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Dublin: 16 °C Friday 31 October, 2014

Column: Low rate of lending to Germany has put them in driving seat

The gap between those who can access the markets and those who can’t continues to wide, writes Nick Leeson…

Nick Leeson

IT’S BEEN A crazy week in the financial markets. The euro touched its lowest level against the dollar since July 2010 as the European bloc’s sovereign-debt crisis deepened in Spain, Greece and even Scandinavia. Against a backdrop of falling markets though, the strangest and possibly most significant event occurred; investors have poured huge sums of money into German Bunds (bonds issued by the German government).

There’s nothing initially surprising in that but the rate – or rather the low rate – at which they are willing to lend money to the German government is astounding. The debentures of the German government are considered Europe’s safest assets. Berlin’s borrowing costs, unlike the rest of Europe, have therefore fallen to record lows.

Initially it seems counter intuitive. Yields on Germany’s benchmark 10-year debt have fallen further than those of other investments traditionally regarded as ‘safe-haven’ investments, the unprecedented moves in the yields have even left US treasuries and the more traditional safety
measure of gold in the shade. The scale of this “flight to quality” was truly brought home to the rest of Europe on Wednesday by the sale of Germany’s first zero-coupon two-year bond, which investors snapped up at a sliver of a discount, to give it a record low yield of just 7 basis points.

In other words, Berlin is paying next to nothing to issue debt.

“The gap between those who can access the market and those who can’t is set to be driven further apart”

Thirty-year bond yields fell below 2 per cent for the first time. Ireland, Greece and Portugal have no access to the debt market and Italy, Spain and a host of other countries are paying exorbitant rates. The gap between those who can access and those who can’t is set to be driven further apart.

Some analysts argue that Bunds are an effective hedge against a full eurozone collapse and break-up, as Germany’s debts would probably be redenominated into Deutschmarks, which would appreciate in value. That may or may not be case but it is not surprising therefore that a feature of the latest Irish Times/Ipsos MRBI poll was the belief Germany is having a dominating influence on the direction of the European Union. They are that powerful.

We are going to have to face the fact that Government or Sovereign debt is longer what it was; we are moving into a new era. I had the misfortune of catching the last twenty minutes of an RTÉ debate on the Fiscal Treaty early last week. I found it quite alarming. The economic policies of the main protagonists of a ‘No’ vote would be more at home on the script of a Hollywood movie than proven economic reality. It’d be like suggesting that Jedward can win the Eurovision because they can sing, they can’t.

Burning bondholders, voting ‘No’ and returning early to the bond markets won’t happen because it can’t. It’s time that people started to accept that. A series of decisions have been taken, they all have consequences and the sooner those consequences are dealt with, the earlier a path to recovery will start. Nobody can turn back the clocks.

“They will not be queuing up to lend money”

In simple terms, as far as the lenders are concerned, Ireland is a country with a litany of Circuit Court judgements, a credit history that even I would struggle to compete with and a recent history that shows government after government failing to deal with the problems. Add in a Central Bank that threw away the rule book, a regulator that failed spectacularly and a housing market that is still in decline and nobody dare call the bottom… You do not have to be an economist to understand that Ireland’s return to the bond markets is not going to be easy. They will not be queuing up to lend money. Handing money to the German government with no coupon is akin to hiding your money under the mattress. It’s not going to increase in value but it is as safe as you can make it.

There was an opportunity to burn the bond holders; I was an early advocate of doing both that and seeking a process of debt forgiveness. The opportunity is now long gone. You cannot prevaricate and take your time in financial markets, you rarely get a second chance. If you don’t act decisively, you simply don’t act and get forced around as the Irish government has been. Equally so, when you have a bad credit history, it takes a lot of hard work, pain and time to make it better.

The opportunity existed several years ago to burn the bond holders but that opportunity has now long passed as the bailout has introduced conditions to ensure that they are paid. Personally I find it even more galling when you imagine that those same bond holders that were ‘risk on’ when investing in Irish debt are now ‘risk off’ and are likely plying the same money that was repaid by the Irish Government into German Bunds with very little benefit. I can’t logically see these or any other potential investors lending heavily or at preferential rates to the Irish any time soon or at least until the credit history improves.

So voting ‘No’ and excluding this country from the cheapest form of Funding, the ESM, is ridiculous and potentially crippling for the nation. Austerity continues whichever way you vote. I accept the argument that the ESM is under-funded but as we all now with austerity and taxes, it is far easier to add than to take away, that is what I expect to happen. When you have no choice left, you have to make the right choice.

Read previous columns by Nick Leeson>

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