How long will the dance continue between Spain and the European Central Bank?

5th October 2012 by The Harried House Hunter

If we add together yesterday and this morning three central banks- Bank of England, Bank of Japan and the European Central Bank- have announced that their official monetary policies are unchanged. As the first two are in the midst of existing Quantitative Easing plans this was not a surprise although the Bank of England’s will complete in the week before its next meeting on November 7th/8th. As for the third the ECB the truth is that we get as much information about its likely actions from the press conferences headed by Mario Draghi as from the official communique. Here we did get a couple of details.

A shift in emphasis from the ECB

Here we did see a change of emphasis as indicated by the quote below from Mario Draghi as he answered a question.

The OMT would not apply to countries that are under a full adjustment program until – and that’s the – that’s what I think I did say last time – until full market, complete market access will be obtained. And this is because the OMT is not a replacement for lack of primary market access.

Let me explain why this correction – and in spite of the denial it is a correction- matters. By OMT he means Outright Monetary  Transactions which is the vehicle by which the ECB will purchase government bonds of Euro nations which are in financial trouble. This week Portugal copied Ireland’s bond swap of a few weeks ago where short dated bonds (2013) were exchanged for ones a couple of years longer in maturity (2015) to demonstrate that she now has market access and I think she believed she was establishing access for OMT aid. She knows better now as does Ireland and is probably muttering something about goal posts moving right now.

The Conditionality Conundrum

This is a big issue to my mind and President Draghi reinforced its importance yesterday.

Conditionality – we view conditionality as an essential part of the activation of the OMT.

Conditionality will actually have several roles. First of all, it will reduce the moral hazard by governments. The second thing – the second role it will have is that, really, in a sense, protects the independence of the ECB. Without conditionality, you would certainly have what people call fiscal dominance. With conditionality, the independence of the ECB is protected.

I consider both his points here to be untrue. Later in his speech we see an example of where the independence point is contradicted.

And it’s up to the other euro area governments to decide whether the programs- whether – you know the conditions. You know that it’s necessary to make a request to an EFSF/ESM program.

If you are doing what governments say then it is hardly a demonstration of independence from them is it? To my mind it demonstrates exactly the reverse.

The moral hazard issue also has the flaw that once a government is receiving OMT assitance how does the ECB ensure that it sticks to the reforms. The only weapon the ECB will have will be to stop buying which will cut off its own nose to spite its face. We can see from the experience in Greece that this is likely to be a shambles full of evasions of the truth.

Governments are very reluctant to ask for OMT aid

Since the last meeting we have seen the Spanish government deny and deny again that Spain needs a full bailout. For example her Finance Minister Luis de Guindos said this only yesterday at the London School of Economics.

There is a little bit of misunderstanding–Spain doesn’t need a bailout at all

I gather there was some muted laughter and frankly I am not surprised. Although of course we know from Sir Humphrey Appleby never to believe anything until it is officially denied.


We are seeing several strands come together at once here. Yet again the grand rhetoric of Euro area announcements is being followed by something of a reining back as we head towards any implementation of it. It is something of an irony that the Spanish denial of a bailout illustrates one of them as the fall in her bond yields – her two-year yield is now at 3.25% which is half its July peak- has taken some of the pressure off Spain which is allowing her government to obfuscate and dither. In other words we are already seeing a type of moral hazard just as we are being told it cannot happen.

Indeed there has been another gain for Spain: Target2 balances

For those unfamiliar with this issue Target2 balances are a measure of each individual Euro area country’s liabilities to the overall Eurosystem. It has become a measure of the crisis as previously stable relationships have changed. For example at the beginning of 2011 the Spanish deficit under this was 46 billion Euros and in August 2012 it was 434 billion Euros with much of the surge coming in 2012 as the crisis built.

However as the ECB made promises about support and OMT we saw in September the  Spanish debit drop to 400 billion Euros (h/t Pawel morski). Whilst this is by no means a fix it is an improvement and it was also seen on the other side of the balance sheet as the German credit balance fell back from 751 billion Euros in August to 695 billion last month.

