Spain's GDP Crawls Ahead - Spurred by Weakness!

Yes! Spain's GDP edged ever so slightly higher in 2010-Q3 spurred by weakness; weakness in imports. Imports fell at an 18.7% rate annualized in the quarter and since imports SUBTRACT from GDP the drop spurred GDP growth in Spain in Q3. At a time when all eyes are on Ireland and its problems, it is important to maintain a focus on other pressured EMU members. It also is instructive to see what 'austerity is doing to these key economies rather than taking an approach to cap excess and let them 'growth their way out of their bind. We have made our choice, let's see what we have wrought.

What kind of adjustment? At the moment markets are asking for blood. But central banks and national government as well as the amalgam known as the EU/EMU are reinforcing these demands by their own efforts and policies. It might have been possible to have let some of the troubled Euro-borrowers have a sliding stop but now-a-days it is essential that they bash headlong into the brick wall of austerity and sort out the pieces.

Speed of adjustment - Economists always disagree on whether this sort of abrupt shock treatment works best. Conservatives like the harsh medicine because it is painful and it sends a message that is unmistakable. Moreover, there is a concern that if you let a profligate borrower off the hook easily once times are better they simply won't be in distress and they won't slim down the same way as if you put their feet to the fire in a crisis. There is also the somewhat more abstract point of being out of equilibrium. There is a cost of being out of equilibrium so the faster a country can make its adjustment, the better. However, when that adjustment thrusts the country into a very painful disequilibrium first, the merits of getting there (or whether you do get there…) 'faster' coming from a worse position can be debated.

Spain's approach and problem - In the case of Spain it adopted austerity relatively quickly when the pressure was put on. Ireland is in different straits so we can't compare the two directly since Ireland has a banking sector problem that threatens to overwhelm it. But Spain's bust came from having much of its GDP push on the back of growth in the overheated property market and that sort of wound is hard to heal too.

Export led growth - but way too little - Spain, like many other EMU nations, is benefitting from export growth. But export growth has withered in Q3. The main Q3 contribution to growth is the shutdown in imports as domestic demand has been slammed shut as if in the face of an unwelcomed guest. Spain's domestic demand has fallen year-over-year for nine quarters in a row- that's more than two full years of unrelenting drops in inflation-adjusted domestic demand. Household consumption is up yr/yr by 1.4% but overall consumption remains weak. Amid austerity gross investment is falling at an 11.3% annual rate in the third quarter and down 7% Year over. The pace of that yr/yr drop has speeded up a bit in Q3 compared to Q2 but it does appear that the accelerated decline from earlier in the recession has been arrested. Still, gross investment has dropped year-over-year; gross investment is lower by over 25% from tis cycle peak.

Spain's awkward dynamic - Due to the drop in imports compared to exports Spain is righting its balance of payments position something that will help it to pay its bills. But this adjustment is coming at a huge cost in unemployment and by running a huge GDP gap (GDP is low relative to potential) and as a result Spain is foregoing a lot of output it could otherwise be churning out and helping it to pay its bills. The drop in capital formation is chilling since this is the raw material for growth in the future. As investment falls off Spain's potential growth becomes more limited. Of course part of this is by design, since Spain was previously investing in the wrong places. The boom in the property market had to stop and this was one way to force Spain from misallocating its investment. But, as we can see, resources have not quickly been mobilized to other investment activities. With Spain's need to contain its borrowing and its fiscal decline still large, the drop off in GDP and concomitant drop in incomes has reduced the pool of savings and probably crowded out some private sector investment. With Spain under duress it is even harder to attract funds from abroad and with the economy still quivering in recession even domestic sourced investment is skittish. Ireland's renewed problems casts Spain in an ugly light despite its progress.

A spoonful of sugar makes the medicine go down, but there will be none of that for Ireland – Always there are costs of adjustment. How will Ireland fare? Ireland looks as though it will get money under the auspices of the IMF which loves austerity the way pigs love slop. The IMF believes in 'old time religion' which involves a lot of pain. Other EMU nations are steering Ireland into the IMF slaughterhouse because they see markets as nervous. Ireland's renewed troubles have made investors wary that the 'other shoes' might fall someplace else. Spain, Italy and Portugal, to say nothing of Greece-are anxious to put fears of this sort of contagion to rest.

And for Ireland? It's not clear that Ireland's deal can accomplish all of that. Spain is showing us how painful austerity can be, even when it is 'voluntary.' Spain's rate of unemployment is at 20.6% and has risen from its cyclical low of 8% some 13 quarters ago. Spain can be seen to be taking the medicine. But it will also need to show progress on its budget. Of course that is hard in a recession when tax revenues fall sharply, but such is the medicine most widely prescribed and it is a stark lesson… it's like a prescription of bloodletting for a hemophiliac.

The Pain in Spain falls mainly without blame...So what about in the US? This is also a lesson for US to learn as a new Congress comes in and tries to get a grip on the message given to it by the voters. One wonders after looking at Spain if the voters even realize what message they may have sent to Congress and what it will mean for them? In the US it is not even so much about the current deficit which is large but not European-like. In the US it's about the future liabilities the government currently carries on its back (that means unfunded benefits promised to its people ). Off-loading some of those seems to be part of the way the government will become leaner and more 'responsible.' What will happen in the US when the voters figure that one out? You can vote democrats out of office and republicans out of office but you can't vote yourself out of the voting booth. That is where the buck really stops. Spain's GDP     HouseH Consump Non
Profit Gross Trade Domestic   GDP Expendi-
-tures Public Consump Fixed
Invst X-M:
bns Exports Imports Demand % Change Q/Q Saar; X-M is Q/Q Change in Blns of Euros Q3'10 0.1% -4.3% -1.5% -1.3% -11.3% 3.5 0.2% -18.7% -6.7% Q2'10 1.1% 6.0% 3.0% 2.0% -2.3% -1.6 5.8% 15.1% 4.2% Q1'10 0.4% 3.7% 0.3% 1.3% -6.4% -0.5 17.7% 18.6% 1.4% Q4'09 -0.7% 0.7% -2.2% 0.7% -7.7% 0.7 11.8% 5.2% -2.0% % Change Yr/Yr; X-M is Yr/Yr Change in Gap in Blns of Euros Q3'10 0.2% 1.4% -0.1% 0.7% -7.0% 2.2 8.7% 3.9% -0.9% Q2'10 0.0% 2.2% 0.1% 1.3% -6.8% 0.2 11.6% 9.3% -0.1% Q1'10 -1.4% -0.3% -0.5% 0.9% -10.4% 3.3 9.1% 2.3% -2.9% Q4'09 -3.0% -2.6% 0.2% 0.8% -14.0% 5.3 -2.1% -9.2% -5.3% 5-Yrs 0.8% 0.5% 3.7% -- -4.1% -- 1.6% -1.2% -0.1%