Greek debt approach will increase German government bond scarcity
The Varoufakis approach: charm, charisma and academic venom
by David Marsh
Mon 2 Feb 2015
Greece’s refusal to engage with the international ‘troika’ of creditors will worsen further one of the chief worries about the European Central Bank’s asset purchase programme due to start next month – a shortage of prime government paper in the euro area.
As financial markets fret about a potential halt to ECB-approved emergency liquidity for Greece, capital is likely to flow further into the ‘havens’ of top-rated government bonds around Europe. The Bundesbank’s undertaking to purchase roughly €15bn a month of securities, of which the lion’s share would be German sovereign bonds, is looking problematic a month before the programme starts.
Many traditional domestic buyers of German government bonds such as banks and insurance companies are required to hold this paper for regulatory reasons. Furthermore, foreign euro investors from official and private sector institutions around the world are reluctant to exchange their German bond holdings in the light of general worries over the euro’s stability following tough talk by the new Greek government over its €320bn of public debt, 85% to 90% of which is held by the ‘troika’ of European governments, the ECB and the IMF.
Anticipation of ECB buying as well as renewed doubts about Greece have sparked large-scale rises in German bond prices. Yields on 10 year paper, above 1% five months ago, touched a record low of just under 0.3% last month. Yields are negative up to maturities of five years, making the Bundesbank extremely cautious about buying such paper even if it can find holders willing to sell.
The flurry over German bonds takes place as Yanis Varoufakis, Greece’s newly appointed finance minister, has embarked on a European tour to set out the Athens government’s economic strategy. In London on Monday after visiting Paris and before he travels to Rome, Varoufakis pointedly has not yet scheduled a trip to Germany. The new minister combines charm, charisma and expertly articulated academic venom, a disconcertingly effective combination that will pose big problems for the German government and the ECB when he eventually reaches Berlin and Frankfurt.
German Chancellor Angela Merkel, who has refused to countenance a reduction in the face value of Greek debt, is likely eventually to submit to a further stretching out of maturities on officially-held debt as well as a reduction in Greece’s already low interest rate burden, which would vastly reduce the real value. The alternative would be that Greece would be forced to leave the euro – an option that both the new Syriza-led Greek government and many political and financial market commentators believe would be catastrophic – or that Germany (together with some other key euro creditor nations) might have to leave because they felt that the euro bloc’s rules were being irredeemably undermined.
Varoufakis, a well-read university professor whose political philosophy embraces a heady mix of free-market economics and Marxism, has thrown down the gauntlet by refusing to recognise the troika and calling instead for a case-by-case approach of negotiating (or ‘deliberating’ as he calls it) with individual governments.
The Greek finance minister says he is sticking to the legal position that the IMF and the ECB are preferred creditors that will be served first in any debt restructuring. But he is hoping for compliance from the IMF (in spite of the deep antipathy to large European loans from many emerging market economies on the IMF board) and a readiness by the ECB to convert its €27bn in Greek bond holdings into low-cost perpetual bonds that would be ultimately repaid in line with the Greek economy’s return to growth.
Varoufakis’ step-by-step procedure is clearly aimed at isolating Germany as the euro area’s biggest economy and largest creditor. He is likely to win at least partial support from France, Italy and the UK on the need for a new look at what he admits is Greece’s de facto bankruptcy. This would encompass a long-term approach to haul the country back to growth and reform after six years of austerity that many experts believe have brought no sustainable respite.
Varoufakis has suggested a four-month cooling off period in which creditors will be asked to find innovative bridging solutions rather than to seek further debt packages or economic commitments that Greece will be unable to fulfil. This period will be highly fraught, with potential for serious setbacks from both the debtor and creditor sides, especially from Germany. Given the intractability of the debtor-creditor divide, and the complex position of countries like Spain and Italy as large creditors towards Greece as well as debtors towards Germany, further politically driven euro weakness looks highly likely.
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