What happens to the Euro?

One of the best articles I’ve read so far about what is likely to happen in the Euro-zone over the next couple years.

The “easy” solution is to hope that economic growth will raise all boats and that eventually the debts will become manageable.

If this doesn't work out, then solving the problem is a political, not an economic issue. How will the pain of adjustment be shared? Each solution (default, leaving the euro, inflation, raising taxes, austerity, etc) assigns costs to a different group.

This doesn’t mean that there aren’t “win/win” solutions to this problem, but these all require a high level of trust and co-operations. Germany has been fundamentally unhelpful in this aspect, a large part due to the lack of leadership of Merkel. She has repeatedly placed narrow domestic political calculations (remember how she let the Greek crisis fester for weeks because she had a regional election to worry about?) ahead of finding pan-European solutions.

Germany tries to blackmail Spain into more cuts

Germany (or at least some German officials) tried to play dirty and plant rumors about the Spanish government being on the verge of needing IMF help in order to try to get the Spanish to go for an even harsher austerity program.

Sort of like shooting someone in order to convince them to donate blood.

Spain retaliated by releasing the results of recent stress tests that showed Spanish banks doing better than average (which Germany had opposed).

I really hope that more European governments realize that Germany is playing with a very weak hand with their austerity drive. Sovereign default in Europe is a game of mutually assured destruction, and Merkel is not willing to pull the trigger.

Squeezing the small guys

The government continues its policy of trying to soak the middle class to pay for decreasing the deficit. Now they want to raise the regulated portion of electric rates by 10%:

The Ministry of Industry has prepared a draft Ministerial Order on the proposed increase from July 1 the regulated electricity tariffs (so-called access tolls) by 10% for homes and small businesses, 5% for medium voltage customers and 0% for large consumers (mainly industry).

This is on top of the increase in VAT for July.

Meanwhile, the story about raising the taxes on the rich has pretty much disappeared (other than Catalunya’s rather symbolic 1% raise).

Perhaps people just need to get more creative, like this builder (who also incapable of building a vertical wall, as demonstrated on left with a level and a piece of cheese) in Mira-sol, who decided to run a hose from the municipal park next door to water the garden:

Hungary accidentally blows up Europe

Hungary recently had an election where the opposition party ran on a platform of promising everyone a pony.

After they won, they realized that this would be unaffordable, but didn’t really want to take the blame for making stupid campaign promises.

So they came up with a cunning plan where they tried to blame their inability to deliver ponies on the previous government’s “cooking the books”, and said that Hungary was in danger of becoming the next Greece.

Unfortunately the world markets heard “Hungary == Greece” and flipped** out.

Hungary shows how small currencies are unsustainable in a common economic area. Due to the high interest rates for mortgages in the local currencies, European banks offered Euro and Swiss Franc denominated mortgages to vast numbers of people.

Now Hungary is stuck and unable to devalue the Forint without bankrupting a large percentage of its own population.

Their only salvation is that the banks that lent the Euros and Swiss Francs are foreign big name European banks.

**Spangish word of the day:

flipar

a vt

1. (=gustar)
   esto me flipa I really love this
2. (=pasmar)
   me flipó lo que pasó I was gobsmacked at what happened **

b vi

1. (=pasmarse)
   yo flipaba al ver tanta cosa I was gobsmacked at all the things I saw **
   ¡este tío flipa! this guy must be kidding! *
2. (=pasarlo bien) to have a great time
   flipar con algo (=disfrutar) to really love sth
   yo flipo con esa canción I really love that song
3. (=drogarse) to get stoned *

c fliparse vpr

1. fliparse por algo to be mad keen on sth
2. (=drogarse) to get stoned *

Spain’s trade deficit and real estate

There’s been a lot of talk lately about how Spain runs a large deficit with the rest of Europe and how this is unsustainable.

Something that is missed is that the way the trade deficit is accounted for may not actual mean that deficit = bad.

Here’s an example:

Mr Catalan, Oriol Pujol builds a house in Lloret de Mar, which costs him 80,000 euros to build. He sells it to Mr Germany, Hans Schmidt for 120,000 euro, and buys a shiny new German BMW with his 40,000 euro profit.

Seems like things have balanced out, right?

Nope.

From a trade deficit accounting perspective, Hans Schmidt’s purchase counts as an investment, so it ends up on the deficit side.

After this transaction has completed, Catalunya ends up with a 120,000 (German investment) + 40,000 (purchase of German good) = 160,000 euro deficit.

