An Interest rate differential of 372% between Greece and Germany tells us why the Euro zone is failing

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.

Three Euros

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.



32 thoughts on “An Interest rate differential of 372% between Greece and Germany tells us why the Euro zone is failing”

  1. Robin Plampton says:

    Shaun, excellent blog as usual.

    The 3 euros, sounds like some operatic singing group!  Shame they were from southern europe otherwise it could have been interesting.

    How about Faith, Hope & Charity?????

    1. Anonymous says:

      Super, Robin. If my memory serves well, only Charity remained at the end (of the defence of Malta). Is that an omen?

    2. Anonymous says:

      Hi Robin

      Welcome to my part of the blogosphere and thank you for the compliment.

      Weren’t they the names of the 3 Gloster Gladiators who initially defended Malta in WWII? And have you put them in order as hope in particular could apply to more than one of the three…..?

  2. D Cox says:


    I little off topic, but there is something I am sure you would know that I don’t understand. When a central bank holds it’s own governments bonds what happens to the yield? I don’t mean the rate, I mean the actual money. Are we currently paying something like 15bn pounds a year to the BOE at the moment as they hold about a third of the UKs debt? Where does this money go? Do the BOE give it back to the government, is it waived (I kind of doubt it), is it used to offset the amount of printed money used for QE? As it’s a pretty large sum it must show up somewhere in some accounts?


    Dave C

    1. Zak. says:

      Good question…. and while its on my mind, if the BOE bought these bonds by using money created out of thin air then what’s to stop them forgiving the government not only the interest but the principal sum in the coming years by destroy the bonds?

    2. Anonymous says:

      Hi Dave C and welcome to my blog.

      One of the ironies of the ssituation here is that it simultaneously requires the Bank of England to claim it is independent whilst also linking it to Her Majesty’s Treasury. In other words this is part of my argument that the Bank of England is not independent.

      If we go through the process the Bank of England buys the government bonds or gilts in the market. For example it purchased £1.7 billion of them this afternoon. These will receive interest as normal. So for the £51.1 million of our 2055 stock that was bought today the Bank of England will receive interest at 4.25% per year as if it was an ordinary investor.

      Accordingly it makes a profit.You could argue it creates the money for nothing but I think that using the base rate of 0.5% is a better guide andso in the example above a profit of 3.75% per annum is made.

      What does the Bank of England do with the profits? It gives them to HM Treasury.

      I have just discussed interest here where there is always a gain. Capital gains/losses are a separate matter and are accounted for annually. As we stand there will be profits but in most future medium and long term scenarios I expect there to be losses.

      1. D Cox says:

        Thanks for that Shaun, I have followed your blog from the old not a yes man days, and I have learned much about the financial world from it. 

        It is what I guessed but I had never seen anybody explain where it went. But the obvious follow up question for me would be if the interest is returned to the treasury then it must show on the plus side and cancel out the same spending when it appeared as an interest payment going out on the negative side. Does this reduce the deficit? If so  this implies that our deficit is really worse than it appears as every month (if interest is payed monthly) some of the deficit goes round the loop, and cancels, whereas in ‘normal’ times it would only go out as an interest payment? Finally if this is the case, what odds that the the BOE’s QE never goes back in to the market? Do you think it will just sit at the BOE until it expires, as if it reduces the deficit by canceling the interest out I can’t see our wonderful politicians letting the ‘independent’ BOE release it back in the market.  


        Dave C

        1. Nickrl says:

          Well on 7th march next year the DMO will be redeeming a 4.5% gilt so we will see how they account for that or will it magically disappear as easily as the money was created in the first place!!.
          I also reckon they will have lost a 400m or so as they paid 107% above face value on the 6.1Bn they’ve purchased offset by interest received..

  3. Rods says:

    Hi Shaun,

    Another great thought provoking blog.

    “I would be interested in suggestions for names as hard,middling and soft do not really cut it.”
    Bundesbank Euro
    Average Euro
    Devalued Euro

    And when conjoined, the current situation BAD.

    1. Anonymous says:

      Very good

      Could Michael Jackson provide the theme song?

      “Because I’m Bad, I’m Bad-Come On(Bad Bad-Really, Really Bad)You Know I’m Bad, I’m Bad-You Know It(Bad Bad-Really, Really Bad)You Know I’m Bad, I’m Bad-Come On, You Know(Bad Bad-Really, Really Bad)And The Whole World Has ToAnswer Right NowJust To Tell You Once Again,Who’s Bad . . .”

      1. Rods says:

        Hi Shaun,

        I never thought of the Michael Jackson connection and really like that.

  4. JR Bearbull says:

    A little off topic trivia to answer Shaun#s question: live cats have a non fatal terminal velocity, so falling from a height they should be able to get up and walk away.  Dead cats clearly will not, hence ‘dead cat bounce’, a stock or security that has fallen and is not going to recover, even if it does appear to have a temporary bounce when it hits bottom.

    1. Anonymous says:

      Hi JR and welcome to my blog.

      Thank you, putting it like that seems logical.

  5. Robert Silver says:

    Excellent blog as usual, thank you.

    One thing I’ve never understood is, why would a bank pay the Bundesbank to hold its money?  Or why would banks deposit money with the ECB, overnight?  Surely, if you’re unsure what to do with your money, why not just hold it yourself, rather than ‘pay’ someone else?  There must be other ways to earn interest in your money overnight, other than park it in a bank?  Hell, they might as well play Russian roulette with it & that way we can get rid of a few bankers, but the banks would, I’m sure, earn more interest in more ways than one!


