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Euro area inflation: gaining momentum below the hood

Today Eurostat released April 2011 inflation for the Euro area. Prices are increasing at a 2.8% annual pace, up from 2.7% in March and very much above the ECB’s comfort zone of around but slightly below 2%.

Today’s report is the second release and includes the cross section of price gains below the headline number. The first ‘flash’ estimate does not specify the breakdown.

Inflation’s hitting all sectors, goods (primarily) and services alike, via inputs to production.

READ MORE AFTER THE JUMP!April core prices rose 1.6% over the year. The goods-price inflation is flowing into the the service-sector as well – headline service-sector inflation is 2.0% in April, up from its low of 1.2% one year ago. There may be some seasonal distortions here associated with the Easter holiday, but the upward momentum has been established.

Price gains at the country level are broad based.

2% annual inflation is increasingly ubiquitous for key countries, Periphery and Core core alike. Below is the diffusion of 2% annual price gains, where an index value above 50 indicates that the majority of component prices are rising at a 2% rate. The legend indicates the longer-term average diffusion of price gains.

Germany is still seeing the majority of annual price gains below 2% – the current index is 43 – but the breadth of 2% inflation is increasing beyond its longer-term average of 34.8. In Spain and Italy, current inflation diffusion indices are likewise increasing, where Spanish price gains are broad, 55.6 in April.

And it’s not just VAT taxes.

The chart below illustrates the tax-adjusted inflation rate across the Eurozone (ex Ireland, unfortunately, whose data is unavailable, Austria, Estonia and Cyprus). This series is lagged one month.

The tax-adjusted inflation rate assumes that all tax hikes are passed fully through to final goods prices. It gives a proxy for the inflation effect of fiscal austerity (hike in VAT, for example).

Although the uptick in inflation is warranted at this stage in the recovery, especially in the core, the momentum in prices can no longer be attributed to taxes only – it’s broader than that. Greece, for example, saw its inflation rate peak around 5.6% in September 2010 when its tax-adjusted inflation rate (inflation excluding VAT) was just 1.1%. Now, however, the headline and tax-adjusted inflation rates are converging, 4.5% vs 1.7% in March. Much of the tax-adjusted inflation can be attributed to food and energy; nevertheless, the base effects of the VAT hikes are wearing off.

Tricky times for Euro area policy makers when the Core AND the Periphery are showing such broad price gains. Meanwhile, the Periphery are contributing little by way of growth.

Rebecca Wilder

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The Euro area is ‘miserable’

For all of our economic problems here in the US, a simple measure of ‘misery’ illustrates that US households are less miserable in March 2011 than those in the Euro area.

The chart below illustrates the simple ‘misery index’, which is the unemployment rate plus inflation. The blue line is a 45-degree line; those countries below it have seen their misery index fall on a y/y basis. Not one Euro area economy misery index fell since this time last year – French and German misery indices are unchanged despite improving employment. In contrast, the US misery index improved over the year with labor market conditions.

The problem is, that European fiscal austerity is clinching aggregate demand, raising inflation (via higher taxes) and producing unemployment. Consumers and firms alike are feeling this in Europe.

In the US, fiscal policy has been accommodative enough to allow for private sector deleveraging while keeping the economy on an upward trajectory. However, food and energy price inflation in April stabilized the misery index compared to last year (not shown) – i.e., it’s no longer improving. Unless the labor market shows marked improvement in coming months, US misery will turn “Euro” as inflation batters consumers amid elevated unemployment. Please see Marshall Auerback’s piece at the New Deal 2.0 regarding QE2 – QE2: The Slogan Masquerading as a Serious Policy.

Rebecca Wilder

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Euro area GDP report: unbalanced

Today Eurostat released their estimate of Euro area growth for the first quarter of 2011. The economy grew smartly, or 0.8% on the quarter on a seasonally- and working day- adjusted basis. On the face of it, Euro area growth, which is 3.3% on an annualized basis, dwarfs the 1.8% seen in the US economy. Really, though, it’s joint German and French growth that tower US Q1 GDP growth.

Eurostat doesn’t explicitly highlight how inordinately unbalanced is growth across the region in their report . Germany and France alone accounted for roughly 72% 78% of the quarterly growth of Euro area GDP.

