The unpleasant political arithmetic of Greek bonds (2 graphs)

‘Greek bonds fly of the shelves‘. Yesterday, Greece successfully issued 3 billion 4,95% bonds – and I’m still not seeing that one coming. Greece does not need new debt to be able to pay its interest bill. It needs frontloaded debt reduction to get debts down to a sustainable level, i.e. 60% of 2015 GDP (conservatively estimated, i.e. taking 0% growth and 3% deflation into account).Credible measures and structural reforms to make the remainder of the debt more flexible (i.e. ‘deflation protected’ bonds) have to be put in place. Tax measures – like a land tax – which increase the velocity of the stock of wealth and induce market oriented and demand boosting use of this wealth have to be introduced. Consideration has to be given to the possibility to enhance liquidity by issuing, next to the Euro, a new national currency which people have to use to pay part of their taxes (including VAT), which can be used to pay for government services (higher education!)  and which will be used to pay part of the wage bill of government employees (teachers!). The Greek national bank has to guarantee deposits: in the case of a bank failure the central bank will change deposit money for cash by in effect stocking the ATP’s.

The reason why Greece needs debt reduction is simple: Greek government debt is not sustainable.

A) The greek GDP-price level is falling at a rate of 2,5-3% a year which means that the real costs of these bonds are about 7,5%, which is killing. Considering the already unsustainable debt load of Greece this is (much) more than the country can bear. When prices keep falling at this rate even 2% economic growth will not lead to a rise of nominal GDP and, consequently, to an increase of the debt/GDP ratio even without new debt. Greece urgently needs less debt, not more.

B) Greece was forced to transfer billions of Euros to the Greek banks to make up for the consequences of the haircut on Greek debt. But there is no guarantee that the banking problems are solved. To the contrary, as long as deflation continues there is a real chance that Greece will be forced to use even more money to keep the banks alive. Actually, as long as deflation continues the problems of Greek banks will become worse – new skeletons are creeping into the closet all the time…. This in fact does not only means that Greece needs less debt but also that part of the debts of the banks have to be written off (while wages in the banking sector have to be equalized with those of the rest of the government sector). Less debt is needed, not more.

C) Some details about the unpleasant arithmetic of a such a situation of debt deflation.

“The haircut alone, lowered the government debt pile by €106.5bn (equal to a debt-to-GDP ratio decline of 55.0 percentage points), but as Greek banks at the same time were holding almost 1/3 of the restructured debt, this also created the need for the Troika and Greek government to pay for a €48.2bn bank recapitalisation in 2012, which added back an additional 24.9 percentage points to the debt-to-GDP ratio. So all in all the net impact of the debt restructure in March 2012, was that it lowered the debt-to-GDP ratio with 30.1 percentage points. In addition, the Greek government in December 2012 also completed a debt buyback of 50% of the remaining PSI bondswhere the issuance of €11.3bn EFSF bonds financed the buying of PSI bonds representing a nominal debt of €31.9bn, thus resulting in a €20.6bn net decline of debt (equal to a debt-to-GDP ratio decline of 10.6 percentage points).^[84] Overall the two debt restructuring measures accounted for a 40.7 percentage point debt-to-GDP decline, so that it only ended at 156.9% ultimo 2012, down from the 197.6% it would have ended on if no debt restructure measures had been performed.

Did I already say that Greek debt is heading towards 197,6% of GDP, again?