I took a look at Greece’s situation yesterday and explained what had happened since Monday (my previous update). When a country slips into a financial crisis events tend to be fast-moving and that is what is happening now. Some of these events have been caused by Greece’s own actions and some have been contributed to elsewhere. For her relatively new (Socialist) government I do have some sympathy as much of this is down to the actions (and indeed misrepresentation) of their predecessors. However they do have a responsibility in that they failed to grasp the nettle when events began to swirl around them. By comparison the leaders of Ireland did and Ireland has remained in calmer waters. As well as immediate implications for Greece there are implications for the Euro zone depending on how it responds. In addition there are follow-on implications for other countries around the world with fiscal budget deficits that are growing because Greece has become an example,a test-case if you like ,of what may happen if a sovereign debt crisis actually occurs. Being the equivalent of an economic test-tube in these difficult times is no fun at all.
If we look at this week there is a clear cause for the acceleration in problems for Greece. It was Greece’s bond auction on Monday. Then Greece came to the market with a five-year bond which was attractively priced at a yield of 6.2% (i.e the yield was higher than current Greek bond yields at that time). Greece planned to issue some 5 billion Euros but faced with demand of four times this size actually issued 8 billion Euros. Many commentators in the press then trumpeted this as a success and as I wrote yesterday I was surprised how quickly they rushed to say this as government bond issues can take time to settle particularly in difficult times like this. Perhaps they are inexperienced in this area. It then turned out that many of those who had bought these new bonds were in effect arbitrage traders who had bought into the story that Greece was about to do a deal with China and that this would lead to China investing some 25 billion Euros into Greek government debt. As the “China story” faded these arbitragers sold their holdings and yields on Greek government bonds rose (and rose). The Greek government has denied that any such overtures were made to China but the damage was done. I suppose there is some cold comfort in the fact that the arbitragers will have lost money.
Where are we now?
In terms of government bond yields the situation has become quite serious for Greece. The ten-year yield comparison with German government bunds has on an intra-day basis exceeded 4% and closed last night at +3.98%. The actual yield of the Greek 10 year government bond closed last night at 7.17%. The two-year bond I have followed now has a yield of 6.44%.
I have looked back to pre-crisis days. On the 30th October 2009 the respective yields were 4.62% for the ten-year and 2.3% for the two-year. I am looking at actual yields now and not ten-year comparisons because this is what Greece will have to pay. So a rise of 2.55% and 4.14%. respectively The rise in two-year yields is a particular signal of the depth of the crisis as governments are usually more able to control shorter-dated yields. But in this instance they have surged more than longer-dated ones.
I would like to put this figures into context. To do so I will compare October 30th with last night and I will assume that Greece has 45 billion Euros of debt to issue this year (as she does) and that she could issue all of it at one price. The interest she would have to pay each year would be.
30th October 2009 level annual cost 2.079 billion Euros
Last night’s level annual cost 3.227 billion Euros
This is a warning for all countries that might slip into a sovereign debt crisis this year. Greece is a small country and 1.1475 billion Euros a year is a large sum of money to find each year. If you wished to price failure there is an example.
Implications for others
Now let us look at the holders of Greek government debt as there will have been large capital losses over this period. The Greek ten-year bond had a price of 110.47 on the 30th October 2009 and it is now 92.02. Holders will have big losses. Many of the holders are other Euro zone particularly German banks. So there will be a small ray of sunlight for Greece here as they will be lobbying their governments to help Greece. Also where have the other losses fallen? Someone somewhere has lost a lot.
The Euro zone
I have seen many projected responses from the Euro zone, whether this is conjecture from journalists or kite flying by EU officials is sometimes hard to determine as I think that we have seen both. I know that there are arguments over section 122 of the EU treaty as to whether Greece can be bailed out by fellow Euro members. As long as Greece remains alone in this crisis I have always felt that a rescue will be organised by fellow Euro members. The political pressure for the federal project will make sure of this. Of course there are hazards in such a course and one of these has been the fall in the value of the Euro since the Greek crisis began. But these are for another day as while there are big issues in a bailout I feel there are many routes where it is in effect a fait-accompli. The big issue would be a fall in Euro zone credibility resulting from a bailout.
Other governments with fiscal problems
There are implications for other governments in this. Just in the Euro zone we have a new acronym “Pigs” which stands for Portugal, Ireland,Greece and Spain and represents countries in trouble. It is a less pleasant phrase than “Club-Med”. However it is unfair on Ireland in particular and maybe Spain. Portugal is however in serious trouble and needs to change course quite fundamentally. Ireland gave an example of how a tough budget can help a situation and Portugal needs to follow her and soon. At the beginning of this year Portugal’s ten-year bond yield was +0.66% when compared with Germany and it is now 1.15%. She needs to act decisively before this deteriorates even further. The example of what has happened to Greece will only lead to fears of contagion.
What should Greece do now?
Domestically the route is clear she should adopt the following four point plan.
1. Cut public expenditure
2.Improve tax collection
3.Start publishing reliable financial statistics
She should also hope for a Euro zone bailout.
A Small Ray of Sunshine
It is dangerous to panic in such a situation. Whilst existing investors have been hurt as I described above new ones might consider Greece’s current government bond yields attractive. They are much higher than they were only 3/4 months ago and there is hope of a bailout. If Greece takes positive action then the situation can be stabilised. Unfortunately real reform will take much longer.