If the Greek government manages to sell it’s long awaited bond offering of 3-5 Billion Euros of 10 year debt there will be a sigh of relief. Crisis averted will be the cry. And of course it will be. For to have a no-bid would certainly force the crisis. Germany would be under intense pressure to step in and buy the bonds or bail the Greek economy in some other way, because if they did not, there would be a run and a default.
So let’s assume that by one means or another the bonds get bought. Then what? Is this a sign that the crisis is over?
Well no! And here’s why.
The reason Greece has to issue debt NOW is because it has about €23B in old bonds which are maturing in April and May. Greece therefore needs to sell new debt to take the place of the old. What this means is that Greece is NOT getting any new cash to deal with it’s ballooning fiscal problems. Not from this sale. All it is doing is replacing an expiring debt agreement with a new one.
But here is the thing to consider. Is Greece paying the same, or more for this new debt, as it was paying on the old? Now I don’t know what the old rate was but it is certain the new rate will be more – much more. Greece will likely have to pay around 6.5% on that debt. That is nearly double what Germany pays.
What this means is that IF the sale goes ‘well’, Greece will be able to celebrate that it has successfully got into a worse state, with larger debts, than it was in before. Hurrah! It will have succeeded in re-financing its debt at an higher interest rate than it was paying before. This is analogous to getting a new and worse deal on your mortgage.
This is step one in what is known as the debt spiral.
Step two goes like this.
You have borrowed money. Now you put it to work. The whole reason to borrow is to invest the cash in something productive and hope like hell that the return on the money is greater than the interest you are paying to borrow it, That is the basis of all borrowing.
But what if you don’t or can’t invest it in something that makes a profit? And don’t forget it can’t be something a little bit profitable. It HAS to be something that makes a profit GREATER than the cost of borrowing. In this case Greece HAS to make MORE than 6.5% return on that money. If it doesn’t the whole thing costs Greece yet more money. And what will Greece do about that if it happens? Why, borrow of course. Only at a higher rate.
And you see how the spiral turns and tightens.
Greece is going to have to make more than 6.5% profit on any money it borrows in an economy that will contract by at least 4% next year. How likely is that?
Of course, the way you can find the cash to make the payments is to make larger cuts in other spending to service the debt. But the more you cut elsewhere the more your economy will contract, the more your tax take declines and the more you will need to borrow. In other words, do NOT pass GO and do NOT collect €200 euros.
Remember this is the scenario if things go well.