Wednesday, April 7, 2010

Economics 07/04/2010: Another lesson from Greece

The lessons for Ireland from Greece are just keep on coming. In the weeks when the Irish Government is engaging in talks with the Unions concerning the reversal of budgetary reductions passed in Budget 2010, the Greeks are offering a somber reminder of what happens to the countries with runaway public finances.

The most important news in the last week or so was the renewal of the upward crawl in the spread of Greek bonds over German bund. The spreads have jumped from about 300bps to 400bps with Greek 10-year bond yields hitting a high of 7.161%.

Let us put this number into perspective. Irish Government currently is borrowing at around 4.6% per annum. This means that annually we are paying €46 million interest bill per each €1 billion borrowed. Through 2015, the total cumulative and compounded Irish Government cost of borrowing will equal, therefore, to €309.8 million per each €1 billion borrowed.

Now, were we borrowing at Greek rates, the same bill would be €514 million or 66% higher than current. Taking official projections for deficit, this means that at Greek rates of recklessness, Ireland Inc would be facing a deficit financing cost of €18.3 billion, as opposed to the current projected cost of €11.2 billion.

Short term borrowing would also be a problem, with Greek 2-year bonds yields jumping up by more than 1.2% to 6.48% overnight last – a record for any sovereign country.

Now, of course the Greeks are a basket case. Latest Eurostat revisions of its budgetary data show that actual deficit reached 13% of GDP in 2009. But Ireland is a close second here – with our deficit as a fraction of our real economy (GNP) being bang on with the Greek latest revisions. Worse than that, Greek economy has shrunk only by about 1/5 of the decline experienced by Ireland.

If you think that Greek rates extreme moves are a temporary blip on the market radar, think again. Greeks are preparing a Yankee bond offer in the US, and per Bloomberg reports, the markets are expecting pricing in the region of 7.25% yield for 10 year paper, or 410bps premium on the German bunds. Per Bloomberg report, Greek yields are now consistent with corporate junk bond yields.

And in a final note to the Unions here at home, Les Echos Jacques Delpla makes a very strong point that based on Fisher’s theory of debt deflation, it is a mountain of private debt, not public debt, that implies PIIGS are even in more deep trouble than the bond markets might suggest. Wage inflation (in real terms outpacing economic growth) and private debt increases (also in excess of real growth in the economy) during the boom times are now inducing a deleveraging withdrawal of consumers and investors from PIIGS. In the end, this is a much greater threat than the Exchequer deleveraging.

Good luck to all our Bearded Keynesians (or shall me say ‘Marxists’, for I doubt Keynes would have favoured an idea of piling up more Exchequer liabilities when deficits are running in double digits).

10 comments:

  1. http://forth.ie/index.php/content/article/its_not_quinn_thats_insolvent_its_ireland/20100407/

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  2. http://forth.ie/index.php/content/article/its_not_quinn_thats_insolvent_its_ireland/20100407/

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  3. http://ftalphaville.ft.com/blog/2010/04/07/197381/cds-report-greece-wider-than-iceland/

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  4. Rigged Market Capitalism

    http://www.swp.ie/index.php?page=838&dept=News&title=Wealth+Watch+III

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  5. Dr. G. Excellent. Whilst I never really approved of Keynes I think the way he's been invoked to justify the current policy is not a fair reflection of his views. Keynes may have been wrong. But he wasn't stupid.

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  6. Surely we are closer to Greece than markets are suggesting. Our Exchequer Deficit is as bad and our aggregate debt ratio is fast approaching 100%. Once all our 'off-balance sheet' operations are accounting for it is even closer to Greece's.

    In the short term I can't see any difference between the two countries, and the long term consequences of huge ongoing borrowings and refinacning of existing debt may also be about to converge.

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  7. PLEASE CAN YOU EXPLAIN WHERE YOU GET THE 309.8M NUMBER FROM? TKS

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  8. Anonymous - do a simple compounding using the rate forward to 2015.

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  9. I'm confused, as a bond holder receiving interest income, it doesn't compound on an anual or semi-annual basis. The government pays its interest when due, it does not roll up. It is simple interest, not compound? Correct me if I'm wrong. Tks

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  10. Ah, that would be the asymmetry between lenders and borrowers. Irish Government has to borrow to pay up interest. It's financial position is really that bad.

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