Sabtu, 14 April 2012

A provocative but well written pice from Gonza Lira - drawing a comparison between Spain now with Argentina back in 2001. There are some similarities playing themselves out - one thought that comes to mind is we presently are seeing a quiet run on the banks of Italy and Spain - with the money flows heading to safer environs in the eurozone. How long before Spain clamps down with capital controls on spanish citizens , businesses and money flows from Spain itself ? In fact , one can argue these steps have commenced. Part of Spain's discreet " corralito " measures include recent measures to preclude cash transactions exceeding 2500 euros - with fines as high as 25 percent for amounts exceeding that bar for the transaction at issue ! So will Spain beat Greece out the door of the Eurozone and install a " New Pesata " devalued as Gonza suggests at 30 percent , on the road to finding its stable value - somewhere maybe 50 - 75 percent off the euro ? ?

Will There Be A “Corralito” In Spain?

Yes, it’s a metaphor. Of what, I dunno.

How Spain could exit the eurozone—a practical guide.

In late 2001, while everyone was in shock over 9/11, the Argentines were going through a little shock of their own: The “Corralito”. Argentina was bankrupt, a product of a stagnant economy, rampant crony-corruption, and—most important of all—of having its currency fixed to the dollar. This currency peg had created a huge credit bubble, and of course massive capital outflows as a result, eventually leading to the depletion of foreign reserves by the government and an inability to raise more funds on the open markets. 

In other words, sovereign bankruptcy.

Coupled to these problems, in the months leading up to the December 2001 crash, people were aware that the country was going bankrupt—so they were quickly converting all their Argentine pesos into dollars, and then sending this money to safe havens overseas.

To solve these problems of sovereign insolvency and massive capital flight, and at the same time to stabilize the situation, on December 1, 2001, the Argentine government imposed the infamous corralito—literally, the “little bullpen”: A series of measures designed to hold in capital and prevent it from fleeing the country, while devaluing the currency to a more realistic, sustainable rate of exchange.

As part of the corralito measures, the Argentine government froze all dollar-denominated bank accounts; converted those dollars into Argentine pesos on a one-to-one basis—that is,confiscated people’s dollars; limited all withdrawals in Argentine pesos to a weekly maximum of AR$250 (you read right: per week); and of course—the cherry on the sundae—it devalued the Argentine peso against the dollar. The devaluation was at first a “mere” 40%—but shortly thereafter the Argentine peso was allowed to float: And it dropped to a rate of four to one against the dollar. 

Literally millions of people lost their life-savings in one fell swoop. The local equity market tanked catastrophically, as did the local bond markets. People on a fixed income also got clobbered, as their pensions lost their purchasing power by 40% overnight—and then eventually by 75%.

Chaos ensued.

Now, the situation in Europe today is virtually identical to that of Argentina in 2001: Overleveraged, with an insolvent banking sector, a flatlining economy and growing unemployment.

But of all the countries, Spain in particular is the biggest trouble.

Spain today has a stagnant economy: 24% unemployment, 53% youth unemployment, an economy shrinking at an annualized rate of at least –1.75%, a banking sector with a collective insolvency that runs some €78 billion, a government that needs €190 billion this year alone to fund itself (on a total GDP of barely €1 trillion)—

—and most important of all: Spain has a looming inability to meet its debt payments, coupled with a rapidly deteriorating reputation among bond buyers. In other words, Spain today is the Argentina of 2001.

Now, as I’ve written here before, the euro is essentially one giant currency peg: Monetary union over the past ten years meant that all the eurozone economies have pegged their currencies to the German currency.

During boom times, this meant that all the peripheral eurozone members enjoyed access to cheap and limitless credit—which they of course took advantage of. But during down times—like now—those debts become insurmoutable—like now.

I argued last week that Spain would leave the eurozone, probably before the end of the year. But the issue is, What would that exit look like? How would that exit be carried out, on a practical basis?