However the improvement here to my mind relied on an apparent stepping into a phone booth by the head of the ECB and his emergence as SuperMario. As you can see from the analysis above his superhero status is weakening. So we will have to wait and see if it can continue.

Spain’s economy continues to weaken

So far this week we have had survey data from the various purchasing managers indices which have confirmed that Spain’s economy continues to weaken. Indeed under this measure her output growth is very weak being 41.2 on a scale where 50 represents unchanged.

This morning has seen the release of her latest official industrial production numbers.

The annual variation of the Industrial Production Index stands at –3.1% in August, as compared with –2.7% in July

The average for the Industrial Production Index registered a variation of –5.5% in the first eight  months of 2012, as compared with the same period the previous year.

So we see continued weakness of the type indicated by the surveys. Industrial production has been falling for a year and actually last August was a small blip in a continuing downwards trend. If we look to the underlying measure it shows the depth of the fall as it is registering 62.5 where 2005 represents the benchmark of 100. Unfortunately the survey results suggest it has fallen further since then.

Euro area economic growth

Whilst the latest headline quarter on quarter number for the Euro area is unchanged at -0.2%  I note that the annual figure is now -0.9% rather than -0.5% so something has changed for the worse. Part of the change is that the former number is seasonally adjusted and the latter uses raw data although that does raise the issue of what was different this year as they did not have a Royal Jubilee.

In some minds the Mad Hatters Tea Party is continuing

Bloomberg is reporting this today.

EU aide says #Greece has the money to make its 1st #ESM payment, approximately €900mln by Oct 12

So a country which has in other news its Prime Minister stating that it will run out of money at the end of November can apparently contribute to the capital of the European Stability Mechanism. The Mad Hatter would be proud of this! Wasn’t using borrowed money as capital one of the causes of the credit crunch?

Of course we also have Greece’s Euro partners and the IMF loaning Greece money to in effect reduce their own payments. Let us hope that this idea gets kicked into grass so long that it cannot be found.


So we see yet again rhetoric that has over stated the likely action. Meanwhile the economies in the Euro area and in particular Spain are weakening so the dithering means that the issues will only be addressed when she is weaker. Mind you if you look at the chaos which is the bail out for Greece it is hard not to have a little sympathy for Spain’s attempts to avoid being in the same unstable lifeboat.

And later we have the US employment and unemployment report,good luck to those of you who will be involved in it.

24 thoughts on “How long will the dance continue between Spain and the European Central Bank?”

  1. Drf says:

    “How long will the dance continue between Spain and the European Central Bank?” For as long as they can get away with it, and they will attempt it for even longer than that!

    1. Anonymous says:

      Hi Drf
      Meanwhile the Spanish economy continues to weaken. They seem to be modelling themselves on Emperor Nero with the strategy being employed. The catch is that the can kicking ends up with a can in a future which is weaker than the present..

  2. Anonymous says:

    Everyone knows that Spain needs a large bailout and that bailouts come with conditions. The banking sector is in a serious mess and from the outside, the labour market is equally disastrous. Rajoy wants the bailout without the conditions. Understandable, but futile. The visible numbers are enormous, but the hidden ones are perhaps even larger. So he is playing for time. Even worse, he has to keep the large ‘informal’ economy off the agenda, for it is that which is keeping Spain afloat at the moment, and damping enthusiasm for riots and demos. The ECB clearly knows about Spain’s black economy but prefers to ignore it, as does the government. Once opened, that can of worms could do untold damage to future prospects for EU grants and similar handouts and general confidence in the country’s government and businesses.

  3. Robert says:

    Shaun hi

    I put a comment on your Blog on October 1st which didn’t come out
    as I think you had problems with the site, but which I wonder will make the
    situation even worse in Spain if this is possible….my comment ran as follows…….

