up destroying the patient and tearing Europe apart.

What is certain is that while many young people in some European countries have no realistic hope of having a job, and they and their parents are subjected to never-ending austerity measures imposed by Berlin, there will be more politicians such as Marine Le Pen spouting their inflammatory nonsense, and others still like Jean-Luc Melenchon proposing lunatic economic measures that would only make things far worse.

When mainstream leaders are incapable of offering solutions to apparently intractable economic problems, extremists will step in. That is what happened in Europe in the Twenties and Thirties. Looking ahead to years of sclerosis which none of our leaders shows the slightest sign of knowing how to prevent, it would be a brave man who said the same thing could not happen again.

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US stocks higher on better global data

US stocks opened higher overnight helped by data showing the US trade deficit narrowed in February and positive indicators in Asia and Europe.

The Dow Jones Industrial Average rose 37.39 points (0.29 per cent) to 12,842.78 in the first five minutes of trade.

The broader S&P 500 gained 3.9 points (0.28 per cent) to 1372.61, while the tech-heavy Nasdaq climbed 8.21 (0.27 per cent) to 3024.67.

“Data around the globe has been generally better than expected, and that, coupled with the mixed Italian auctions, has aided global equity markets,” said

Eurozone industrial production rose in February after being either flat or falling in previous months, official figures showed overnight.

Meanwhile the US trade gap shrank in February on the back of an unexpected drop in imports, mainly from China, according to Commerce Department data released overnight.

The US trade deficit fell to a seasonally adjusted $US46 billion ($44.78 billion), from a revised $US52.5 billion ($51.11 billion) in January, sharply below the average analyst estimate of $US53 billion ($51.59 billion).

Traders appeared to shrug off an unexpected rise in weekly data on initial unemployment claims, an indicator of the pace of layoffs.


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Apple is an iconic brand. Now it is a totemic investment, too – PFG Special Report

April 14, 2012

Mathieu Armand
European Regional Managing Director – Asset Management

THE new iPad, which was released on March 16th, is the most popular version of the tablet yet. Apple sold 3m of them in just four days. But some buyers took to discussion forums to report that it has a tendency to heat up. A similar debate exists about Apple’s stock.

The company’s share price has risen by 83% in the past year, and by almost 50% so far in 2012. Apple is now easily the largest company in the world by market capitalisation, at some $565 billion. It looms over Exxon Mobil, which is worth a mere $408 billion. Since the start of this year it has added $187 billion to its valuation, roughly equivalent to the entire market caps of companies like Procter & Gamble, Johnson & Johnson and Wells Fargo. Apple is larger than the American retail sector combined.

It accounts for 4.5% of the S&P 500 and 1.1% of the global equity market (see chart 1). Some bank analysts have started to report America’s corporate earnings without Apple, because including the firm so skews results. Fourth-quarter earnings are expected to have risen by 6.7% from the prior year for companies in the S&P 500, but by a much more modest 3.6% if Apple is excluded, according to UBS.

Around a third of all hedge funds own it, including big names like SAC Capital and Greenlight. Some have made very big bets. Many hedge funds that have done well in the past year owe much to this single position.

The stock’s gains this year have not only boosted the spirits of shareholders but also brightened the whole equity market. Apple is responsible for more than 10% of the S&P 500’s rise this year (see chart 2), and for 39% of the NASDAQ 100’s gains. No other stock has ever grown to have such a significant impact on an index so quickly, says Howard Silverblatt of Standard & Poor’s, a ratings agency.

The share price keeps soaring. On March 20th, a day after Apple announced it would use some of its cash hoard (estimated at $97.6 billion at the end of 2011) on a quarterly dividend and a $10 billion share buy-back, its shares closed at a record high of $605.96. This is the first time in 17 years that Apple will pay a dividend. Dividend funds, which had not considered investing in Apple before, could pile in, potentially pushing the price higher still.

Most analysts remain committed fans of the shares. Some claim that a $1 trillion valuation could soon be possible. The bullish case runs as follows. Apple has low penetration in the personal-computer and smartphone markets, and can hook millions more customers in emerging markets like China and Brazil. Although questions remain over how much of Apple’s innovation was due to its magician-in-chief, Steve Jobs, who died last October, the launch of the new iPad has calmed nerves somewhat. Apple is poised to enter new arenas like television and mobile payments.

The firm still has a ton of cash to invest in new products and ward off emerging threats. Horace Dediu of Asymco, a data-analysis firm, has estimated that even after the dividend payout and any buy-back activity this year, Apple could still end 2012 with over $35 billion more in the bank than it had at the end of the previous year. With an historic price-earnings (p/e) ratio of 22, shares are not as dear as you might expect, and look even more attractive when the p/e is calculated based on forward earnings. Apple’s revenues are forecast to grow by at least 51% in fiscal-year 2012 and by 23% in 2013, according to Morgan Stanley.

