Spanish bond distress,the Greek economy and arrogance from Mervyn King

Yesterday was a much quieter day in world equity markets and now (only?) 20 of the last 30 days have seen triple digit moves on the Dow Jones Industrial Average. This is still rather extreme particularly considering volumes have hit a summer/World Cup low. However bond markets and particularly the Euro zone peripherals are doing their best to take up the slack. In particular Spain is in the front line and after her surprising ( in case you do not follow football Spain were pre-tournament favourites) defeat to Switzerland yesterday I would imagine that there is much wailing and gnashing of teeth going on today in Spain on both the economic and football front. There is a certain irony in the fact that Germany won her first game 4-0 as it would appear that in football as well as in their economy the Germans are doing well. Although perhaps the economy did not have the advantage of using a new ball before everyone else!

The Greek economy

Having considered Greece’s position again yesterday I thought that it was time to take a look at her economy and where she currently stands. We know that she is beginning a very severe austerity programme but  her economic state when she began it is important as it gives us a clue as to what we can  expect going forwards. My figures are mostly from Eurostat with one or two additions from the Greek statistical body NSSG.

Growth: Greece’s economy grew by -0.8% in the first quarter of 2010 which made for a year on year growth of -2.3%.

Unemployment: The unemployment rate is at 10.2% and the Bank of Greece expects it to rise to 11% during 2010. These figures are the latest but are for December 2009 and are somewhat out of date and slightly confusingly NSSG has it at 10.3%.

Inflation: The Harmonised Index of Consumer Prices is rising at 5.3% which is very high compared to a euro zone average of 1.6%.

Industrial Production: The figures for April showed a 3.4% fall on the previous month and on a year on year basis fell by 6.4%.

Balance of Payments: The figures for March 2010 showed a current account deficit rising 327 million Euros to 3015 million. For the first quarter as a whole the deficit rose by 2.7 billion Euros to 10 billion. ( The Bank of Greece points out that a Common Agricultural policy payment of 2 billion Euros expected in May was paid earlier last year and has distorted the figures somewhat).

Industrial Producer Prices: These rose by 9.8% in April according to NSSG.


These numbers essentially tell us the state of Greece’s economy as she approached and then began her austerity plan. Her economy was already contracting so she had not fully recovered from the credit crunch yet she was also suffering from the highest inflation in the euro zone. The numbers for industrial production are poor and show no sign at all of a recovery led by increased competitiveness led by the fall in the Euro exchange rate over the last 6 months and the growth in world trade. Just as a comparison Germany’s year on year industrial production rose by 13.9%. Yet the lack of industrial growth was combined with a high producer price index presumably driven by the rise in taxes and the fall in the exchange rate.

To go forwards one needs to add the austerity plan which just as a reminder plans to reduce Greece’s fiscal deficit from the 13.6% of Gross Domestic Product (GDP) in the last fiscal year to 2.6% in 2014. This will lead to a severe contraction in the Greek public sector and I can only see this impacting very severely on economic growth in the Greek economy. I have said before that I feel official forecasts of a fall in economic output of 4% over the next year for Greece are too low. I have written before about Latvia’s experience which was much more severe and I fear that over the year from now Greece’s economy is likely to contract by something more like 6/8%. Her task looks very Herculean (sorry) to me and I am unable to change my previous conclusion that some type of restructuring or default will be required to help Greece through what will be a painful adjustment process.

The figures for balance of payments and in particular what are called “current transfers to general government” which turn out to be transfers from the EU under the Common Agricultural Policy(CAP) stood out from the figures to me at 2 billion Euros. It put a figure on these transfers and I would like to know from my Greek readers as to how dependent you feel Greece has become on the CAP. It has been a topic debated in the UK but from the other side (i.e a contributor).

Having reviewed the situation it is now time to remember the scale of effort the euro zone has put in to help Greece with its 110 billion Euro aid package and the ECB’s Securities Markets Programme which has announced so far purchases of 47 billion Euros of peripheral government and private debt. Yet her ten-year bond yields rose to 9.61% which is +6.93% when compared with the equivalent German bund. In spite of all the help still no-one wants her bonds and accordingly suggestions as to her long-term solvency are deteriorating because at such levels a Greece trying to refinance herself would rapidly become insolvent. I notice that newspaper journalists have quietened down on this subject but in some ways Greece’s position is worse than ever. In other words the euro zone effort is showing signs of failing.

Spanish government bonds

Today is an important day for the Spanish government bond market as she is auctioning some 3.5 billion Euros of 10 and 30 year government debt. This follows on from the problems for her that I have highlighted recently. The last time she issued such instruments in May and March respectively they yielded 4.05% and 4.75%  so markets will be watching to see the difference this time.