    One aspect that has recently reared its head and which i would have thought
    would have a very negative effect on the EZ in general, is the likely demand
    for Catalan independence. From family there, I understand that there is a very
    genuine majority support to demand independence.

    Leaving aside the rights and wrongs, surely the effect on the Spanish bond
    market will be huge, especially if there is a ‘formal’ demand of the central

    I would have thought that this can only deteriorate the economic situation in Spain as a
    whole, as it will look even less attractive to investors, but the other issue, is that surely a divorce is financially impossible
    to achieve. Even if there was agreement between the Spanish Parliament and the
    catalan Governemt (which is most unlikely), it would surely take years to agree
    the split in the National debt etc etc. During this period, without the support
    of the ECB (and Germany),
    the bond market would be effectively closed. Therefore, any wish for
    independence is academic unless Mrs Merkel is prepared to underwrite the
    Spanish deficit whilst the process proceeds.

    I can see this will create a huge problem, and as the Economist commented
    this week, – to create a Constitutional crisis on top of a financial crisis, –
    is playing with fire. But this seems to be what is happening.

    Am i right???


    1. Anonymous says:

      Disqus was posting everyones comments during ‘the problem’ – just the text was posted in white, and white on a white background is tricky. If you ‘select’ the text on the whole webpage,, you can read the highlighted white text.

      1. Anonymous says:

        Hi DLinneridge
        Thanks I did not know that either and was going into the wordpress site to reply directly.

    2. Anonymous says:

      Hi Robert
      I agree that this poses all sorts of questions. There is also the current situation where supposedly wealthly Catalonia has asked for money from the 18 billion Euros put aside for regional governments by the central government. It is a bit hard to ask for 5.023 billion Euros and then say you want to leave!
      So it is quite a can of worms..
      As to the regional fund with the request from the Canaries yesterday of 757 million Euros it looks as though it is nearly used up with claims for 16.5 billion Euros already.

  4. JW says:

    Hi Shaun
    US figs just out. Unbelievable, literally. Biggest monthly jump in employment since 2003. Divergence of trend of U3 and U6. As this comes from a ‘survey’ and the proximity to the election……. Just add it to all the other random numbers generated to tell a story. As DaveS has said, ‘nominal’ is the new ‘real’.

    1. JW says:

      Ah, its part-time employment, gone through the roof. Add unemployed to under-employed and that has increased by almost 0.5m in a month. The exact opposite of course to the headline ‘fall’ of unemployed from 8.1% to 7.8%.

      1. Anonymous says:

        Doesn’t one of the combatants employ lots of part time labour as part of his campaign at this point in the cycle? How else to spend his share of the, what, $1B?

        Or maybe James, above, is correct that we are all too cynical this Friday ……

          1. Anonymous says:

            Hi JW
            Yes a better report but with some questions. I responded on twitter to it saying it looked better but the issue was around the measure of underemployment or U-6.
            “However the US “underemployment” measure or U-6 was stable at 14.7% seasonally adjusted last month unlike headline unemployment #nfp ”
            There is quite a debate going on about these numbers in the US,as much of it is politically inspired I will leave that alone. However I will point out that Gallup the polling organisation agreed that there were employment gains in September but concluded that
            ” Gallup’s seasonally adjusted September unemployment rate was 8.1%, unchanged from August.”
            For those that do not follow the U-6 measure the reason why is was unchanged was mostly that it was registering a 582,000 rise in part-time work (for economic reasons) in September.
            It was also interesting how many “experts” quoted numbers from the wrong survey…

          2. JW says:

            Hi Shaun
            As they are all ‘surveys’ , the Gallup one is just as valid as any, indeed it seems to have been more robust in the recent past.
            Food stamps are now up at 21m , not exactly a sign of improvement.
            I don’t ‘buy’ either sides politics in interpreting these numbers, but find brainless the acceptance of one months numbers as being meaningful, given the spurious nature of the data collection, the limitations of the X12 program , and the deliberate ‘mixing’ of two separate ‘survey’ data to ‘prove’ a position.