(As I highlight below, the Euro area quarterly growth rate in the chart is slightly different to that in the Eurostat report since some euro area members are missing. The cross-sectional contribution should be roughly unchanged during the revisions, though.)

Update: This chart has been re-posted with only slight modifications from the original. It does not change the article’s premise in any way. H/T to Philippe Waechter in comments below.


READ MORE AFTER THE JUMP!

If final demand was growing so quickly in Germany, I would say that the Euro area is adjusting more healthily than I had expected. Spenders become savers and vice versa, and capital flows adjust current account balances (and trade) accordingly. Germany spends more at home and abroad, while the Periphery less so. This does seem to be occurring according to the Federal Statistical Agency:

In a quarter-on-quarter comparison (adjusted for price, seasonal and calendar variations), a positive contribution was made mainly by the domestic economy. Both capital formation in machinery and equipment and in construction and final consumption expenditure increased in part markedly. The growth of exports and imports continued, too. However, the balance of exports and imports had a smaller share in the strong GDP growth than domestic uses.

Euro area average growth is likely slow down a bit, as the global economy moves toward a tightening bias and fiscal austerity clenches demand further. However, the outlook for the Euro area as a whole does look increasingly reliant on the trajectory of German and French economic conditions. This is a risk, especially since Germany is an export-driven economy.

As a comparison, 2005 saw growth as broadly more balanced, where Germany and France contributed a smaller 50% to total Euro area growth.


The Q1 2011 growth trajectory (top chart) is entirely consistent with ECB targeted at the core countries.

Rebecca Wilder

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What? Greece has to raise capital in 2012 and meet a 7.5% deficit target this year?

Over the last couple of months, a string of events made policy makers and investors alike say, what? Greece must raise capital next year and meet a 7.5% deficit target this year? Yes, they do, unless circumstances change. It’s near impossible to bet successfully on what Euro area policy makers are going to do, so let’s just review the facts here.

Greece missed its 2010 budget deficit target by near 1%, 9.6% of GDP projected (see .pdf page 45) vs. 10.5% actual (see Eurostat release, .pdf). The 2011 target is 7.5% of GDP.

Greece needs to raise roughly 30 bn euro in the private market next year – see .pdf page 50 here, where the IMF projects that Greece will finance 40.3bn in 2012, up from the 11 bn required in 2011. Furthermore, they’ll need to issue debt with longer maturity than the 3-month bills they’ve been marketing this year. At 1200 basis points over German bunds on a 10yr note, Greece cannot ‘afford’ this and is very unlikely to be tapping markets for term loans anytime next year.

Greece’s privatisation plan – selling state-owned assets – is probably too aggressive, amounting to roughly 4% of GDP per year through 2015 (10 bn euro average per year, see .pdf of presentation here, as a percentage of average GDP spanning 2010-2012).

But here’s something that is really important, and another reason why I do not believe that Greece would voluntarily default until at least next year: they’re expected to run a primary surplus in 2012. I take note that one can challenge the IMF’s forecast, but it’s the best information that I have at this time.

The chart illustrates the IMF’s 2011 and 2012 primary balance forecast across the Euro area (16) from the April 2011 World Economic Outlook. Those countries above the zero axis are expected to run 2012 primary surpluses – Greece, Germany, and Italy.

The primary balance is general government net lending (borrowing) excluding net interest expense. Better put: if the government runs a primary surplus, tax revenues are sufficient to pay all the government’s bills except the interest payments on the outstanding debt. Restructuring when an economy is in primary surplus makes much more sense.

If Greece runs a primary surplus in 2012, it will have a strategic ‘default card’ to play. This year it doesn’t, or Greece still needs the EFSF/EU/IMF to finance its spending. Next year, Greece can say “hey, we don’t need your money anymore.”

What to expect

Barring an immediate secession, I anticipate that Greece’s ‘circumstances’ will change in one of two ways over the near term: (1) Greece terms out its loans – a very soft restructuring – in the amount of 30 bn euro (or roughly thereabouts), or (2) the EFSF raises another 30 bn – that’s what it’s for.

On default, there’s a body of literature that attempts to quantify the costs of sovereign default – see the Economist article for a short literature review. Broadly speaking, the true economic impact could be ‘short-lived’ but is difficult to measure (see specifically this IMF paper).

