Tag Archive: Greece



 

Osborne's Autumn Statement speech revealed more borrowing

Switch in focus from growth

Austerity is still the answer but now the question has changed. ‘How do we rescue the country’s economy, eradicate the deficit, and return to growth?’ has been replaced with, ‘how do we ensure that the cost of borrowing doesn’t increase?’

 

When governments borrow money they do so by selling bonds (gilts). These can best be described as IOU’s where investors buy a certain amount of bonds to be repaid, plus interest (yield), over an arranged period of time. Keeping down this yield is paramount to a government’s ability to repay its debts. If the government becomes insolvent then it will default and trigger the kind of austerity measures currently seen in Greece.

 

Britain’s coalition is trying to ensure that the country is still seen as a safe haven for money markets. When investors suspect that a country is unlikely to be able to repay its debts then credit lines dry up and the governments have to offer higher yields to convince potential investors that the extra reward merits the enhanced risk. An example would be Italy where a lack of liquidity has led to yields of eight per cent to be repaid in just three years. This contrasts with Britain’s relatively luxurious position of selling, at just over two per cent, bonds that don’t have to be repaid for a decade.

 

So Chancellor George Osborne is understandably keen to maintain cheap borrowing levels and avoid massive interest repayments.

 

How is the coalition maintaining market confidence?

 

Just how one keeps borrowing down is the dividing point in the country’s political landscape. The Conservative led government hopes that by maintaining their austerity programme to eliminate the structural deficit over the course of the parliament, they are keeping the faith of the markets. But austerity comes hand in hand with lower investment, lower spending and lower growth. The UK economy has flat lined and as a result borrowing has to increase to fill the void left by lower tax revenues. The government’s argument is that avoiding austerity measures and allowing the yield on UK bonds to grow by just one per cent would mean every family in the country paying an extra thousand pounds so Britain could repay its debts.

 

The Director of the Institute for Fiscal Studies, Paul Johnson, appearing on the BBC’s coverage of the ‘Autumn statement’, noted that due to declining growth increasing the amount Osborne has had to borrow, he has to factor in more cuts than previously to eradicate the structural deficit:

 

“He’s had to take another 15 billion [pounds] away from public spending in the years after the next election. Now he hasn’t told us how he’s going to do that, he’s simply said that in his forecast he’s taking an extra 15 billion away, that’s enough for the OBR (Office for budget responsibility) to say he will meet his target. Had he not pencilled that in the OBR would have to have said he’s going to miss his targets.”

 

Osborne’s analysis is that should this happen the effect would be to shake the markets’ confidence.

 

 

So what of the opposition?

 

Polls are currently reflecting the public’s lack of faith in Labour’s economic plan. ComRes found that 21 per cent of people trust Labour with the economy whilst 50 per cent do not. Ed Balls’ argument for his economic philosophy has hit a wall. The party’s message is that spending more and therefore increasing borrowing costs will lead to lower borrowing costs. On the surface the claim appears illogical and they have failed dismally in getting across any sort of economic argument to support the claim.

 

The coalition has found political capital in claiming that despite inheriting a huge deficit they have maintained a low level of borrowing costs. This appears true when compared with European neighbours like Greece and Italy, but does this tell the whole story?

 

Today’s bond market:

  Price Yield
US Gov 10 yr 100.00 2.00
UK Gov 10 yr 113.27 2.23
Ger Gov 10 yr 97.23 2.31

 

The above graph shows that the UK does indeed borrow a similar amount to both the USA and Germany. If the theory of cutting the budget deficit to increase the attraction to borrow follows, then you would expect them to have similar budget deficits:

 

Budget Deficit (% of GDP)

US 9.3
UK 8.7
Greece 7.0
Germany 1.1

 

So far so good.

 

But the US, despite the best efforts of the Republican Party, isn’t following a similar austerity plan to keep favour with the markets.