Why internal deflation won’t work

An excellent comment in an otherwise stupid post by Edward Hugh (a Barcelona-based economist and master of cross-posting his articles to a bazillion different blogs):    

Perplexed in Montreal Says:

Regarding the insanity of internal devaluation policies, I'd like to point out that these policies never worked anywhere. Deflation within the Gold standard, the closer historical similarity to this strange experiment called Euro, was a disaster when it was carried out, in UK in the 1920s, in Germany in the early 30s, in France in the mid-30s.

I also would suggest to have a look at Ireland. Ireland was hit quite early by the financial crisis and has dutifully applied the internal deflation recipe since. It has been a success, in the slightly surreal Brussels definition of a success: the patient has taken the pill and hasn’t died.

Well, success it is not. Ireland deficit is still way above 10% and doesn’t show signs that it will decrease rapidly below the 3% magic limit. Meanwhile the collapse in nominal GDP has mechanically made the relative debt higher.

Note that Ireland had been an early and enthusiastic adopter of the so-called ‘labor market reform’ policies. They work very well, especially in books written by economists.

The quest for deflation is a dangerous folly. It has never worked. Why expect that it will this time? ‘This time is different’, anyone?

UK exited its 1920s’ deflation by a huge devaluation of the pound, in fact exporting its problems towards its neighbours. I believe they decided it was a success, so they applied the same solution this time. France had political troubles that ended with the Front Populaire government and serious divisions that let the country totally unprepared to deal with the German response to deflation, which was quite different, and slightly more unpleasant, than that of UK or of France.

The proponents of economic suicide by deflation might want to consider the political consequences.

The really sad thing is that any graph shows that the economy of Spain is clearly recovering. Europe jumping into a suicidal austerity binge is probably one of the few things that would derail the recovery.

Anti Euro-silliness

It's become fashionable lately to talk about how the Euro was a mistake, since having Euro-zone countries pegged to the same currency doesn't allow for imbalances to be resolved by changes in exchange rates.

Sure, in an ideal world, this could work, but in the real world, there's nothing stopping people and companies from getting loans or borrowing money in whatever currency they feel like. If Germany had kept their interest rates extremely low, most likely borrowers in the rest of Europe would have started taking out their mortgages in German Marks.

It would be impossible to devalue the currency at that point without bankrupting half the population. To make things worse, in a crisis situation, a relatively small economy like Spain would be unable to defend its currency and would most likely fall to currency speculation, causing an enormous amount of collateral damage.

Chinese real-estate craziness

Reading about the property bubble going on in China would make any ex-Spanish property speculator feel inadequate.

It's gotten to the point now where even the maids are are speculating on the property market. One lovely quote:

“You should buy two,” the sharp sales girl suggested. “In three years, the price will have doubled. You could sell one and get one free.”

A recent TV drama series named "Snail House" was pulled off the air, apparently hitting a bit too close to home:

In the fictional city of Jiangzhou where they live – the show is shot in Shanghai – ever-spiraling costs and rising prices outstrip every effort by Haiping and her husband to save. The harder they try, the more they fail, and quarreling becomes common.

But Haizao, who works for a property developer, finds a solution to both of their dilemmas: She dumps her innocent boyfriend and becomes a mistress to the mayor's powerful chief of staff, the handsome and corrupt Song Siming. Soon, Haizao has cash for her elder sister's down payment – and gets her own home.

Marbella anyone?

Reporting on Spanish economy for dummies

For positive stories about the Spanish economy (like for example, that apparently "la crisis" is over as of today, woohoo! 0.1% growth, baby!) , please use this picture:



For negative stories about the Spanish economy (imminent bankruptcy of Spanish banks, for example), please use this picture instead:



And you thought coming up with bad metaphors about the Greek crisis was too easy...

Sports-linked investment products

I've been looking around for term deposit rates after realizing that Spanish mutual funds were a recipe for US tax code disaster.

I encountered a very peculiar kind of deposit... the sports-linked term deposit. For example, Banesto offers a 1 year deposit that pays 3%. Unless Spain wins the World Cup, in which case you get 4%.

Asking around the office, it seemed like everyone had some kind of sports-linked bank account... one guy was getting a bonus every time his favorite player scored, another got better interest if Sevilla got a certain number of points... the possibilities seemed limitless.

Update:

This blog makes a funny point that by refusing to take out insurance against Spain winning, the Banesto is actually betting that Spain will lose. Current odds put Spain at 20% chance, so if Banesto doesn't buy insurance, it is betting that the actual chance is lower. Of course, Banesto spins it that they are being loyal by not betting against Spain. This isn't really true, since in order to hedge its bets, Banesto would need to bet for Spain, not against it.

Multi-speed Europe or multi-speed USA

One of the reasons I've heard that the Euro cannot stay together is that the countries involved have such different rates of economic growth so that it is impossible to have a coherent monetary policy. Interest rate policies that are suitable to some Euro-members might cause bubbles or stagnant growth in the remaining countries.

