The Pain in Spain

In the musical, My Fair Lady, Professor Higgins and Colonel Pickering set out to change Eliza Doolittle’s pronounced British Cockney accent by having her recite a series of speech exercises. When, in repeating the refrain, “The rain in Spain stays mainly in the plain,” Eliza finally gets it, the trio breaks into song, a catchy and memorable melody.

In reality, the rain in Spain does not stay mainly in the plain. Much of it falls in the northern Pyrenees mountains. Unfortunately, the pain in Spain, engendered by the debt and banking crisis, doesn’t stay mainly in the plain, either. One can see the strain in demonstrations across major cities and in volatile stock and bond markets worldwide.

 On Wednesday, July 18, 2012, tourists in Barcelona were exploring Antoni Gaudi’s fanciful building on Passeig de Gracia, Casa Battló, when a noisy commotion arose on the street below. A well-orchestrated group of protestors had barricaded the front door of a Barclays bank branch, allowing no one in or out, as traffic slowed and police stood by doing nothing.

 The group was protesting austerity measures imposed on the debt-ridden economy as well as foreclosures following the collapse of an overheated real estate market. Unemployment, at 9% in 2008, now approaches 25%. For those under age 25, youth unemployment is a startling 53%. Discontent is understandable. A banker hung in effigy over the door to the bank emphasized the frustration of the protestors.

Fears of weak growth and rising unemployment in the euro zone and elsewhere have buffeted global stock markets. Investors and money managers analyze the pronouncements of Ben Bernanke and European Central Bank head Mario Draghi for clues as to various bailout and stimulus schemes.

“Cold-hearted” bankers may be a favorite whipping boy in times of stress as foreclosures mount in Spain and elsewhere. But investors and savers are funny about their money. When they put money in a bank, they expect to get it back. Taxpayer guarantees only go so far. They also would like to know that $100 in savings, for example, will buy $100 worth of goods ten years from now, although no one believes that. Compensation, an inflation premium, adds to interest rate pressures.

 If repayment of the money lent to banks or governments on the part of investors is suspect, risk premiums are demanded. Currently it costs the Spanish and Italian governments roughly 7% to borrow money for 10 years, whereas the U.S. 10-year Treasury note yields 1.62%. As interest rates rise, bond values decline, harming fixed income investors.

To quell fears of a breakup of the euro currency zone, Mario Draghi said he would do “whatever it takes” to save the euro. Investors are trying to figure out exactly what Draghi means. Is the cure worse than the disease? Massive bond buying programs unleashed by the U.S. Federal Reserve Bank and cheap funding for European banks are being engineered with printed money. A debt monetization and inflation strategy designed to jump start the economy is favored by Keynesian policy makers, but in the long run serves to erode a currency’s buying power.

 The good news is that the United States is not Spain or Italy...yet. Since money chases perceived safety, despite a lowered credit rating, Uncle Sam still is viewed as a relatively safer bet compared to elsewhere. On September 1, 2011, it took $1.44 U.S. to buy one euro. In early August 2012, it only took about $1.22 to $1.23...good news for the tourists in Barcelona; not so good for the protestors in the street.

 With “all items” inflation running at a 1.7% annualized rate in the U.S., exceeding the rate paid on most “safe savings,” the chase for yield will continue apace. Adjusted for taxes, safe money returns are a net loser, and so the pain in Spain shows up in stealth form to erode your purchasing power.

 We aren’t hanging bankers in effigy...yet!

 The Investment Coachä 1994, Walker Capital Management Corp. Lewis Walker is President of Walker Capital Management Corp. and Walker Capital Advisory Services, Inc., a Registered Investment Advisor (R.I.A.) Securities and certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA).  Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with the Walker Capital Companies.       3930 East Jones Bridge Road ▪ Suite 150 ▪ Norcross, GA 30092 ▪ 770-441-2603