..........................................So what can Spain do? It needs to become more competitive — but it can’t have a devaluation, because it’s a euro country. So the only alternative is wage cuts, which are desperately hard to achieve (and create big problems for debtors.)
Contrary to what everyone seemed to be saying even a few weeks ago, being a member of the eurozone doesn’t immunize countries against crisis. In Spain’s case (and Italy’s, and Ireland’s, and Greece’s) the euro may well be making things worse.
And Britain’s plunging pound, unpopular though it is, may turn out to have been a very good thing.
Edward Hugh is out once again with a discussion about the "appropriate" way of adjustment. This time he is laying out his arguments based on the current standing in four EU countries: Ireland, Greece, Latvia and Hungary. Read the full article!
Here are couple of most relevant excerpts, in my view:
Well really there are no very easy solutions here, and anyone who suggests there are is kidding you. In all the countries we are talking about above (and a good few more) the citizens, and the corporates (and in some, but not all, cases the governments) are very highly leveraged (indebted in relation to their realistic future income expectations) and the debt accumulation process has pushed living standards to a level which is higher than sustainable. Just think of your own household. If you push all the available credit to its limit during the first half of a year, its clear you can’t live on the same level in the second half unless you keep borrowing, but when the lenders not only won’t allow you to do this, but even have the nerve to ask you to pay some of your borrowings back, well then your standard of living in the second half is bound to drop, and this, of course, is what is happening across all these countries.
There is an additional problem here, however, since all that “over-the-top” borrowing drove these countries forward above their normal “capacity” level, and that is also what all the above four economies have in common. This driving-forward beyond capacity is what is called “overheating”, and this overheating is normally reflected in above average inflation, which is again what we have seen in these countries. The end product is that they have not only an indebtedness problem but also a competitiveness one, and that is what the IMF packages are intended to address.
Of course, the problem is if you get your salary cut it becomes harder to pay back the money you owe (loan defaults) and you can’t spend as much on consumption (demand slump). And on top of this, as these first two lock-in, government revenue falls (less VAT) while expenditure rises (unemployment payments and bank bailouts), so we get fiscal deficit problems. So not only do you have banks lending less, households spending less, and companies investing less (as demand drops), we also have governments finally forced to cut back (at least in the more vulnerable economies), as the ratings agencies get to work. So you get a downward spiral of falling wages, and falling prices as GDP just comes down and down. And this process can become systematic (deflation) meaning that nominal GDP starts falling even faster than real GDP, making for a car that becomes increasingly “wobbly” and difficult to steer.
In this environment, there really is only one way to halt the spiral, and to jump start the economy, and that is to export, and to try and encourage export directed investment. But to get going with exports you need to recover competitiveness. You can achieve some of this restoration via productivity improvements, but not enough, and not quickly enough, especially if the distortion is large, and has been going on over a number of years (see the real exchange rate chart for Hungary above). So you can either do one of two things, devalue, or cut wages and prices. Neither is easy, but as we are now seeing the second is hardly universally popular either.
Or, if we sum up in very basic terms, the major concern behind the scenes is:
...then eventually the political process goes bust, and then the financial bust ... follows.
Are you sure who controls the political process?
Definitely, exports are one side of solution, but you know our recent theme of "export-mania", so one should be careful where he puts his head. Exports are very needed for Latvia to pay off the foreign currency debt. Another way to do the "balances" right - try to reduce the imports with own local goods and services ...
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