Yesterday there were further developments in Spain. The rumour mill was in full force about a potential 250 billion bailout being led by the EU/IMF. The Bank of Spain announced that it will publish the results of a stress test into Spanish banks probably thinking that such results are unlikely to reduce the general consensus view of the Spanish banking sector and in particular its cajas or savings banks. Mr Zapotero’s Spanish government also announced some reforms of its labour market in essence planning  to ease firing rules for employers in economic difficulty, while discouraging an over-reliance on temporary hiring to try to help trim a 20 % unemployment rate, which is  the euro zone’s highest. Unfortunately even a decree on this subject may take some time to go through Parliament and I notice that in Spain there are suggestions that the reforms do not go far enough.


The net effect of the pressure on Spain is that her ten-year government bond yield rose to 4.97% which is some 2.28% over that of the German equivalent and is much worse than the 4% yield she had on the day after the euro zones “shock and awe” rescue plan. The impact of this is significant as Spain is a much larger economy than Portugal, Ireland or Greece and any support for her will accordingly be much more expensive. It is also significant because of the ECB’s Securities Market Programme means that this is happening whilst it is trying to support the market.

As someone from the UK there has been a fascinating development which goes as follows. If you go back to two months ago then ten-year UK Gilts (government bonds) yielded 3.99% whilst the Spanish equivalent yielded 3.83% so a difference of  -0.16% from the Spanish perspective. As of last nights close the difference was +1.43%. This to my mind shows two things. Firstly how the Spanish situation has developed and deteriorated and secondly how favourably (and in many respects surprisingly) debt markets have recently treated the UK.

As I type the results from the ten-year auction have been published and Spain has auctioned 3 billion Euros worth at a yield of 4.86%. So we have a rise since the last auction of 0.81% which is an indicator of the deterioration in the perception of Spain’s financial circumstances. The yield is below last nights close which looks good but please remember that as I have said many times before the full impact of an auction takes several days to come through. There would have been a lot of pressure to buy today I think.

Just as a matter of tactics if I was in charge of the ECB’s Securities Market Programme I would not only be buying today but I would step up my purchases.

Mansion House speeches

Last night Chancellor George Osbourne announced the following.

I can confirm that the Government will abolish the tripartite regime, and the Financial Services Authority will cease to exist in its current form.We will create a new prudential regulator, which will operate as a subsidiary of the Bank of England.

As someone who has worked under the system of financial regulation set by the FSA and has been a critic of its role I would like to say that I support this move. I believe that the FSA has been very expensive (£3.5 billion over the past decade), very bureaucratic and when it came to the test it failed. I know that many vested interests have come out in support of it and that many are afraid of change but the new body will have to go some in my view to do worse than the FSA. My only caveat is that  if we look at a football analogy when you sack a manager you need a new (hopefully better!) one ready….

Mervyn King however gave a speech somewhat different in tone which I found to be rather complacent when it came to monetary policy and I would like to illustrate this with a few quotes.

Of late there have been those who doubt our ability or willingness to meet the inflation target.


of which I am one and part of my reason for this is

for much of the past three years (inflation) has been above the 2% target


but apparently

No one should take this as a sign of complacency……and…..No one should doubt our determination to meet the target


Unfortunately Mr. King then rather embarrassed himself as he defined a central banks role by implication

the role of a central bank in monetary policy is to take the punch bowl away just as the party gets going


You see that is what he  and his fellow members on the Monetary Policy Committee failed to do. So to my mind his performance was disappointing to say the least.

Update 12:30 pm

I have the full results for the Spanish bond auctions and the 30 year bond was issued at 5.91% and some 479 million Euros were sold. So Spain auctioned the 3.5 billion Euros she wanted and markets have initially taken it well with her stockmarket improving and the initial move in government bond yields being down.

I notice many cries pretty much saying “victory” on the newswires and believe one should be careful. Bond auctions take a few days to settle down as I have argued before and what happened on some Greek auctions/issues backed my point up I would suggest. Also the 30 year bond was issued at a 1.16% higher yield than her immediate precessor. Or to put it amother way will cost some 111 million Euros extra in interest payments over its lifetime.


13 thoughts on “Spanish bond distress,the Greek economy and arrogance from Mervyn King

  1. Your posts are one of the best sources of information about the financial crisis. Spin-free and not beholden to the many vested interests constantly attempting to pull the wool over the public’s eyes. Many congratulations.

    I share your scepticism about the MPC and inflation. Their ongoing refusal to address this issue suggests that they are acting deliberately. Why did the BOE pension fund switch heavily into index-linked guilts about 18 months ago if a rise in inflation was only going to be a temporary blip?

    • How interesting that they did that!! Maybe the pension fund is managed by more savvy people than the MPC or perhaps (as you allude) it is actually managed by the MPC.
      Personal interests do seem to take precedent over national/collective interests more and more, which is very sad.

  2. Mr King’s speech contains answers to your implicit criticism, but I single out two :1) the spare capacity theory – I note the CBI economist supports him on this 2) the fall in the effective sterling exchange rate which has accounted for a 3% overshoot on the inflation target over the last three years is helping to rebalance the UK economy. I think risks are being taken but maybe 2) explains why?