It all comes down to this: I’m Greece, and I’ve put through structural reform that gets me a primary surplus next year – why subject the economy to further depressionary austerity measures rather than haircut my creditors and start from scratch? It’s been done before (see Table 2 of this paper). Or, I’m Germany (or France), do I want to write a check to Greece? Or recapitalize my banks outright.

Rebecca Wilder

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The re-balancing of trade within the Euro area: some improvement but not enough

I thought that the whole point of fiscal austerity was to turn the balance of trade and capital flow within the Euro area: debtors becoming savers and capital flows out of the Periphery and into to the core. We’re seeing the outset of such a shift; but it’s probably too slow in the making.

The chart below illustrates the trade balance (exports minus imports) within the Euro area (17) for key austerity – Ireland, Greece, Spain, and Italy – and core – Germany, France, and the Netherlands – countries. The data span the last six months and are normalized by the European Commission’s 2010 GDP estimate for each country (listed on the Eurostat website).

(Let me be clear here: the trade balances illustrated below include only trade flows within the Euro area.)

It should be noted that this is an incomplete picture, since there are 17 Euro area countries. However, the following point is worth noting: the balance of trade is arduously improving in Spain and Greece at the cost of just a small share of surplus in the core. To me, policy makers are grasping at straws when they stick to the ‘exports will grow the Periphery out of their debt problems’ story.

* The Netherlands’ intra-Euro area trade surplus increased near 2 pps to 22.6%.
* Italy’s intra-Euro area trade deficit hovered at just under -1% of GDP.
* Spain’s trade deficit improved somewhat, falling roughly 50 basis points to -0.5% of GDP – probably nothing to write home about, given that the economy’s facing a 20%+ unemployment rate.
* The Greek trade deficit improved 90 bps to -5.3% of GDP.
* Ireland remains as open as ever.
* The German surplus dropped 15 bps to 1.3% of GDP.

It is true, that the re-balancing will take time. Some will argue that it’s extra-euro area trade that will provide the impetus for growth in some of these countries (Spain, Ireland, Greece, the usual suspects). However, while exports to the extra-Euro area market have played an important role in some growth trajectories – Spain, for example – intra-Euro area trade is critical. Below I list the average share of total export income derived from within the Euro area:

Average share of exports (source: Eurostat and Angry Bear calcs)
40.9% 38.8% 41.5% 55.7% 48.6% 43.8% 62.0%
Germany Ireland Greece Spain France Italy Netherlands

How much more austerity and ‘competitiveness’ will it take to turn the tide here? Probably more than some are willing to give. A nominal devaluation is needed. Without that, it’s ultimately ‘bailout’ or ‘default’, or both.

A side note: it would have really helped if the ECB allowed prices in Germany, for example, to overshoot the 2% Euro area inflation target.

Rebecca Wilder

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ECB policy is tightening – has been for some time

Update: Nouriel Roubini front pages this post on Euromonitor here.

The ECB dove in and hiked its policy rate by 25 basis points to 1.25%. I had the pleasure of listening to Wolfgang Munchau on Thursday, and he reiterated what I reluctantly understood: the ECB’s strict inflation target is ridiculously simple for such a complex region; but more importantly, the Governing Council is just itching to tighten.

Eurointelligence blog highlights the various interpretations of the ECB’s shift in policy: Thomas Mayer at Deutsche Bank suggests that the ECB’s normalization is appropriate, while David Beckworth and others (links at Beckworth’s site) are more sympathetic to the impact on the Periphery. They highlight that relative price fluctuations could facilitate the much-needed redistribution of capital flows (i.e., the current account); and furthermore, that ECB policy is even too tight for the core (a google translation of Kantoos Economics). Yours truly has written extensively about this – among others, here’s one, another, and another. Who’s right? Ultimately time will tell.

But I do suspect that we haven’t seen the end of this crisis. The ECB is squeezing out liquidity when more liquidity is needed. Furthermore, the core remains subject to export shocks via external demand; and there’s building evidence that global growth will slow (see this excellent post on global PMIs by Edward Hugh).

