10th January 2012 by Shaun Richards
Just like a shower on a hot summer’s day the Merkozy summit of yesterday seems already to have dis appeared without trace. However today I wish to point something out which illustrates the depth of the problem and the scale of the crisis. Regular readers will be aware that I use different interest-rates as signals as to what is happening and what will happen. Here is today’s installment.
Greece has a one-year government bond yield of 372% and Germany has a one-year government bond yield of minus 0.03%. So there is a differential of just over 372%! As they are in a currency union if you felt that there was no risk of default everybody would sell their highly priced German bonds and buy Greek ones. Accordingly there we have a measure of the default risk which is 368%.
For those looking for a sense of perspective it was as recently as September 12th 2010 that I wrote about Greek one-year bond yields exceeding 100%.
If we move onto two-year bond yields the Greek version has blasted higher this week and is now at 175%. The German two-year Schatz is at 0.14%. So we have a differential of just under 175% per year here.
If we were examining an online economics textbook on currency unions it would probably start behaving like HAL in the film 2001 at this point! The situation above cannot be sustained for any length of time. You could consider the numbers above as part of the failure to add fiscal and political union to the currency union.
What changed in Greece?
It was interesting that it was the two-year bond yield in Greece which shot up yesterday (and accordingly the price fell heavily). It showed a change in the perceived default risk I think. As to the rationale then it was due to the troubles with the debt haircut plan (called private sector involvement or psi). As I pointed out yesterday there are two clear flaws.
Apparently those who did not sign up to a 21% haircut and and 50% will be keener on a 55/60% one…..
There is a deeper flaw in all this and that is as it stands a 100% haircut on the current basis would not bring genuine benefits to Greece.
The official story that the PSI plan is going well (brought to you by the same people who predicted its conclusion by the end of October, then November , then December) is beginning to sound more than a little like the boy who cried wolf. Even if it should happen its credibility took a further knock when the International Monetary Fund agreed with my point that it will have too small an impact in its present form.
What has changed in Germany?
The continued spread of something I discussed back on the 2nd of September last year in the article linked to below.
There was a change in this situation as Germany held a debt auction for some 6 month bills and received some 4 billion Euros of funding at an interest-rate of minus 0.01222. Whilst trading (called the secondary market) has exhibited negative yields in recent times this is the first time that debt has been issued at one in Germany (called the primary market). There fore we see a move at this end of the spectrum too as investors are so keen to take advantage of Germany’s perceived safe haven status that they are willing to pay her to hold their money. An interesting consequence of a crisis caused by too much debt is it not? And certainly one which requires a bit of lateral thinking.
We see a position here where the two polar opposites are in fact moving away from each other at this time. The scale of the move is different as Greece saw quite a jump in two-year bond yields yesterday but in other ways the German issuance at a negative interest-rate is just as significant. Just like London buses where there is one there is likely to be others….
A Bad day for the European Central Bank and accordingly for Euro zone taxpayers
The ECB is known to be a buyer of shorter-dated bonds and although it never publishes a breakdown of its buying was a particular buyer of such bonds in its intervention in Greece. So heavy falls in the price of two-year Greek bonds will impact on a balance sheet which is already straining under the losses made so far. Of course it can pass the losses onto the constituent central banks like the Bank of Greece, the Central Bank of Ireland and the Bank of Portugal, oh, well okay it can pass them onto the Bank of Spain or the Bank of Italy, oh, I think you are getting the idea.
Speaking of the Bank of Italy
According to the Bank of Italy December saw Italian banks increase their level of borrowing from the ECB to 210 billion Euros from November’s 153 billion which is a sharp rise. Italian banks are now estimated to constitute just under a quarter of the ECB’s recent actions in such areas. The main driver of this was the three-year long-term refinancing operation which took place in December as Italian banks raised their LTRO exposure from 68 billion Euros to 160 billion. So we can see that not only have Italian banks borrowed much more but they have on average also extended the length of the period they have borrowed it for which is not a good sign. As it is the mirror image of this the balance sheet of the ECB then it (and hence Euro zone taxpayers as they ultimately back it) find themselves exposed to even higher risks.
This Italian bank has become a symbol of problems in the Euro zone as it attempts to raise some 7.5 billion Euros from its shareholders in a rights issue. I pointed out back on November 15th that investors should steer clear of this particular issue and backed this up with a description of major problems for Unicredit last Thursday. Whilst the stock is attempting a rally this morning ( and after very heavy falls it is due what is somewhat unpleasantly called a dead cat bounce, and no I do not know why dead cats were picked out for this…) the market capitalisation according to Bloomberg is 13.9 billion Euros. So shareholders will pay in 7.5 billion Euros to protect what is currently worth 6.4 billion Euros without it.
Whilst these woes may be bad enough for Unicredit there are contagion dangers from it. After all who will want to try a bank rights issue now? The problem is that many European banks do need to raise capital and even the bureaucrats at the European Banking Authority have figured out that over 100 billion Euros is required.
I regularly get asked how could things be improved for the Euro zone and today I have a suggestion. Many times I have discussed the fact that in economic terms the Euro zone has two speeds So two Euros, a hard Euro and a soft one? There are two weaknesses here as the hard Euro would, ahem, be subject to the football terrace chant, are you the Deutschmark in disguise? To which the answer is plainly,yes. And why would a country want to be a member of the soft Euro? I can see some reasons but remain to be thoroughly convinced.
Anyway looking forwards I think that three Euros would be required if one were to take the route of splitting the Euro up. I would be interested in suggestions for names as hard,middling and soft do not really cut it. But I will give you a proposal that as we stand the core or hard Euro might only comprise three countries which would be Germany, the Netherlands and Finland. As ever I would be interested to hear your thoughts.