One Chart To Rule Them All, One Chart To Find Them (Out)
By Edward Hugh
Look, if there is one simple chart which sums up everything that is wrong with current thinking at the International Monetary Fund, then it is this one.
Basically, I spent much of the day yesterday scratching my head, trying to work out how the hell the IMF could be forecasting Spanish GDP growth of 1.7% in 2012, of 1.9% in both 2013 and 2014 and 1.8% in 2015. And now it has dawned on me how and why they can. Quite simply they are forecasting current account deficits for Spain of 5.3% of GDP in 2010, 5.1% in 2011, 5.0% in 2012, 5.0 in 2013, 5.0% in 2014%, and 5.0% again in 2015. In other words, the assumption is that nothing fundamental is going to change in the post 2008 world, when compared with the years that preceded it. And this is clear when you come to look at the whole structure of current account balances revealed in the chart above, which are based on the IMF forecasts through 2015 as set out in the April 2010 World Economic Outlook. It is a case of plus ça change.
And all this becomes even clearer when we see that it isn’t only Spain where the current account deficits are going to persist, since they are also expected to continue in the US, and the UK. The structural surplus countries China, Japan and Germany – will also continue on their path, as if nothing important had happened. Which means the global imbalances will remain just the way they were, untouched and unmolested by the crisis – OK, some of Spain’s most severe "excesses" will be gone, since the deficit will fall from 10% to "only" 5% – and I can’t help asking myself, wasn’t that how we got here in the first place?
The thing about these CA deficit assumptions is that they effectively make the argument a circular one. You don’t start with the real growth potential of the Spanish economy (that was what had me scratching my head yesterday about the degree to which the export sector could rise to meet the challenge). Now I realise I was wasting my time. The export sector isn’t going to have to grow, since Spain is going to continue to run a trade deficit, out into the future and as far as the eye can see, it seems.
But the interesting question to ask is what exactly the current account deficit is going to be for. I mean, who exactly is going to be doing the borrowing that it will be funding? What has happened in Spain has been the result of what some have termed a "causal reversal", since in the current case it is the capital inflows (borrowing, made possible by structural surpluses elsewhere in the Euro Area which lead to comparatively cheap interest rates) which produce the current account deficits, rather than the the normal balance of payments problem where growing deficits lead to the need to borrow. And it isn’t hard to see evidence for this kind causal reversal in the Spanish case. Under normal circumstances when a growing current account deficit produces the need for external borrowing, the exchange rate tends to fall, and the interest rate charged rises. In causally reversed situations, the currency tends to rise, and the central bank holds rates down to try and discourage the arrival of even more liquidity.
In Spain, there is no exchange rate to fall, and interest rates are set elsewhere – over at the ECB, and in the Euro Area interbank market – but still the funds arrived (via the interbank market) to meet the mortgage needs of a Spanish citizenry who were rather light on savings. Spain is, in fact, relatively insulated from current account pressures on both the above fronts, or at least it was. Then, of course, what was called the "European Sovereign Debt" crisis set in, and the interbank market seized up (effectively closing its doors to Spanish banks) while spreads on government bonds started to rise. In the Spanish case the term "Sovereign Debt" crisis is a complete misnomer, since as many commentators tirelessly point out, Spanish sovereign debt (at this point) is comparatively low by European standards, and what Spain is suffering from is a "Private Sector Indebtedness" crisis. Which is what makes the assumption of ongoing current account deficits look rather odd, because it leads me to ask: who exactly is going to be doing the borrowing that will produce the current account deficit, the private or the public sector?
If it is to be the latter – and I can’t avoid the conclusion that it is going to have to be – then it suggests to me that the IMF are already assuming that Spain’s fiscal deficit is going to be above the 3% level for considerably longer than up to 2013. Let’s have a look and see.
Private Sector Debt
Spain has accumulated a very high level of net external debt. It currently hovers somewhere around 90% of GDP (see chart below), and continues to rise (naturally, that current account deficit), even as GDP hardly moves.
Private debt (both corporate and household) is large, and shows no signs of reducing significantly. Corporate debt currently stands at around 125% of GDP, and while it is down slightly (2.1% in June) on an annual basis, it has remained pretty stable during 2009 and 2010. With Spanish company indebtedness well over the European average, and the economy at best lethargic, their accumulating more debt at this point seems very unlikely.
Household debt stands at around 85% of GDP, and while it has been more or less stationary since mid 2008, even this has started to rise again even if ever so slightly (it was up an annual 1% in June). Some see this as a sign that credit is moving again, and thus a positive feature, but if Spain got into the mess it is in because its households became overindebted, accumulating yet more debt seems an unlikely solution.
The Dependence On External Credit Grows, Rather Than Reducing Over The Forecast Horizon
As I explained in this post, the slight GDP growth which was obtained in the first quarter of 2010 was primarily as a result of improved internal demand, and the net trade impact was negative (see chart below).
And this is hardly surprising given that the trade deficit has deteriorated.
And it would not be surprising to see the same pattern (of slight growth, largely supported by internal demand) being repeated in the second quarter, given that the trade deficit seems to have deteriorated further. And of course, the improvement in the current account position that was so evident in the middle of 2009 has now come to an end – but then the IMF seem (at this point at least) to be more or less resigned to this situation (although I can’t for the life of me understand why they are).
Basically, the only serious reading which can be given to the IMF current account deficit forecast is that someone – the ECB or that new European Financial Stability Facility which conveniently came into official existence on Friday – will be intervening in the markets to provide the liquidity to make it possible to fund the deficits, although again, and for the life of me, I can’t understand why they should want to do so.
And as I suggest above the only sense I can make out of those 5% annual current account deficits is that the government will be doing the borrowing to make them possible (via larger fiscal deficits than are currently formally anticipated) since I can’t realistically see the private sector being willing and able to assume the debt that will be required – and especially if they start to raise interest rates at the ECB. Really I am not sure what is going on here, since I’m sure I can’t be the only person around who is capable of making these (fairly reasonable) deductions. So if it is the investing community you want to convince, rather than the general public with nice headlines, something a bit more rigorous is really required.
But then, at the end of the day, the forecasting process probably got itself stuck, between the need to show reasonable growth rates, and avoid consumer price index readings that smell of deflation – so they end up projecting inflation of a little over 1% a year between 2011 and 2015 – and of course, if you do that, there is no way you are going to get a goods trade or current account surplus, since the misalignment in Spanish prices is just to great. So here we are. My feeling is that all this will only go on for as long as it does, and one of these days the Spanish government, the IMF and the EU Commission will find themselves trapped between an angry group of those so-called "bond vigilantes", and an even angrier group of Spanish voters, who will be demanding "Hungarian style" just why so many years of crisis and austerity have only served to get them even deeper into debt. At that point I don’t think I especially want to hang around to see what gets to happen next.