It’s ironic, too. While the ECB is currently being heralded or chastised for raising rates, monetary and financial conditions in Europe have been tight for some time, both on a relative and stand-alone basis!
(read more after the jump!)

First, the ECB’s bond purchase programs, the Securities Market Programme and the Covered Bond Purchase program, amount to just 1.4% of 2010 Eurozone GDP. In stark contrast, the size of the Fed’s program broke 16% (and is rising) and the Bank of England’s purchase program remains firm at around 13% of GDP.


The asset purchase programs are emergence liquidity programs and are not normal monetary policy tools. But while the Fed and the BoE do not sterilize their flows, the ECB does. And my interpretation of ECB rhetoric and policy as of late is that they want out of the secondary-bond purchase business. For example, they’ve slowed their SMP purchases markedly in 2011 (see the ad-hoc announcements here).

Second, Eurozone financial conditions have been tightening since August 2010, while those in the US and England loosened up. Goldman Sachs constructs a financial conditions index, which is comprised of real interest rates (long and short), real exchange rates, and equity market capitalization. I love this index (subscription required), as it represents a broad measure of monetary policy pass-through.

Even though the ECB just started its rate-hiking cycle, they’ve been effectively tightening for some time.

I would say that Eurozone (as a whole) growth prospects are seriously challenged at this time, especially by comparing monetary policy to that in England and the US. We’ll see if the ECB’s able to push its target rate back to 2.5-3% through 2012 – I suspect that may be just a pipe dream, as tight liquidity and a slowing global economy drag economic growth.

The ECB’s actions imply to me that they still do not understand the following: Europe faces a banking crisis not a fiscal crisis!

Rebecca Wilder

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Germany is competitive on a relative basis as measured by productivity, standard of living or prices

The point of this article is to demonstrate that Germany has enjoyed increased ‘competitiveness’ as measured by productivity levels and relative prices. But the clarity of Germany’s ‘competitiveness’ cannot be established by using German data in the form of a black box – a bird’s-eye view of the region is the only way to see this.

In a very well written piece, Kantoos highlights that the German current account surplus is more a function of reduced investment and productivity passing through to low market-clearing wages than it is ‘competitiveness’, per se. While I agree with his economic analysis, I disagree that Germany is not competitive – Italy, yes; Germany, no.
(read much more after the jump!)

The term ‘competitiveness’ is rather non-discriminatory. It can refer to a lot of things. Below, I discuss national competitiveness, i.e., measuring a country’s relative position in the global market place. In contrast, micro-level competition – firms compete in various industries for market share and profits – is not really relevant here. The fact that we’re talking about a nation’s competitiveness means that it’s not clear how to measure competitiveness. Let’s explore.

In order for Germany to be deemed sufficiently ‘uncompetitive’ globally, relatively weak productivity gains would have left German wages relatively low compared to major trading partners. And by extension, Germany’s standard of living must also have suffer compared to its trading partners. From what I can see, only relative wages have been surpressed. Therefore, I conclude that Germany is competitive.

Exhibit 1: German productivity gains over the last decade – I use the period 2000-2008, so as to not bias the results downward from the global recession – have not been striking, but positive nevertheless.


German productivity has increased on a cumulative basis compared to Euro area trading partners, like France and Italy. Notably, the Euro area average is down, which is probably biased by Italy’s 8.7% cumulative drop in productivity. So on a relative basis, Germany’s productive and second only to Spain in this sample (notably Spain gained a whopping 4.1%!). (Also, please see Chart 18 of this ECB research paper for a broader comparison – it’s a .pdf file).

Exhibit 2: Despite the relatively weak productivity gains, albeit positive I remind you, the standard of living has increased in line with other Eurozone economies, like France, and surpassed others, like Italy.

This chart, to me, illustrates that productivity gains have been ‘competitive’ enough to support decent growth in the average standard of living (as measured by real per-capita GDP from the IMF).

And to really hammer down the point, please see page 24 in a recent ECB research report, Chart 18 referenced above, on the impact of the global recession on Euro area competitiveness. Germany’s 2000-2008 annual average productivity gains are in line with many other European economy, but wage compensation is relatively muted. In fact, German average annual compensation per employee is the lowest of the cross-section (according to Chart 18). My point is, that productivity gains were not fully passed on to workers via nominal compensation gains (probably a better comparison would be real compensation per employee).