    • Hi Shireblogger
      I did see the “output gap” theory being wheeled out again by Mervyn King. My contention with it as an argument is simply the evidence.My contention with those that use it as an argument is that they need to provide a convincing explanation of a) why the evidence of the UK economy does not so far agree with them and b) when and why they expect this to change.

      I do agree that the fall in the exchange rate helped our economy (although in terms of the balance of payments by less than one might have hoped) but you see this began and built up in 2007 and accordingly the majority of it preceded the QE experiment. Except the same “output gap” theory that Mr King still apparently follows predicted a large undershoot in UK inflation..

  3. Hi Shaun,

    per today’s reports in the Greek press (based on numbers from the Greek Statistical Agency), unemployment for the first quarter of 2010 was at 11.7%.


    • Thanks for this. I notice it is now on the Greek statistics website but was not last night…. It only adds to my point as the level of 11% was given by the Governor of the Bank of Greece in a speech at the end of April and these figures predate the austerity programme which is only likely to raise unemployment in 2010/11.

  4. Hi Shaun.. your analysis is, as best I can tell, the best on the web. Par excellence my friend.

    Sadly, I was hoping your excellent analysis would’ve led to a more positive conclusion. Indeed it appears to be deteriorating rapidly; I’m rather surprised the equities markets have held up as well as they have all considering the true danger of Spain. At the end of the day, most PIIGS nations will be forced into “restructuring”, leading to a possible currency and/or banking crisis and likely a political crisis in some. It’s not a matter of if, but when. Latvia is these nations’ future.

    My question is.. how will this play out in the Euro banking system ? As we speak, they are essentially refusing to loan to one another unless they go thru the ECB. What part do you see credit default swaps playing in all of this ? Thanks again..

    • Hi Mr.K and thanks for the compliment.

      As to restructuring I think that sooner or later Greece will have to get around to it and that such an event will be a big test for the European banking system. If you look at it another way I think that this is the real reason for the efforts the euro zone have put in to the Greek aid plans. The side effect of the contagion is that the interbank system has frozen up for banks perceived to be at risk. Of course such a situation is prone to rumour and counter-rumour. Just look at Spain, one day it is supposedly going cap in hand to the IMF for 250 billion Euros the next it supposedly has the banks rated no’1 and no’2 in the EU stress-tests. The main effect of this for now is that there is no exit for the ECB from its extraordinary monetary measures and its role is growing. Reading between the lines of its pronouncements I believe that it is becoming increasingly uncomfortable with this. So it may play out next at the ECB……

      As for credit default swaps I do follow them but take them with a pinch of salt. The reason for not following them slavishly is that liquidity is often quite low in them and so they may be unreliable. Markets with low liquidity are prone to being “high-ticked” and “low-ticked”. So a signal yes but I look for confirmation in underlying market movements.

    • Just re-reading this again. Aren’t Congdon’s comments quite striking? These comments must have been made in full awareness that over this period the M0 measure of the money supply is the USA has increased astronomically. But this is having no affect on M3. Expansion of the narrow money supply isn’t working. He’s assuming that regulatory pressure is the only reason that banks aren’t creating money through further debt creation. But surely the more important reason is that they increased M3 already in the preceding years, and too much of that has turned bad, and so they are building back their capital base against the future problems which are shortly to come?

  5. I’m not sure where inflation targeting sits between different economic theories and I don’t know how they do it in other countries, but in the UK the MPC is loaded with a number of economic brains. So if inflation targeting was just about raising interest rates if inflation is above target it would be a purely administrative function requiring no reflection at all. And so you wouldn’t need a committee to debate it.

    So may be there are causes of inflation for which raising of interest rates would not be considered an appropriate response.

    There’s probably a well established time lag between an interest rate change and when it takes affect. And so when the decision to change interest rates occur it probably is with consideration of where inflation is likely to be when the interest rate change starts taking affect. At least the existence of a time lag is a relevant consideration.

    One example which occurs to me is the rising cost of food. (It’s now falling of course, given that all those agriculture themed investment funds have been launched). Say a country was in the difficult position of importing most of its food. And say that the consumption of food weighed heavily in its total consumption basket. So increases in imported food prices meant that inflation was rising and was threatening to breach the country’s inflation target. The country’s central bank decides to raise interest rates. This means that the domestic currency appreciates on the foreign exchanges, and so imported food prices fall. But so do the prices of other imported goods, competing with domestically produced goods and services. Also the cost of borrowing and of servicing debt increases domestically.

    I’m not suggesting here that the country concerned needed to have the punch bowl taken away; the source of price inflation was external. Perhaps the country should produce more of its own food, but having its domestic interest rates increased? I think that would be a matter for some debate.

  6. I am in Greece for vacation. Very pleasant atmosphere and weather. Of course there are discussions about the economic problems but not really any over the top worries for a default. People out in the streets, shopping etc. Business as usual.

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