Will Greece benefit from a European Monetary Fund? Judging her bond issue

8th March 2010 by Shaun Richards

Last week was a major one in economic developments for Greece. First we had a severe economic package proposed by her government which included tax rises (Value Added Tax rose from 19 to 21% for example) and cuts in civil service pay particularly around holidays. Greece is different to us in that salaries are divided by 14 and paid in fourteenths with the two extra payments coming at holiday times.Secondly we had a government bond issue where some 5 billion Euros of ten-year debt was issued. Since then the Greek Prime Minister has gone on a tour having met Chancellor Merkel on Friday and will meet President Obama this week, with the plan being to rally international support.

Fiscal Adjustment

It would appear that Greece has finally realised the scale of the adjustment required and the measures proposed look sufficient now. However the two dangers are firstly that Greece has a poor record in implementing fiscal moves honestly and there does appear to be a build up in union militancy with a general strike planned for March 11th. As time goes by these austerity measures will also adversely impact on economic output as I have discussed before.

Last Weeks Bond Issue, was it a success?

In my Thursday update I suggested that journalists were often in a rush to give a view on the success or otherwise of a bond issue and in the last instance of  a Greek issue such behaviour was not only premature it proved to be wrong. In addition there has been some interesting talk from the man in charge of Greece’s debt office.

In the simplest terms the issue can be considered a success because it was sold, and in Greece’s rather dire circumstances where a German official had said she “is liquid until the end of March” which of course really means that she will not be liquid in April! Then simply selling the bonds is more of a success than it would be in more normal circumstances. But there was a heavy price to pay in terms of the interest offered. You see Greek ten-year government bond yields had fallen to 6.02% as of Wednesday nights close and the new bond was issued at 6.47%.

So the price if you put it those terms (some might consider it the literal price of success) is 0.45% per year. As it was a ten-year bond and 5 billion Euros were issued that translates to 22.5 million Euros a year and that will be for ten years. Perhaps not quite such a success now particularly when Greece has to save every cent and penny she can.

There is another way of looking at the cost and this is to take a wider view. Six months before this bond issue (September 3rd 2009 closing levels)  Greece had ten-year bond yields of 4.67% and as she had not yet been exposed as a serial fiddler of her national accounts my contention is that she is likely to have been able  to issue at such a level. If she was then the cost of this sovereign debt crisis on this particular bond issue is now 90 million Euros a year and remember this has to be paid each year for ten years. Not such an unqualified success now is it?

The man in charge of Greece’s debt office Mr Christodoulou arranged for this issue to be syndicated which meant that several banks (but not the vampire squid) took part. He also stated that the issue would be for “long-term” holders and that he would issue the bonds to those who has “real money” to invest. My first thought was exactly how will he achieve this which was replaced with a smile when I discovered who had bought this bond issue. The structure was as follows, 

Greece (23%) UK (20%) Germany (14%) Asia (8%) Nordic countries (8%) France (7.5%) Benelux (4.5%) Italy (4%) Iberia (3%) Switzerland (2.5%) Other Europe (3%) Middle East (1.5%) Americas (1%)  (from an official press release)

You may be surprised to see that the UK was the second biggest geographical investor and my wry smile was if you reduced the geographical area to Mayfair (many UK hedge funds operate their) what difference would be made to the UK figures? I often write about our so-called elite being less than competent but to be effectively contradicted by your own press release is quite an achievement. I suppose Mr Christodoulou’s  apologists will be saying he was playing to the crowd.

Europe’s leaders and a proposed European Monetary Fund

Whilst President Sarkozy of France has been assuring everyone that Europe has a plan and will back Greece.  He has also contradicted himself in a quote for which I thank the Bloomberg news service.

“Speculators and the markets should know that solidarity means something and that, if there’s a problem, we are there,” said Sarkozy. “The sooner we say that and the more firmly we say that, the more rapidly we settle the problem.”

Unfortunately there is the clear implication from President Sarkozy that talk will be sufficient. As it has not been so far perhaps he will explain how this situation will change. My view is that if you read between the lines he is in effect admitting there is no concrete plan so to the thinking man such a speech is in danger of making things worse.

Moving towards the longer-term time horizon Germany’s Finance Minister Wolfgang Schäuble has come up with something more thoughtful. He feels that Europe needs to set-up a European Monetary Fund so that in future crises there would be somewhere for a nation like Greece to turn to.

How would this work?

Details are sketchy at this stage but the principle is as follows. A euro zone country in trouble would have the option of offering European Monetary Fund (EMF) bonds rather than its own. It may even have the option of replacing some of its own bonds with EMF ones. There would be a price which would be a “haircut” on the bonds. For those that do not understand the concept of a haircut it simply is a way of calculating the price (and establishes the principle that such facilities are not free!)


Now much remains to be done but one clear advantage would be that such a fund would operate in Euro’s and this compares with the International Monetary Fund who would not operate in Euro’s for a Euro zone member.  This reduces potential currency risk.Frankly such a fund should have been instituted as the beginning of the Euro. So it would be an improvement but is only a partial solution I feel. Of course it would have to be accepted by Germany’s Constitutional Court.

Also Wolfgang Schäuble came up with some further interesting thoughts where he said  that speculators were not the root of the problem, but they made the problem worse. Also he felt that  more economic policy coordination is needed within both the European Union and the Euro zone. So finally some sense from a politician let us hope for more of it.

It remains to be seen how Greece will get out of this crisis as many potential problems await her. For example her debt redemption timetable has 2011,2012 and 2014 as years where there are substantial redemptions and if you look at the darker implications of my analysis with declining output then these could hit her with declining economic growth. Therefore Europe will need to help her I feel and I hope that her economic news will be better than I fear. But 2011 and 2012 could be very difficult years too.

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