Yesterday saw some very disappointing results from the Euro-summit in Brussels. Regular readers will be aware that I set some criteria for a successful summit. Please look at my article from yesterday for my criteria for a successful action from Euro zone leaders and my view on the dangers/moral hazards which faced them. There is one danger which I shall repeat below.
1. That Europe’s politicians seeing the impact of their meeting on financial markets lose their sense of urgency and dither. Let us face it being politicians they probably enjoy the limelight and illusion of importance but they must resist this temptation and come up with decisive action.
What we actually got was mere promises. Both the German Chancellor and the French President used the same phrase “we have sent/delivered a clear political signal”. To which my reply is that the situation needs more than a signal. It looks as though we may know more after the Econfin meeting which finishes on the 16th February. However Angela Merkel did say they would look at the situation again in March. So my call for decisive action is not going to be achieved. As an aside such correlated phrases make me wonder how much time they spent on economics and how much they spent on media presentation/public relations.
What do we know?
There will be money loaned by Germany and France to Greece. This will be to help it finance its debts of which some 40 billion Euros of issuance will be required by the middle of this year. In addition the International Monetary Fund (IMF) will police the Greek deficit reduction programme and maybe whilst it is there it can cast its eye over Greek statistics.
There is a technical issue here which has not been explained in the press which is important. There are rules for the cost of IMF money. In the case of Greece if she borrows more than $4.2 billion (the ratio is her IMF quota multiplied by three) the IMF would charge an interest rate of 4.25% for the money. This leads to the following conclusions.
1. It is currently cheaper for Greece to borrow from the IMF than it is for it to borrow from the markets.
2. We can measure how tough the Euro zone is actually going to be with Greece by the rate of interest she is charged on the money they loan her. In other words we can compare it with the cost of IMF funding. It will be interesting to see what this measure tells us and whether it tells the same story as politicians words.
Potential Moral Hazard
An interest rate below that charged by the IMF would mean that other Euro zone countries suffering from fiscal incontinence would be disincentivised from tightening their budgets.
As the news filtered out the Euro and equity markets fell presumably disappointed by the news (or perhaps lack of it…). Later on American equity markets rallied and European leaders must be grateful for the large share buy-back programme announced by Phillip Marlboro ( US $ 12 billion). In terms of bond markets I have used the German ten-year bund as a benchmark and last night’s comparative closes are shown below.
Greece +2.75%,Ireland+1.38%, Portugal+1.19%, and Spain +0.79%
The Greek two-year government bond I have been following now yields 5.08%. So there have been improvements here although the cautionary note is that much of this took place before the announcement and perhaps the full effect of the announcement will take time.
Whatever the German Chancellor Angela Merkel means by ” determined and coördinated action” is unclear and that is the problem. The economic crisis has been littered by politicians making statements which they believed to be sufficient in themselves. For example Henry Paulson the US Treasury Secretary felt that simply announcing that he had the power to bail out Fannie Mae and Freddie Mac would save them in late 2008, it didn’t and the US taxpayer had to ride to their rescue. So perhaps it was predictable but it is also disappointing.
Some concerning economic news has come out of Germany today. Her statistical office has published figures this morning stating that her economy did not grow at all in the fourth quarter of 2009. Now this is a first estimate and I counsel caution in dealing with all first estimates of economic figures. But Germany is such a bell weather not only for Europe but also the world that such a number is worrying.
As I have stated above Germany’s help is required for Greece and maybe other Euro zone members. But there is a deeper problem. I wrote on this subject in an article on parallels with the 1930s on the 18th January 2010. Many countries are hoping for export led growth and as a country which is a net exporter Germany is one of the countries which can buy these exports. If she is not doing well it is hard to see the German consumer helping much to correct this particular example of a world imbalance. This is bad news for everyone.
There was more hopeful news from France which grew by 0.6% in the fourth quarter but this only partly offsets the German numbers. Later numbers for the whole of the Euro zone in the 4th quarter of 2009 showed growth to be only 0.1% in line with the UK.
The UK’s government bond yields
As measured against the German benchmark our ten-year bond yields have edged higher this year. As of last night’s close it was +0.78% and we opened the year at +0.61%. Now we have almost the same spread as Spain albeit mostly because of the improvement in Spain’s perceived situation.
The end of Quantitative Easing was always likely to see our government bond yields drift higher. Last year we bought all our issuance off ourselves (in fact we actually bought more than we sold) and this year we have to find a buyer elsewhere. I do not expect this to lead to an immediate calamity but we have £225.1 billion of government debt to sell this year according to the Debt Management Office. The situation is complicated by the General Election expected in May as a political change is likely and markets may well be waiting for this. Sooner or later though this will cause indigestion and yields will rise in my view.
Put another way if we stay as we are then in relative terms our issuance this year will cost us an extra £400 million approximately in interest. This will be every year until the bonds mature. To put this into perspective the political debate over free personal care for the elderly in England this week has led to a figure of £670 million being quoted as a cost.