Let’s assume that the decision has been taken by Spain to exit the eurozone. Let’s further assume that on the day of the exit, Spain will initially value the New Peseta (NP$) at par with the euro—but that a devaluation will happen immediately thereafter, of say 30%.

Before anything else, the Spanish government would have to make sure that nobody—and I mean nobody—knew that the decision had been made until after the decision had been implemented. Foreknowledge of a Spanish exit of the eurozone and a return to a local currency would cause a bank run of staggering proportions: People would realize that the government was going to devalue the currency, so they would rush to their banks to withdraw their euros and either send this money out of Spain or else hold it in cash under their mattresses. Either way, such a bank run would crater the entire banking sector instantly—because the banks certainly do not hold reserves to meet such a run.

Brothers in Debts
In point of fact, this is exactly what happened in Argentina: Because of the rampant cronyism, oligarchs and the well-off got wind of what the government was planning—and instantly pulled all of their money out of Argentina’s banking system, and sent their money to overseas safe havens. There were literally lines of truck with money, driving away with the oligarchs monies. And ultimately, it was this run which triggered the December 2001 crisis in Argentina.

So secrecy—and surprise—would be key. This is the reason that, if and when there is in fact a Spanish exit of the eurozone, we will not hear a whisper about it until it actually happens. Now, if and when there is a Spanish eurozone exit and devaluation, this is the order of events as they would happen:

Once the trigger is pulled for Spain to exit the eurozone and go back to a local currency, the Spanish government would order all banks in Spain—both foreign and domestic—to convert all their customers’ accounts and all of the banks’ cash holdings from euros to New Pesetas. The Banco de España, Spain’s central bank, would then take receipt of these euros from the private banks, and exchange them for New Pesetas on a one-to-one basis. Because of the modern electronic banking infrastructure, the entire currency exchange operation could be done over a weekend.

Because of the prevalence of credit cards and cash machines, very few people carry more than €100 on their person at any given moment. Therefore, the Banco de España wouldn’t bother getting the actual physical cash from people, and obliging them to exchange those euros for New Pesetas. It would simply not be worth the effort: The amount of money that people have—assuming the people are caught by surprise—would be minuscule compared to what the banking sector would have.

Immediately after the banks had surrendered their euros to the Banco de España and received their New Pesetas, the Banco de España would devalue. An initial devaluation of 30% seems reasonable.
After conversion and devaluation, the next step would be to impose a corralito on the Spanish economy: No one would be able to withdraw more than, say, NP$500 per week.

Why would a corralito be imposed on the Spanish economy? For the same reason it was imposed in Argentina in 2001: To prevent a massive bank run.

Don’t misunderstand the corralito: People (and corporations) would be able to trade funds via the banks. For instance, someone buying a house would be able to transfer the funds to the seller’s account—so long as the seller’s bank was Spanish. The point of a corralito is not to end trade—the point of a corralito is to prevent capital flight.

The corralito in Spain would end once the internal domestic situation had stabilized—and this would be signaled by a stable exchange rate between the New Peseta and the euro.

The quicker a stable exchange rate between the New Peseta and the euro is reached—no matter how low—the better for the Spanish economy. Because once the true exchange rate has been discovered by the markets, only then can trade and economic activity restart and rebound.

Though the New Peseta would be immediately devalued by 30% in my hypothetical discussion, the ultimate exchange rate is unknowable at this point in time. But it seems to me that a stable rate of NP$2.50 to €1.00 is reasonable. But I repeat: Only the market can determine the true rate of exchange; my guess is just that—a guess. The immediate effect of a currency exit and devaluation would be a spike in unemployment as businesses shut down temporarily or permanently, until the true exchange rate is reached.

But once the New Peseta reached a stable floating exchange rate—say within six months—the Spanish economy would reignite, because of the principal benefit of a currency devaluation: Its exports are now cheap, as are its capital goods. A doo-dad which sold for €10 euros before the conversion and devaluation is now NP$10—which would be equivalent to €4 million at a NP$2.50 exchange rate. A factory worth €1 billion would now be worth NP$1 billion—or in other words, €400 million at a NP$2.50 exchange rate.