So how "different" are these rates, really? If you take the last couple years of growth GDP in the Euro area, you end up with a standard deviation of approximately 1.3-1.7% (sorry to statistics majors for abusing standard deviation).

What about, say, the grand old USA? Doing the same calculations on a state-by-state basis, the GSP (Gross State Product) growth varies with a standard deviation of about 2-2.5%.

So the US manages to survive on a much more varied set of regional economies with a single currency and interest rate policy.

Even if you take into account the ability of the federal government in the US to shift around money, the imbalances tend to mirror approximately the same amounts of money that are shifted around by the EU in structural funds.

The sky is not falling

People here need to remember that any story in the Wall Street Journal that quotes "experts" from the American Enterprise Institute should be treated with extreme caution.

The story presents this scary graph:



Examined more closely on a quarter/quarter basis vs year/year, it looks like Spain is pulling out of the recession:



I'm not sure what the point has been of all the fear-mongering that's been going on over the last month. If you look at any GDP chart of Europe, you get pretty much the same.

Here's the UK for comparison:

Reward for hard work

There's been a lot written lately about an alleged lack of competitiveness in the club-med countries.

One theme I've seen is that Spanish view financial success as a sort of gift from above, and thus feel that it should be shared, contrasted to the Anglo-Saxon approach where individual success should lead to individual rewards.

I don't think either side has a monopoly on the truth... I've experience the grasshopper and ant story first hand with my extended family here (we get to be the ants). On the other hand, in the US, the attitude that "I'm rich because I work really hard" leads to all kinds of problems with social inequality.

In addition, most of the research that I've seen about performance-based pay suggest that it doesn't really lead to better results. It tends to lead to an obsessive focus on benchmarks vs reality, and decreased cooperation and trust among employees. My guess is that much of the justification for performance-based pay comes from the CEO's office, who would like to think that he makes huge amounts of money because he does such a good job.

Accidentally rewarding destructive behavior also played a big role in the financial crisis, with bankers thinking more about the commissions they would get for writing loans than about the long term health of their company.

To the outside world, Spain might look like a country of funcionarios and lazy workers with ultasecure jobs, but with 3 million small businesses of 10 employess or less, it also has one of the largest rates of small business employment. From an economic perspective, small business provides the ultimate in pay-per-performance, without having to construct weird and artificial benchmarks.

Death by structured products

My bank just tried to sell me their latest exploding financial product.

You get a 3 year bond from a major bank in Spain for 3%. Then the bank writes a CDS using that bond for another 1.5%. Woohoo! 4.5% yield on a 3 year A- bond!

(except for the tiny fact that in any restructuring, failure to pay or default will see you immediately lose 100% of your capital. You've just sold your rights for any recovery.)

The nice thing is that the sales guy pretty much admitted it was crap and that he was only flogging it for the commission.

I don't understand why banks are allowed to sell these things.

"Guard labor" and social inequality in the US

This is turning into a series of posts about the US.

A very interesting report about Samuel Bowles and his theories around the causes and consequences of the incredibly high levels of social inequality in the US.

Especially interesting I found the idea of "guard labor":

Inequality leads to an excess of what Bowles calls “guard labor.” In a 2007 paper on the subject, he and co-author Arjun Jayadev, an assistant professor at the University of Massachusetts, make an astonishing claim: Roughly 1 in 4 Americans is employed to keep fellow citizens in line and protect private wealth from would-be Robin Hoods.

The job descriptions of guard labor range from “imposing work discipline”—think of the corporate IT spies who keep desk jockeys from slacking off online—to enforcing laws, like the officers in the Santa Fe Police Department paddy wagon parked outside of Walmart.

The greater the inequalities in a society, the more guard labor it requires, Bowles finds. This holds true among US states, with relatively unequal states like New Mexico employing a greater share of guard labor than relatively egalitarian states like Wisconsin.

In case you are wondering, the "Gini index", which measures social inequality (where 0 is totally equal and 100 is where one person has everything) for the US is are 46 (comparable to most 3rd world countries), whereas in Spain it is about 31 (average for EU). Sweden has the lowest in the world at 26.

State of real estate in Sant Cugat

Commercial real estate is really hurting. For some reason, Sant Cugat built large numbers of office towers, which are now completely empty (as in you can see right through them). And they are still building more.

The new Mira-sol “market” is starting to look somewhat post-apocalyptic, with the entire commercial ground floor unoccupied. In typical Spanish fashion, graffiti, garbage and broken windows aren’t really helping make it very attractive.

