It's Time For Madrid To Pay The Piper

Includes: EWP
by: Kyle Spencer

Imagine a Spanish politician unlucky or unwitting enough to run under the banner of Prime Minister Mariano Rajoy's Partido Popular (PP) in the upcoming regional elections in Catalonia.

The PP candidate grips both sides of the podium and speaks eloquently and at length about European solidarity and Spanish sacrifice. Now the opposition candidate steps up to the microphone, leans forward, and asks: "Are you better off now than you were a year ago? No? How about four years ago? How about five?"

The answer is an unqualified no: The Spanish haven't been this miserable since the Spanish Civil War. At 26.44%, Spain's Misery Index exceeds that of Greece. The Misery Index of Spain's youth now sits at 54%.

Courtesy of our friends at ZeroHedge:

Now take a look at the Consumer Confidence Index (CCI) indicator for Portugal, Ireland, Italy, Greece, and Spain below. The CCI data illustrates how deflation is taking hold of various sectors of the Spanish economy, most importantly housing. (The CCI is calculated with 1985 as the benchmark year, since that year was neither a peak nor trough in the business cycle.)

The impact of the austerity cuts on Spanish businesses can hardly be overstated. The new Spanish budget commits to a further $24 billion in austerity measures while servicing over $12 billion euros in debt, while at the same time reducing revenues via the tax amnesty, which the Spanish government introduced in March. Meanwhile, domestic demand growth has slumped to -3.21%, down from -2.86 in Q4 2011, and the international markets have been closed to major Spanish companies like Abertis (OTCPK:ABFOF), Gas Natural (OTCPK:GASNF), ACS (OTCPK:ACSAF), and Telefónica (NYSE:TEF) for months.

Misery Loves Company

Germany has thrived at the expense of its neighbors over the last few years. Investors flocked to the perceived safety of German bunds, reducing borrowing rates for German state and local governments, businesses and homeowners.

That's all over. German unemployment has climbed for six months in a row, as of September, as export losses begin to outweigh domestic demand. The chart below details just how rapidly German consumer confidence has collapsed over the last year.

While the tipping point between economic self-interest and political upheaval may be difficult to quantify, investors ignore sociopolitical factors at their peril. The social dimensions of the Spanish crisis are as important as the interest rate on Spanish bonds, or the solvency of its banks. One third of Spaniards now frequenting a food pantry or a soup kitchen has never known poverty. Many of them are undoubtedly living in a state of shock.

The erosion of confidence in Madrid is breathtaking: politically "unstoppable" only a year ago, 84% of Spaniards now have little or no confidence in Rajoy. The approval of Partido Popular has suffered accordingly, falling from 42.7% in January to 36.6% in July. If this trend continues into October, as it no doubt will, Partido Popular will be trounced next month in the regional elections, and nowhere will the Party suffer more than Catalonia.

Catalonia Turns On Madrid

This month, 1.5 million Catalans demonstrated in Barcelona to demand full independence of Catalonia from the Spanish Kingdom. Catalonia accounts for 20% of the Spanish GDP and a quarter of Spain's exports.

According to Turkish Weekly,

Eighty-four of the 131 regional lawmakers voting backed the call for a "consultation" on the "collective future" of the region, whose government says it is bearing an unfair burden in the recession and wants more control over spending.

The way regional president Artur Mas sees it, Catalonia could repair its own balance sheets if the region didn't have the burden of supporting the rest of Spain. The government of Catalonia is pauperizing itself by paying $20 billion more per year in taxes than it receives in services from Madrid, with the paradoxical result that the regional government is forced to beg money back from Madrid.

Considering Catalonia's enviable debt-to-GDP ratio under the last four administrations, it's not difficult to understand why Catalonia would want out of the Spanish brand.

If Catalonia were to secede from Spain, the regional government's Debt-to-GDP ratio would fall a further 40%.

False Hope

Investors should be careful about where their information on the Spanish crisis originates. For example, Time Magazine's Lisa Abend reported that:

Not everyone sees it that way. For Alicia Sánchez-Camacho, head of the Catalan Popular Party, the bid for independence is making a bad situation worse. "To call snap elections, when we're not even halfway through the legislative term is irresponsible and proof of Mas' failure to govern," she says. "And by pushing for independence, he's taking the economic crisis and adding an institutional one to it, which will only generate instability and uncertainty.

The implication is that Catalans are split along political lines with regard to the succession question, and that this division might kill the independence referendum before it makes it to the ballot box.

However, a closer inspection of Spanish politics suggests that Time's reporter in Madrid is being taken for a ride by Camacho. The PPC holds only 18 seats in Catalonia's 135 seat parliament, and wields no veto power over Catalan legislation. On Thursday, the Catalan parliament voted in favor of holding a referendum on independence after November elections whether allowed by the Spanish government or not.


If the referendum for Catalan independence is approved by a large majority, Madrid will not be able to ignore Catalonia's request by declaring it unconstitutional. A defeat for Madrid in the upcoming elections will rock already jittery financial markets and send Spain's borrowing costs soaring, despite the threat of intervention by the ECB.

The social fabric of Europe is unraveling. It hardly matters if austerity is the right medicine for Southern Europe at this point: an economic solution that requires more time to bear fruit than the social and political realities allow for is an a priori failure. The question is not whether to invest in Europe today, but whether or not to invest in Today's Europe; which will likely be controlled by political parties with very different views about the sanctity of debt.

All but short-term traders should be wary of European financial institutions with high exposures to Spain in the weeks ahead of the Catalan elections in October. This includes Barclays (NYSE:BCS), Deutsche Bank (NYSE:DB). U.S. banks with significant exposure to Spain include Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS), Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM), and Citigroup (NYSE:C). Investors may also wish to initiate short positions in the iShares MSCI Spain Index (NYSEARCA:EWP).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.