The 'Great Stretch'
Last week the Greek government celebrated its return to the bond market, selling 3 billion euros in five-year bonds at a yield of 4.95 percent. Reportedly there was great demand for the issue, which should be no surprise given the current propensity of investors to buy all sorts of junk debt as long as it yields more than just a smidgen.
Reuters report on the backdrop that made this successful auction possible:
“Call it the Great Stretch. Two years ago, Greece's debt crisis almost brought the euro zone crashing down. Now European partners are preparing to ease Athens' debt burden without writing off their loans but by stretching them out into the distant future, extending maturities from 30 to 50 years and further cutting some interest rates, EU officials say.
Greece made a successful, if artificially engineered, return to the long-term capital markets last week for the first time since its international bailout in 2010, and just two years after imposing heavy losses on its private creditors.
But with its economy shattered, the country is still a long way from being able to fund itself unassisted in the market. The International Monetary Fund says Greece is likely to need further financial help from the euro zone over the next two years.
One reason why the sale of 3 billion euros in five-year bonds at a yield of 4.95 percent went so smoothly, on the eve of a support visit by German Chancellor Angela Merkel, was that investors are widely anticipating official debt relief.
"That has been quite substantially priced in, and the market is also expecting Greece to be quickly upgraded by the credit rating agencies," said Alessandro Giansanti, senior rate strategist at ING bank in Amsterdam.
"In a second stage, the market is also expecting a reduction in principal on official debt, and no private sector involvement (write-down) in the coming years," he said.
Whether such expectations are fully realized will only become clear later this year, when negotiations start with the euro zone and the IMF on Greece's longer-term funding, and the end of its wrenching bailout program.
But EU leaders share an interest in helping conservative Prime Minister Antonis Samaras' shaky coalition cling to office rather than seeing leftist anti-bailout firebrand Alexis Tsipras sweep to power demanding a massive debt write-off.”
(emphasis added)
In other words, investor expectations regarding the probability of debt reductions and other measures to help the Greek government are quite rational in view of the political situation. There have been numerous polls in recent months that indicate that SYRIZA would win any new election hands down at the moment.
The Government Debt Ponzi
Reuters further notes that what is being done in Greece is the 'government debt version of extend and pretend' that is usually heavily criticized when private banks engage in it. A few more excerpts:
“But extending the maturities and cutting the borrowing cost has already been done once – the loans were originally granted for five years at a punitive interest rate – and it is less politically explosive in Germany, the Netherlands and Finland.
It is a government version of the "extend and pretend" behavior of private lenders who keep bad loans on their books, hoping something will turn up, rather than writing down losses.
"This kind of restructuring of official sector debt has already quietly been happening," said Elena Daly, principal at EM Consult, a Paris-based sovereign debt consultancy.
"Stretching out the official sector loans and reducing their interest rates opens a window for new private sector lending without fear of competing with existing official sector creditors when the time comes for repayment," she said.
A country's debt profile – the timeline of future repayment or refinancing obligations – is more important to investors than the absolute size of its debt stock.
Asked what European authorities planned to do about the mountains of official debt owed by Greece, Ireland and Portugal, a senior EU policymaker replied with a riddle. Who was Britain's prime minister, he asked, when it paid off its World War Two lend-lease debt to the United States? The answer is Tony Blair in 2006, more than 60 years after the war ended. Indeed, Britain still has some World War One debt to Washington outstanding, a century after that conflict began.
After two EU/IMF bailouts worth a total of 240 billion euros and a "voluntary" write-down of privately held bonds, Greece has a public debt equivalent to 175 percent of its national output, far beyond what the IMF considers sustainable. Gross domestic product has slumped by 25 percent, wages and pensions have been cut sharply and unemployment stands at nearly 27 percent, including more than half of all young people.”
(emphasis added)
In other words, all concerned agree that government debt is nothing but a Ponzi scheme anyway. It depends on new investors replacing old ones when they are getting paid (in fact, the same investors receiving payment are often the buyers of newly issued debt). The underlying idea is that 'governments can stipulate for all eternity' as Ludwig von Mises derisively put it.
The funny little riddle about when the UK was paying off its WW1 debt leaves out the important point that the money that was used to pay the last vestiges of this debt was worth a tiny fraction of what it was worth when the debt was originally contracted. It was still called 'dollars' or pounds', but its value had declined by at least 96% by the time the last payment was received.
Obviously, precisely the same fate is going to befall Greece's government debt. If the ECB manages to devalue the euro by 2% per year as is its official plan, then Greece's debt will be worth less than half as much by the time the last sliver of its bailout debt is paid in 50 years time (if it manages to hew to the repayment schedule, which is far from certain).
Every €1 million would require the repayment of €2,7 million in 50 years time to reflect the same purchasing power at a constant rate of monetary debasement of 2% per year - and there can of course be no guarantee whatsoever that the euro will be debased merely at the 'target rate' of 2% for the next 50 years running. Currently the euro area's 'harmonized consumer price inflation index' is running at a lower rate of only 0.5%, but such calculations have to be taken with a big grain of salt, as it is actually a mathematical and logical impossibility to 'calculate' the purchasing power of money.
There exists no fixed yardstick to calculate with, as money's purchasing power is influenced both by the supply of and demand for goods and services and the supply of and demand for money itself (which is economically speaking just another good, with the sole distinction that it is used as the medium of exchange – and what applies conceptually to a commodity money in this respect also applies to fiat money, in spite of its abstract nature). There is no constant against which prices could be measured, and it makes logically no sense to add up the prices of disparate goods to calculate an 'average price level'.
The only thing we we can observe as an objective measure is the rate at which the supply of outstanding money grows, and that growth rate is as a rule far higher (currently 6% p.a. in the euro area) than the official 'inflation rate'.
As Mises wrote in 'Human Action':
“The long-term public and semi-public credit is a foreign and disturbing element in the structure of a market society. Its establishment was a futile attempt to go beyond the limits of human action and to create an orbit of security and eternity removed from the transitoriness and instability of earthly affairs. What an arrogant presumption to borrow and to lend money for ever and ever, to make contracts for eternity, to stipulate for all times to come! In this respect it mattered little whether the loans were in a formal manner made irredeemable or not; intentionally and practically they were as a rule considered and dealt with as such.
In the heyday of liberalism some Western nations really retired parts of their long-term debt by honest reimbursement. But for the most part new debts were only heaped upon old ones. The financial history of the last century shows a steady increase in the amount of public indebtedness. Nobody believes that the states will eternally drag the burden of these interest payments. It is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of interest and principal according to the terms of the contract.”
(emphasis added)
This was as true in 1949 as it is today. The main difference is that the global public debtberg has grown to such absurd proportions that it has become even more certain that the eventual liquidation of the debt won't take place 'according to the terms of the contract'.
Private investors in Greek or Argentine debt can already attest to this fact. Other creditors of governments won't fare any better – it all depends on the Ponzi nature of the government debt scheme surviving forever. How many Ponzi schemes are there that have not collapsed? There are only two ways governments can possibly go about handling their debts in the long term: massive monetary debasement or outright default. Most likely a mixture of both will take place.
Greece's 10 year government bond yield, daily. Testament to investors' love affair with junk – click to enlarge.
Chart by: investing.com