  5. Jason Aris says:

    The real reason for Spain not wanting a bail-out is one of the ‘strings’ attached will be a significant haircut for private sector investors holding assets in the banks which get cash injections. To date this has fallen on institutional investors who have been able to disguise the impact to ordinary people as these can be drip fed out to them over a number of years. Spain is different, the desparation of the Caja’s in particular to secure adequate capital and remove contingent liabilities has seen them by fair means or foul persuade a large number of ordinary depositors to move to what they were led to believe were higher interest paying accounts. They were no such thing they were linked to preference shares or bonds of these institutions, therefore these assets will be subject to the haircut. Some €30 – €40Bn is at stake at least.
    The howls of protest are bad now can you imagine the scenes in Madrid and elsewhere when people who have had 90+% of their savings wiped out watch as the banks revert to their normal modus operandi and start paying massive bonus’s again. This will not be pretty.

    1. JW says:

      Excellent observation Jason. How many in Catalonia I wonder?

    2. DaveS says:

      Wow – Spanish lawyers will be getting massive bonuses too.

      Then again I think law is the new boom industry in the City too.

    3. Anonymous says:

      Hi Jason
      A very good point. There was a lot of this and it distinguishes Spain from Ireland. I have argued many times that bondholders in Irish banks should be in the vernacular “burned” or to be more specific fulfill their obligations rather than be paid out. But in Spain many more ordinary investors were miss-sold these type of bonds and from this one way or another there will be an unhappy ending.
      It all sounds rather similat to the zeroes scandal in the UK from a while back for those who remember it.

  6. james says:

    I agree with almost all of the article, but am sure that the eurocrats/polititcians will see the same facts and will put the following gloss on it:
    1. By doing nothing except talk, interest rates have halved on Spanish debt at no cost – what a result
    2. There is an agreeable number of acronyms (OMT, ECB etc etc) behind which to hide whatever is going on
    3. Well, ok so none of the problems are solved on the ground, but our pensions are safe for the time being
    4. If the price to pay is a bit (well, ok, a lot) of unemployment and suffering, we can talk bravely about the pain necessary (to be endured by others, naturally) to achieve restructuring of the economy
    5. It looks as though we can pretend for a further while that democracy still exists in Europe while the Spanish government pretends to set its own budget.
    6. The real problems are much too hard to articulate let alone resolve, so let’s keep everyone in the dark as usual and kick the can down the road.
    Too cynical for a Friday afternoon?

    1. Anonymous says:

      Hi James
      It would be a good exam question I think for say degree students. Something like, Can you be too cynical about our political class/establishment?

      1. James says:

        As a matter of interest, Shaun, do you agree with my analysis or just the comment about cynicism?

        1. James says:

          Another thing. Are you not shocked and I mean shocked at the apparent indifference to the level of unemployment in Spain. If I were running a country with 50 per cent youth unemployment, I would be thinking the unthinkable even leaving the euro. At what point does u employment matter?

  7. Anonymous says:

    We are going to one of the Spanish islands next week where we have many Spanish friends who are all business owners and who i gave a good heads up to the coming (at the time) storm..
    One of them delayed a expansion due to it and is so grateful as it would of wiped him out..
    I talk to them on Skype and they have been saying takings are down 50% at the very least and i do wonder how many years of suffering they can sustain..
    I know of quite a few English people who owned bar/restaurants on the island and had to disappear during the night never to return.
    When we first looked at buying property the cost for a 2 bed villa was 200k and we paid 80k for one of the same three years later.
    I look forward to meeting these friends to get their take on how things are panning out for them on the ground.
    Plus i get to do nothing for 11 days..bliss

    1. Anonymous says:

      Hi Geoff
      I think that one has to have a very cold heart not to feel a fair bit of sympathy for the ordinary Spaniard caught in this mess. Please come back and let us know what they are actually saying.

      1. James says:

        On my Greek holiday this summer, they also said takings were fifty per cent down…

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