So once a stable rate of exchange is reached, Spain would experience strong exports and strong capital inflows—which would reignite Spain’s economy.

Which after all is the whole point.

In Argentina, the corralito ended about a year after it was imposed—it ended after the Argentine peso had reached a stable exchange rate with the dollar. The same would happen in Spain, though at this time it is impossible to say how long that would be.

Insofar as the insolvent Spanish banking sector is concerned, with all these confiscated euros on its balance sheet, the Banco de España would have the ability to nationalize any insolvent bank, pay off it losses, then turn around and sell the now-healthy bank on the open markets. So in two moves—eurozone exit and subsequent devaluation—the Spanish economy would be essentially reset, with a now healthy banking sector, a reignited export-driven economy, and a now-attractively priced capital goods.

Sounds pretty good—so who would suffer?

Bondholders, and those living on a fixed pension.

Obviously, pensioners and others living on a fixed income—who are predominantly the elderly—would suffer terribly. The purchasing power of their pensions would be reduced by the amount of the devaluation, which I’ve hypothetically stated could reach 60%—but it could easly reach 70% or even 80%. It reached 75% in Argentina.

Workers also would suffer, but less so. They would certainly suffer immediately after the exit-and-devaluation, as many of them would lose their jobs. But as exports began reigniting the Spanish economy, it would be reasonable to expect that within a year or two, workers would be able to demand salary and wage increases without breaking the nascent economic boom.

Bondholders would take the biggest hit. Bond prices would suffer a Greek-scale collapse in value—but it would not be self-evident that such a collapse in value was justified. Insofar as Spanish debt is concerned, since so much of it is in Spanish banks, the Banco de España would be able to palliate the balance sheet holes with the euros it confiscated during the exit-and-devaluation.

Insofar as the Spanish debt held by foreign players is concerned, the initial collapse in value might be a mistake—because the Spanish might in fact be able to make good on their bond payments, now that they’ve exited in the eurozone. It’s reasonable to think that the Troika—the ECB, the EC and the IMF—would negotiate Spain making the Spanish bondholders whole, in exchange for assistance or Debtor-In-Possession credit or some other such bankruptcy assistance.

Because after all, a eurozone exit and devaluation would essentially be a Spanish bankruptcy.

Initially, like anyone else who’s gone through bankruptcy, Spain would certainly be a pariah in the international bond markets—but only for a time. Eventually, as the Spanish economy improved under the devalued New Peseta, lending to Spain would become attractive again. Consider Iceland: They defaulted in 2008—yet within three years, they were able to successfully auction a bond issuance on the international markets.

Anyway, in the early days of the exit-and-devaluation, Spain would not need foreign cash. After all, by forcibly converting to the New Peseta and then devaluing, the Spanish government’s liabilities would be discounted by the percentage amount of the devaluation. Thus they wouldn’t need access to foreign credit markets—because their liabilities would have been severely discounted. The key, of course, is rapidly reaching a stable, free-floating exchange rate. Only then can the corralito be ended. Only then will economic activity reignite, as Spanish products became cheap on the international markets, and thus Spanish domestic production took off. Only when a stable exchange rate is reached would foreign capital be willing to enter the Spanish market. 

Crazy as it may sound, all those half-built summer houses on the Costa Brava might well get snapped up by foreign money, if Spain exits-and-devalues. But that’s what happens when you devalue your currency: Everything becomes cheap for foreigners, who rush in to buy.

The more you look at the situation cold-bloodedly, the more obvious it is that a eurozone exit and devaluation is the absolutely best thing for the long term health of the Spanish economy.

It remains to be seen if the Spanish leadership will have the cojones to do what has to be done, to save the Spanish economy: Exit the eurozone, devalue, and rebuild.
This article is adapted from a larger Supplement that appeared in my Strategic Planning Group. If you’re interested, check out SPG’s preview page to see what it’s all about.

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