Others reckon that the outlook for its business is not the only thing that has been driving the steep ascent of Apple’s shares. The stock has seen such heavy gains in recent weeks that many investors can’t afford not to have Apple in their portfolio. Fund managers that are judged against a benchmark where Apple is heavily weighted, like the NASDAQ 100 or the S&P 500 technology index, have to scramble to keep a heavy exposure to Apple. “The speed of the move and the size of the company scare people who haven’t got it,” says Andy Ash of Monument Securities. “The danger is that you end up with everyone buying it because they have to rather than because they want to.”

Some wonder whether the stock is headed into bubble territory. Apple’s p/e is much lower than that of stocks in the dot-com bubble; America Online’s was a ridiculous 154 in 1999. But contrarian thinking is thin on the ground. There is very little short interest in Apple. “Call” options, which give the right to buy Apple stock, are much more expensive than “puts”, which give the right to sell the stock, says Mark Sebastian of Option Pit, a consultancy. Of the 54 analysts who track Apple stock, only one has a sell rating, according to Bloomberg. Robert Shiller, a Yale economist and author of “Irrational Exuberance”, reckons that the “emotional attachment” to the Apple story and “wild” enthusiasm about its stock are reminiscent of a bubble. “You could play the bubble, because it might not be over yet, but I wouldn’t put money in Apple stock,” he says.

Even if bubble talk is over the top, a higher share price is justified only if Apple continues to meet earnings expectations. That usually gets harder. The stocks of market-leading companies historically underperform once they have reached the top slot, since they are less nimble and more vulnerable to attacks by regulators and the press. It is harder to continue impressive earnings growth on a large base. Even a modest earnings miss could have a big effect on the share price, since more of Apple’s shareholders today are fickle traders.

If there was a fall, it would ripple. Technology investors, which have a higher concentration of Apple in their portfolios, are the most vulnerable. Apple makes up more than 18% of PowerShares QQQ, an exchange-traded fund with heavy exposure to technology stocks, for example. More unsettling are funds that have strayed into buying Apple against their mandate, including some mutual funds that are supposed to focus on smaller companies. “If Apple has a wobble, you could see it dictate broader market movements,” says Alec Levine of Newedge, a broker.

Hedge funds could be among the biggest losers. They look clever now for buying a stock that has seen such a rise, but they will look dumb if they lose money when it falls. Some may question whether they should earn such high fees simply for buying into the world’s most valuable listed firm. Where’s the genius there?

Correction: The original version of this article wrongly said that Citadel had a $5.1 billion stake in Apple. This figure included stock held by its broker-dealer, as well as options. The amount held by Citadel’s hedge fund was $118m as of December 31st. Sorry. This was removed on March 29th 2012.

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Return of the euro crisis After the sugar rush – PFG Special Report


April 14, 2012

Mathieu Armand
European Regional Managing Director – Asset Management

Spanish bond yields have risen as the effect of cheap ECB cash wears off

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.

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. Missteps by Spain’s new government have not helped. Beneath all this lie deeper fears about Spain’s injured banks, the stringency of the government’s fiscal plans, and the impact of both on an already weak economy.

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.

This virtuous cycle turned vicious in early March. Some investors say the buying petered out once yields fell below 5%, when the bonds might no longer be considered cheap. But the conclusion of the second and last LTRO may have been the main trigger. Banks which bought periphery bonds have used up their ammunition. “The minute the ECB says ‘no more,’ the bank bidder is lost,” says a hedge-fund manager. Since there are few committed buyers of bonds beyond such banks, the smart money bet that yields would rise again. 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.

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.

Anxiety about Spain’s banks worsens the outlook further. A messy end to Spain’s long construction and mortgage boom means a lot of bank loans have already turned sour. More are likely to. Property prices have not yet fallen as far as in Ireland, the euro zone’s other housing black spot. Investors fear that the state will be called on to recapitalise Spain’s banks.

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 accumulation of a long series of current-account deficits. The increasing home bias of euro-zone investors makes it harder for countries with foreign debts to roll them over. Greece and Portugal have similar foreign debts but have higher borrowing costs (see chart 2).

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.

Spain could volunteer for the kind of support programme that Greece, Portugal and Ireland have signed up to. But Italy is scarcely in any less trouble and the euro zone’s meagre rescue fund could not stretch to a bail-out of both countries for long. 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.


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