The United States is not the only country attempting to “soak the rich” in order to pay its bills.  The United Kingdom has also regrettably moved in that direction, and now Spain has indicated that it too will raise taxes on high-income earners.  The Financial Times writes, “Spain’s cash-strapped Socialist government is poised to emulate the UK and increase taxes on the rich, reversing its policy of tax cuts…”

With unsustainable budget deficits, the Spanish government has decided that it’s easier and more politically expedient to plug the gaps with tax hikes rather than unpopular spending cuts.  Sound familiar?

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Ernest Hemingway must be spinning in his grave right now.  Two Spanish towns south of Madrid have had to cut back or cancel their annual bullfights — and the accompanying running of the bulls through the streets — for lack of funding.  A summer in Spain without bullfights is like a summer without sangria — unthinkable!  But the global recession has bitten Spain hard, and Spanish cities are facing funding crises not too different than those in California.  (Read FT Article)

Spain — like California, Florida, Arizona, and Nevada — had a major housing bubble in the mid-2000s that saw the country’s economy become dominated by homebuilding.  When the housing market died an inglorious death (alas, it didn’t die bravely like a well-bred Spanish fighting bull…), an enormous hole was left in the Spanish economy — and in local government budgets.  When Spanish towns rein in their spending on their annual summer fiestas, you know the straits must truly be dire.   But, as the FT article explains, when a town owes back pay to 800 municipal employees, it is rather difficult to justify spending $700,000 on a party.

This situation is reminiscent of the Los Angeles Lakers recent NBA championship.  The Lakers won their 15th championship in June — second only to the Boston Celtics — but the city of Los Angeles couldn’t afford to throw them a victory parade (see Reuters article).  Of the decision, Reuters wrote: “…such a celebration could cost the city $1 million or more at a time when city leaders, faced with a deep budget deficit, were contemplating worker layoffs and cuts in services.”

City officials are right, of course.  When you can’t pay your workers, you have no business funding a party.  But it sure does make life in a recession a lot less fun.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

One of our readers forwarded this headline to me:  ”Global Deflation Pandemic Begins to Brew.”The Journal writes, “Broadly, prices in Europe are tipping into a deflationary dead zone. In the 16-nation euro region, prices fell 0.1% in June from last year, the first such drop on record. Prices have been flat or down in Finland, Portugal, France, Germany, Ireland, Spain and Switzerland.”

I missed this story when it was originally released because, ironically, I was on vacation in one of the hardest hit of the countries mentioned: Spain.   As an American paying in depreciated dollars, I hardly noticed that prices were lower.  And the bars along Madrid’s Calle de las Huertas seemed as busy as ever.

But, I did see more “Se Vende” (”For Sale”) signs in Madrid windows than on my last visit in 2003.  The main shopping streets appeared to be in full liquidation mode, with aggressive discounts that rivaled those seen in the U.S. last Christmas season.  And, between pitchers of sangria, my old Spanish friends assured me that things were indeed quite bad and that they felt themselves lucky to still have jobs. Read the rest of this entry »

We’ve heard a lot about “green shoots” in recent weeks.  After more than a year of bitter pessimism, many investors and economists are starting to see fragile signs of recovery.   We agree with this, to a limited extent.  But we also firmly believe that this recession is FAR from over.  

We continue to see anecdotal evidence that the economy and the financial sector remain very weak. Consider this headline from today’s Financial Times: “Spanish bank offers employees five-year work break on 30% pay.” 

Yes, Banco Bilbao Vizcaya Argentaria (BBVA) — one of the biggest banks in the world —  is offering some of its employees a five year holiday.  It appears that this financial giant sees business being slack for at least the next five years, and is letting some of its employees take what amounts to a leave of absence.  

So, if you are planning to take a vacation to sunny Spain any time soon, you might find the beach resorts and tapas bars a little more crowded.  Perhaps this is BBVA’s attempt to generate more rental business for vacation homeowners on the Spanish coast who happen to have mortgages with BBVA?   

We say this jokingly, of course.   But our original point remains:  ”green shoots” or not, this global recession is not over.

Deflationary, tight-money conditions have a way of speeding up the “creative destruction” process so critical to capitalism.  Weaker competitors fail, making room for stronger competitors to expand and take their market share.  The high-profile bankruptcies of Linens ‘n Things and Circuit City are a case in point.  Stronger rivals such as Bed, Bath, and Beyond; Best Buy; Target and Wal-Mart are now left to dominate. We believe that we will see more high-profile business closures before this recession ends, and we’ve mentioned a few names (General Motors and Chrysler much?).  

Seekingalpha.com has now created a list of 12 brands likely to disappear in this recession and its aftermath (Link to Seeking Alpha).  Some of these brands are stand-alone, independent companies (such as Borders Books and Esquire Magazine, Crocs, Palm, and United Airlines); others are merely one brand within a company’s portfolio (such as GM’s Saturn, Chrysler’s own Chrysler make, and Gap’s Old Navy). For nearly all of these companies, the root causes of their declines are obvious: overcapacity in their respective industries, weak consumer demand, and  (generally) weak balance sheets laden with debt. Just as in all significant recessions of  the past, there will be consolidation, and familiar names will disappear.  Such is life, it appears. 

We see other signs that this recession is nowhere near finished.  The acute crisis stage has (hopefully) passed, but we now face a prolonged period of slow growth and falling prices in formerly inflated assets, such as high-end homes.  The Wall Street Journal this morning ran a story on Leona Helmsley’s old mansion in Connecticut.   The stately home was put on the market for $125 million a year ago.  The asking price has now been reduced to $75 million–a haircut of $50 million!  We might also add that no buyers have yet come forward.

Finally, the news coming out of Spain today is truly scary.  In the aftermath of Spain’s bubble–which was considerably larger than that of the United States given the size of Spain’s economy–the unemployment rate is over 15% and may be on its way to 20%.  The New York Times writes, “With the combination of rising unemployment and falling prices, economists fear Spain may be in he early grip of deflation, a hallmark of both the Great Depression and Japan’s lost decade of the 1990s…”

Deflation is bad, bad news, as we have written here before.  It creates a spiral of decline in which consumers and companies delay purchases in anticipation of lower prices, which then become a self-fulfilling prophecy.  Company cannot dream of expanding their operations in such an environment, and growth slows to near zero or actually goes negative.  This goes beyond the typical “creative destruction” of most recessions and takes down the strong along with the weak. 

Currently, Spain’s situation might be the worst in the Western world.  Will our situation get this bad?  Probably not for the foreseable future, but given the global nature of this recession and the continued state of fear and uncertainty, it cannot be ruled out.