Exhibit 3: It’s all about levels; and Germany’s 2010 average income is relatively high (measured in GDP per-capita PPP dollars for comparability across exchange rate regimes).


The German standard of living (i.e., relative per-capita GDP) fairs well against a cross-section of developed economies in Europe and abroad. Average income (standard of living) is the fourth highest behind Norway (for comparison to Kantoos’ article), the US, and Canada. Italy runs low current account deficits (trade is pretty well balanced), and average income falls at the bottom of this sample. That’s very uncompetitive in the relative sense.

The second issue that I mentioned is measurement – i.e., there’s a problem with using just unit labor costs to measure ‘competitiveness’ (see a recent Naked Capitalism article to the point).

However, no matter how you look at relative prices – the real exchange rate, relative export prices, relative unit labor costs, relative GDP deflators, etc. – Germany stands out as very ‘competitive’, or at least ‘exportable’. I have no direct chart to support my previous statement; but the European Commission does. The EC publishes a quarterly report on price and cost competitiveness; and according to the most recent report, 2Q 2010 (.pdf), Germany is very competitive by any measure of relative prices(see pages 15-16 of the .pdf).

In conclusion, it’s difficult for me to see how Germany is not ‘competitive’ on a relative basis, if ‘competitive’ is either (1) standard of living and relative productivity gains, or (2) in a relative prices sense.

I would state here that within the Eurozone, a healthy rebalancing of current accounts is underway (i.e., typical creditors dissaving and typical debtors saving). This would be made much easier if the ECB would run looser policy and allow German inflation to overshoot, effectively facilitating the relative price adjustements. Please see David Beckworth’s article to this point.

Rebecca Wilder

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Greece is not Argentina

I politely disagree with the conclusions of the article written by my Angry Bear colleague, Kash, where he envisages Greece defaulting in 2011 similarly to Argentina in 2001.

I do agree, that the macroeconomic initial conditions in Greece scream default (actually, if you focus just on the measurable factors, like the current account, debt levels, or fiscal imbalances, Greece is much worse than Argentina in 2001 – see Table 4 of this IMF paper to see Argentina’s initial conditions and compare them to Greece in 2009 using the IMF World Economic Outlook Database).

Where I disagree, arguing that Greece is not like Argentina, is that the debt crisis in Argentina didn’t bring down the banking system of Latin America overall. In contrast, the default of Greece has the potential to do just that in Europe.

Update: see David Beckworth’s Macro Market Musings includes Rebecca’s thoughts on ECB

In Argentina, the Latin American banking system (and sovereign bonds, for that matter) was quite resilient in the face of the sovereign default in Argentina. Uruguay was the exception, whose two largest private banks, Banco Galicia Uruguay(BGU) and Banco Comercial (BC), which account for 20% of the country’s total, saw near-term liquidity pressure and an ensuing banking crisis in 2002 (see this IMF paper for a history of banking crises). All else equal, the IMF reports only minor impact to the region as a whole:

With the possible exception of Uruguay, economic and financial spillovers from the Argentine crisis appear to have been generally limited to dateā€”as indicated, for example, by the muted reactions of bond spreads in most other regional economies and their declining correlation with those of Argentina, together with other favorable trends in financial market access and the general stability of exchange rates over recent months.


In contrast, the European banking system is highly interconnected. For example, according to the German Bundesbank, Germany’s bank exposure to Spain was roughly 136 bn euro in December 2010, where most of it is held in the form of Spanish bank paper, 56.4 bn euro, and Spanish enterprises, 58.3 bn euro; the rest is in sovereign debt. Furthermore, German banks are sitting atop 25 bn euro in (worthless) Greek paper, primarily in the form of sovereign debt. Euro area countries are exposed to other banks AND the sovereign; but more importantly, the ones that save (run current account surpluses) are the ones holding the worthless (in some cases) bank and government debt. (read more after the jump)

Bank risk is a big risk in Europe. Based on the consolidated banking data at the Bank for International Settlements (BIS), German banks hold 22% of the Greek external debt load i.e., bank debt + sovereign debt + corporate debt), while French banks hold 32% (see Tables below). Furthermore, German banks accumulated 20% of all Irish external debt, 14% of Italy’s, and 21% of Spain’s.

