And we’re
back. Nearly four years after Greece set off the European debt crisis, the
Hellenic Republic is being allowed to borrow from global bond markets again, [paywall]
with a projected €2 billion ($2.76 billion) debt offering today.
The debt-to-GDP ratio is the gold standard
of debt metrics, because it measures liabilities -or debt- as a share of an
economy’s productive capacity. In other words, it tells you whether the economy
is productive enough to generate the money needed to pay its debts. Without an
economy, it’s hard for a country to pay its creditors. And that’s the heart of
the problem for Greece.
About 25% of the Greek economy has been
destroyed. (To be more precise, it’s 24.8%. During the fourth quarter of 2007
Greece’s GDP was €53.20 billion by the fourth quarter of 2013 it was about
€40.01 billion.) Nobody knows if any of it is going to come back any time soon.
But try explaining any of this to the bond
market. This year Greek bonds have been some of the hottest investments around,
and prices have surged. The Bank of America Merrill Lynch Greek Government bond
index has returned more than 30% in 2014.
Yields, which move in the opposite direction
from prices, have tumbled. In fact, yields on Greek debt are now starting to
return to within shouting distance of Germany, which are seen as the safest
form of euro-denominated debt. If the market sees a borrower as riskier, that
risk is measured -in part- by how much higher its bond yields are compared to
Germany.
With that in mind, this chart tells you a
lot. The short version: Greece used to be thought of as risky. The market
forgot about the risks when it joined the euro. Then it suddenly remembered
them back in 2010.
What’s so dumbfounding about investor
willingness to buy Greek government debt is that investors suffered heavy
losses just a couple of years ago. Remember all of the hubbub about private
sector involvement? Basically investors were forced to “voluntarily” fork over
their Greek bonds in exchange for new ones that paid a lot less. The Reserve
Bank of Australia estimates that private sector investors suffered losses of
54% -in nominal terms- on the swap.
Of course, that’s ancient history now. (It
was 2012.). But the question remains. Why would investors lend any money to
Greece? As we’ve said before, it’s not because of the country’s dynamic
economy. Nor is it because Greece’s debt load has been restructured in a way
that makes it possible to manage over the long term. Nor is it because of the
country’s track record as a debtor. (Reinhart and Rogoff famously noted that
the country has been in default for roughly half of the years since it gained
independence from the Ottoman Empire in the 1832).
No, the answer must be that a consensus is
building in the markets, which the European Central Bank now stands behind
Greek government debt in a way that it didn’t before. After all, the bonds of
all the troubled European nations -Portugal, Ireland, Italy, Greece and Spain-
have been enjoying a gob smacking rally since ECB chief Mario Draghi vowed to
do “whatever it takes” to preserve the euro back in July 2012.
Savvy investors know it will be tough for
the ECB to disabuse the markets of this notion. Is Draghi going to come out and
specify that his “whatever it takes” comments don’t pertain to Greece? He
can’t. It would immediately set the markets on a hunt for the next country
where “whatever it takes” doesn’t apply.
At the same time, the ECB needs to think
long and hard about the kind of conventions that are getting baked into the
bond market right now. Financial markets run on conventional wisdom. When
Greece won entry to the euro zone in 2000, its bond yields inexplicably
converged with those of Germany. Nobody said anything, and as a result, the
markets began to view all euro-denominated bonds as essentially
interchangeable.
It only took 10 years for the bond market to
realize the Greece and Germany are very different countries. It’s taking even
less time for the market to forget that hard-won lesson, all over again.
(Source: qz.com)