 

Upon arrival to the White House President Obama initiated an $800bn bill and recently fought hard for a $447bn package of tax cuts and government spending. Hardly austerity measures and when combined with the life and death struggle to raise the debt ceiling, which had it not been achieved would have led to an American default, would surely deter any nervy investors. Yet that isn’t the case, so Chancellor Osborne’s theory of ‘austerity or exorbitant borrowing costs’ appears to fall down.

 

The example of America’s economic situation is much more consistent with Britain’s position than the European countries. Britain hasn’t defaulted on its debts for 300 years, it has its own currency, an independent central bank and control of its own monetary policy. Our flexibility is far greater than the likes of Italy and Greece and is as such a far safer economy to invest in.

 

Economist Paul Krugman believes austerity rain will lead to an austerity flood

Labour will need to work hard to convince the country that stimulus is the way to go with even former Liberal Democrat leader and Keynesian, Lord Paddy Ashdown, subscribing to the government’s argument. During a debate with Alistair Darling in response to the ‘Autumn Statement’ he reiterated the party rhetoric; “debt as high as Italy yet borrowing rate lower than Germany.” Labour has to show that this is a distortion of cause and effect to gain any credibility for their argument. Ashdown’s party has always wanted to join the Euro despite the disadvantages of the loss of a sovereign monetary policy. These monetary conditions are again ignored in the austerity hypothesis. Italy cannot print money into the system in order to devalue; it has no control over interest rates and is tied into a political entity that is forcing austerity measures that only increase the likelihood of default and further disincentivise investors.

 

The 2008 Nobel Prize winning economist Paul Krugman states in his blog: “it turns out contractionary policy is contractionary after all. As a result, despite all the austerity, deficits remain high. So what is to be done? More austerity!”

 

Perhaps the Labour Party would be well served to adopt this point in favour of the distinctly less successful ‘too far too fast’ campaign.

 

 

 

Deadline set for Greek solution


Crunch time for Eurozone leaders

In an information light announcement at a bilateral summit in Berlin, President Sarkozy and Chancellor Merkel set October as a deadline to reach agreement on a package of measures to stabilise the Eurozone. This will include a recapitalisation of European banks if required. After months of dithering over the politics and ignoring the economics, their hand is clearly being forced by growing international pressure for action as the announcement will come just before November’s G20 summit.

Whilst detail is thin on the ground it does seem that recapitalisation of banks will be at the forefront of any announcement. For weeks there has been talk of a boost to the European Financial Stability Fund (EFSF) with figures as high as €2tn being discussed in order to offer liquidity to member states. But after the break up of the Belgian bank Dexia and downgrade in credit rating of 12 UK financial firms, attention has moved to avoiding a repeat of 2008’s banking crisis.

The international pressure for Europe to find a resolution is enormous. Today in an interview with the Financial Times Mr Cameron urged the euro membership to accept collective responsibility and backed an increase in the eurozone’s €440bn (£378bn) bailout fund. The hope is that decisive action will bring an end to the uncertainty that is currently destroying confidence in the markets.

But how will the cards fall for Greece? Whilst the current Prime Minister has refused to speculate on a Greek default, former PM John Major made it clear yesterday in an interview with the BBC that Greece would have to default.

“In the short term the banks need to be recapitalised and Greece needs to default, the sooner that happens… the sooner you remove something from the overhang in the markets.”

In this scenario banks would take a big haircut and if they weren’t sufficiently capitalised it would spark another banking collapse. But it seems increasingly likely that this will be the course of action as the German news agency DPA has reported a discussion between Eurogroup senior officials about a potential haircut of up to 60 per cent on Greek bonds’.

Reassurances by Sarkozy and Merkel that recapitalisation is on the table and banks would be given all the support they needed add weight to this likelihood.

A default would badly damage banks that are exposed to the Greek debt and would set a dangerous precedent to other heavily indebted economies. At the moment Italy and Spain are not insolvent but have liquidity problems that would not be helped by the drying up of lending likely to occur if banks take a haircut over Greece. But banks may be prepared to accept this so long as they are sufficiently recapitalised. The time for leadership and the use of EFSF funds has come and perhaps an acceptance of a default will end the uncertainty.