Residential hasn’t drop by price by that much, although it’s generally not selling very quickly. We have a house next door that’s been on sale since we moved here over two years ago. The new developments are selling with all kinds of gimmicks (100% mortgages, rent with option to buy, etc). On a monthly payment basis, the low interest rates make the overpriced places still quite affordable.

At one place the bank will buy it back from you in 5 years (assuming the bank is still around).

Rents have dropped much faster. We recently got our landlord to drop our rent by about 15% (we could have probably gotten more, but we’re pretty bad negotiators).

Sadly enough, our international neighbors have moved back to their home countries for economic reasons. One guy’s job over the last year was to close most of his company’s factories, turn the lights off, and move back to his country.

Nonperformance incentive pay

Employment law in Spain is a case study in good intentions gone bad. What began as measures to protect employees have turned harmful as everyone figured out how to game the system. The finiquito is a great example of this. If you are a full employee and your company decides that they no longer need you, they generally have to pay you 1.5 months of salary per year worked to avoid legal trouble. If you leave on your own, you get nothing.

Given how costly it is to lay people off, most young people work on one year contracts (which is renewed one year, then bye-bye). The end result is that the population on average has less job security than in many countries that have lower protections.

Since I’ve been at the same company about 17 years, I would get an insane amount of money if my company laid me off. Enough to get me wondering about how hard I should really be working.

Needless to say, the phrase "you can't fire me, I quit!" is not often heard in Spain.

The mystery of the toll both lines explained

I've wondered why there's such a line at the Manual booths, when the credit card lanes are totally open. Most people here have credit or bank cards, so why pay cash? It turns out that this is quite closely connected to Spain's wonderful underground economy (Woohoo 2nd in Europe after Italy).

As a salaried employee, you cannot escape taxes. Everything is done automatically for you and the deductions are few and far between.

However, running your own business gives you almost limitless opportunities to cheat on your taxes. One of the challenges in any semi-legit business is how to recycle your black money into clean tax deductions.

Thus, paying tolls with cash gives you a double benefits: use the black money for something useful, while saving the receipt to get the tax deduction that amount.

Okay all you salaried mileuristas, go back to your jobs, nothing to see here. Suckers.

State of High Tech in Barcelona

I've been spending the last two years trying to infiltrate the high-tech scene here in Barcelona. The sad thing is that it is pathetically small. Everyone knows everyone else because, well, there's not a whole lot of us.

Ironically, there's actually quite a bit of money available from the local venture capital, but they can't find anyone worthwhile to spend it on.

Local talent is very immature and senior leadership is few and far between.

For a vibrant high tech center, you really cannot build it from home grown talent. I've worked in Silicon Valley and the number of people that I met who were actually from that area was very small. Large multinationals (Google, MS, Intel, etc) are the magnets that can bring in enough talent to create a self-sustaining ecosystem.

Unfortunately, Catalunya's pissing match with the central government has created an environment that most multinationals don't want to deal with. The system of enchufe also means that your choice between Barcelona and Madrid is a matter of "taking sides", so Madrid is really the safe choice, since Madrid enchufe is really going to be what makes it happen, rather than those jokers in the Generalitat. Oh maybe they'll put a sales office in Barcelona for those juicy government deals. Other than that, they pretty much steer clear of Catalunya.

The fact is, if you set up your main office in Barcelona, you will not be able to recruit people from anywhere else in Spain. Whereas in Madrid, it's trivial to recruit from anywhere in Spain. In addition, Madrid is a gateway into South America, which provides incredible growth opportunities in the emerging markets. Catalunya tries to do its own thing, but mostly ends up confusing foreigners who don't understand the local politics. It's too bad, because Catalunya used to have great connections to South America (ie habaneras)

It's been sad for me to meet very talented people and then have to say goodbye to them after they get frustrated from the lack of seriousness here. My situation is weird enough that none of this bothers me too much, so I'm still here :)

Update:

Just to be clear, it's pretty easy to recruit young smart people from all around the world to Barcelona. It's one of the big plusses. However, trying to get high level experienced folks to move here is a nightmare, even from other parts of Spain. Remember, these people are not the desperate ones, but the people who could get a job anywhere they want.

The newsweek article "Silicon Envy" is a good description of the various failures around Europe to create the next silicon valley.

Ghost towns in Sant Cugat

Went for a walk yesterday around the new construction around the Mira-sol station. It's an amazing testament to the "build-it-and-they-will-come" philosophy of town building. It looks like the residential parts are occupied, but the street level commerical areas are completely empty.

Given the rate of vandalism here, I wouldn't be surprised if the commercial areas become completely unusable. Like, for example, that giant empty eyesore next to the Corte Ingles in Sabadell.