  6. Anonymous says:

    Many many thanks for the insightful analysis, and the explanations for people like me who are interested but financialy ignorant readers.
    “I would be interested in suggestions for names as hard,middling and soft do not really cut it.”
    Dont know if it would catch on but I fancy Hard, Soft, and  Ooooozing.
    As in cheese, of course, to help the visualisation and perhaps the olfactory

    senses  ….

  7. Jan says:

    How about “the Good”, “the Bad” and “the Ugly”?

    1. Anonymous says:

      Hi Jan

      I think that this is my favourite so far although quite a presentational job will have to take place to persuade people to accept a currency called bad or ugly I suspect…..

      I like the image in the film where Lee Van Cleef has the watch ticking and Morricone’s fabulous score plays in the background. Currency Wars…….?

  8. Anonymous says:

    Shaun – an insightful piece and it’s not surprising the EZ isn’t working (as it should). My view on the three currencies required: THE GOOD, THE BAD, THE UGLY and leave the geographical aspects to Madam Ashton (she might know…..but…)

  9. Russell Branch says:

    Hi Shaun, I’m interested that you include Finlalnd as one of your group of three Euro core nations. Having worked for a Finnish company for a while, it soon became obvious that the vast majority of Finnish people hold some stock in Nokia either
    directly or as a part of their pension. Nokia disproportionally dominates
    the Finnish economy, accounting for about 1/3 of the capitalization value of the Helsinki
    stock exchange, so its fortunes play a large part in the fortunes of
    most Finns
    I must say that if investor confidence in an economy is important, then as long as Nokia is doing OK, and trees continue to grow, Finland will be OK! NB, this is possibly a slight over simplification :-)
    However, Nokia is meeting some strong headwinds from its rivals (HTC, Apple and Samsung especially) so don’t be surprised if things get trickier for Finland over the next couple of years.

    1. Anonymous says:

      To misquote Genesis, And then there were two?

  10. Mcgrathr20 says:

    I’m not sure about this, but didn’t S Africa once upon a time during apartheid introduce two Rands: the commercial rand and the financial rand?    It was a resounding disaster,  if my memory is correct, because the clever lads in the financial world made a lot of money by round tripping.    And that was with a common fiscus etc, just how much worse would it all be in the Eurozone?

    1. Anonymous says:

      Hi Mcgrathr

      These would be separate currencies and yes they would need each to correct the errors made in the construction of the existing one.

  11. Pampaulwalnuts says:

    If I was in the  Netherlands or Finland I may prefer to copy the German example and be in a currency union which keeps my exchange rate pegged lower than it should be to boost my exports – perhaps they could all join the sterleuro

    Always look forward to reading your blog and glad to see its been recognised ( by your appearance on Jeff Randall)


    1. Anonymous says:

      Hi Pampaulwalnuts

      Welcome to my blog and thank you for the compliment.

      You make a good point except I think that the situation you described has happened and is happening but is unlikely to be able to continue in its present form for too long….

  12. Anonymous says:

    Hi Shaun – you suggest splitting the Euro currency union into several currency unions. The ECB structure looks to be broken. There is no single political master – currency union without political union has failed. Why should it work a second time, when it failed the first time ?

    1. Anonymous says:

      Hi Expat

      Some sort of fiscal and political union would indeed be required which I think would be easier in the 3 separate groupings I describe as opposed to trying to pull all 17 nations together in one group.

      1. Anonymous says:

        I can see that a hard currency grouping of Northern European nations could work – based on protestant fiscal discipline and respect for the rule of law. They would be standing on common cultural ground.

        However I do not see a currency grouping of Greece, Ireland and Portugal working – what do they have in common besides the fact that their governments are insolvent ?

        Engineering graduates are sometimes taught kiss “keep it simple stupid”. To simplify european currencies, bring back the Deutschemark with a single political master and the reliable Bundesbank.

        Allow other countries to use the DM or peg to it. They do so at their own risk just like Argentina’s peg to the dollar. If you overspend – it’s your problem.

  13. Nemesisforpredators says:

    Is there some hidden agenda working through these events? For instance some have suggested that, instead of a slow motion train wreck, this is in fact a slow motion hidden coup d’état on the European democracies and that we’ll only react when the fait is accomplit and it’s far, far too late.
    Also, much enjoyed your your talent for enlivening finance writing with well-chosen idioms such as the shower on a hot summer day, the London buses, the boy who cried wolf, the dead cat bounce, the football terrace chant, and the three speed Euro.

    How about the Marko, the Sarko and the Banko. Or the Markel, the Sarkol and the Bailout?

    1. Anonymous says:

      Hi Nemesis

      My tutor at the LSE Willem Buiter certainly thinks so and has argued this case for a while. I do not doubt that they will try it but I do disagree as to the likely success of their efforts.

  14. nicodemus says:

    – I thought the Mark’s brothers had already been named, Groucho, Harpo and Chico?

  15. Sean Fernyhough says:

    What are the limits to the ECB expanding its balance sheet? 

    1. Anonymous says:

      Hi Sean

      The theoretical answer is that there are none. But I disagree with that. The problem is we are only likely to discover the exact limit from the other side once it has been exceeded.

      The construction of the ECB and the way it is backed by the central banks of 17 separate sovereign states (and hence their taxpayers) could go wrong in the current and likely future environament. What if one or more leave and refuse to pay up?

      I can answer a little more about the rate of expansion as the ECB stated that its bond-buying (SMP) would not exceed 20 billion Euros a week. However more than a few rules have been broken so far.

      Why are central banks getting away with this? Well partly because so many are at it which limits the exchange rate issue as frankly there are plenty to sell but which one to buy?

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