So the question is, not what will happen if Greece defaults, per se; but will a Greek default set off a chain reaction liquidity crunch that challenges asset valuations in the other Euro area banking systems (for bank paper and sovereign paper)? I suspect that it will, since the European banks are still building their capital buffers.

My point is, the Germans are partial to NOT letting Greece default. All fiscal austerity aside, the Germans have demonstrated that they’d rather write a check than take the writedowns, at this time. Therefore, from this perspective, I find it very unlikely that Greece defaults this year (or next, really).

Now, you’re probably thinking: well, it’s in Greece’s best interest to default. Willem Buiter calls Greece leaving the Euro area ‘irrational’. An irrational chain of events must be put in place in order to presage such a disorderly default (see 8. ‘Break-Up Scenarios for the euro area’ in the publication). We’re not there yet, since Greece is still in asset-selling austerity mode.

It’s political repression.

BIS data representation I: in Shares of external debt outstanding (click to enlarge)

BIS data representation II: in levels of external debt outstanding (click to enlarge)

Rebecca Wilder

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Europe’s industrial new orders: 3 very different stories

Spain vs. Germany vs. UK: production trends showing holes in some growth stories

Eurostat reports new orders for January:

In January 2011 compared with December 2010, the euro area1 (EA17) industrial new orders index2 rose by 0.1%. In December 20103 the index grew by 2.7%. In the EU271, new orders increased by 0.2% in January 2011, after a rise of 2.9% in December 20103. Excluding ships, railway & aerospace equipment4, for which changes tend to be more volatile, industrial new orders increased by 1.6% in the euro area and by 1.9% in the EU27.


This was a disappointing report, as Bloomberg consensus was expecting a 1% monthly gain. The Eurostat press release reports new orders by country and production type only(capital, consumer, intermediate, durable, and nondurable). However, I look at the origination of orders by region: domestic, non-domestic extra-euro (which is the same as non-domestic for the Euro area as a whole), and non-domestic intra-euro.

The idea is, that with ubiquitous fiscal austerity, Euro area countries rely on external demand for growth. So here’s my question: how’s Spain to survive? (more after the jump)

Exhibit 1: Spain’s industrial sector is barely growing amid fiscal austerity

No industrial production growth = a big problem. It’s not just fiscal austerity, per se, it’s that the economy needs plenty of nominal income gains to improve the cyclical budget deficit in order to even see the benefits of structural adjustment. The structural balance cyclically adjusts the government deficit (or surplus) for non-structural items to leave just the structural deficit (net spending on pension payments, unemployment insurance, normal capital expenditures, etc.).

Without growth to increase nominal revenues, the negative cyclical balance will keep the overall balance very much in the red. Spain needs growth! Apparently, it’s not coming from the industrial sector.


Spain was deriving quite a bit of industrial demand from within the Eurozone (the red line in the chart above) through the end of September 2010; however, that source of order growth is tapering off. Now, it seems that extra-euro industrial orders growth (the green line) may start a sideways trend, too. Normally I wouldn’t put too much stock in one data point – but with tightening across Asia and possibly the UK (not the US for a bit), slower orders growth is inevitable.

Exhibit 2: The German industrial machine

The German machine is also deriving industrial production growth from extra-euro orders. Notably, too, domestic orders have been strong. But for all of the talk about Germany’s overheating export sector, industrial production is still near 6% below its Q1 2008 level.

And finally,

Exhibit 3: The poster child for fiscal austerity, the UK.

Why? Because they’re nominal exchange rate depreciated quite markedly, allowing the trade-sensitive industrial base to find a very shallow bottom. On a trade-weighted basis, the British pound is 24% lower than in mid-2007, according to the JP Morgan nominal effective exchange rate index.

I’d like to hear how you all think that Spain’s going to get through this as the ECB raises short-term rates (for those of you who do not know my Euro-centric commentary, you can see a list of my recent commentary on the Eurozone, which includes articles on the ECB by my name on the AB sidebar), Germany slows, the US struggles to keep the consumer alive, and emerging Asia tightens its belt.

Spain’s a trillion dollar economy, and the fourth in terms of GDP in the Eurozone…

Rebecca Wilder

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