Europe

Bombs, beaches and bonds

Greeks Protest Austery Cuts

A car bomb exploded on Thursday 10 April outside one of the Athens offices of the Bank of Greece. This was a timely reminder that Greece is a country with major economic and social problems. On the same day the highly indebted Greek government managed to borrow 3 billion euros at less than 5% interest. Have bond investors lost their senses?

Greece is a beautiful country with a rich history and culture. And from time spent in the past on Greek islands in the Mediterranean sea, I can confirm that the beaches and hillside towns are truly beautiful. But the economy has suffered a deep depression since 2008. GDP has shrunk by a quarter, falling every year for seven years.

Yet on 10 April the government managed to return to the bond market, borrowing 3 billion euros (US$ 4.1 billion) for five years at an interest rate of just 4.95%. It wasn’t even difficult to do: the bond issue was 6.7 times subscribed, receiving total orders of 20 billion.

This is staggering when you consider the state of Greek government finances. Government debt is 176% of GDP…Current Greek debt is 322 billion euros, versus 2013 GDP of 183 billion euros.

This is staggering when you consider the state of Greek government finances. Government debt is 176% of GDP, second only to Japan (226%) and Zimbabwe (202%). Current Greek debt is 322 billion euros, versus 2013 GDP of 183 billion euros.

Even before the global financial crisis and ensuing Greek economic meltdown the country had a very high debt level. The ratio of government debt to GDP was 107% in 2007, before it skyrocketed to current levels over the next seven years.

It’s no surprise that the country has a junk credit rating according to the global credit rating oligopoly that assesses these things (Moody’s, Standard & Poors and Fitch)

That means there is a high risk of Greece defaulting on its debt. There’s nothing new there. In the last four years the country has been bailed out to the tune of 240 billion euros. In modern times Greece has defaulted previously on five occasions: in 1826, 1843, 1860, 1894 and 1932. The country has a dubious track record.

The collapse in the economy has hit ordinary people hard. Because Greece is locked into the euro currency club it can’t devalue its currency to provide relief. So it’s embarked on severe austerity measures in an attempt to bring costs under control and restore competitiveness. Last year MSCI, the index provider, downgraded Greece from developed market to emerging market status.

Unemployment is 28%, which is definitely depression levels, and youth unemployment is even worse. Over 58% of Greeks aged 18 to 25 are unemployed.

Salaries have been cut by around 30%, with teachers down 40%. At the same time taxes have been raised, squeezing net incomes even further. Unemployment is 28%, which is definitely depression levels, and youth unemployment is even worse. Over 58% of Greeks aged 18 to 25 are unemployed. Some estimates suggest that over 40% of Greeks are now living below the poverty line.

With a situation like that it’s no surprise that there was another general strike on 9 April (the 36th such shut down since 2010, by some estimates). In fact the biggest surprise is that there is any remaining social stability at all. Revolutions have been triggered by a lot less.

With all this going on it just seems amazing that anyone would lend money to the government for five years at less than 5% interest. Investors are clearly betting on two things: Greece will stay in the euro zone (there won’t be a currency devaluation) and the country will be bailed out again in future if (when) it gets into trouble.

This is just yet another sign of how jigged and rigged the world of investing is these days, especially when it comes to bond markets. Prices have been bid up to crazy levels, floating on a sea of printed QE money, and investors, as usual, are exhibiting extremely short memories.

(You can find out more about the dramatic shifts in the world economy, in our free report Wealth Workout Just see Step 1. How to invest in a fast changing world)

These days a 10 year Greek government bond yields just 6%. But as recently as early 2012 that was 36%. (Bond prices fall as yields rise and vice versa.) Apparently, Greek bond investors have the same ability to learn from experience as the notoriously pea-brained goldfish.

I’m not saying Greece will definitely default. Nor that the EU and IMF won’t bail it out again. But those institutions are backed by countries that also find themselves with ever rising levels of already high debt. And at the end of the day this is about international politics, the most uncertain of all the dark arts.

Plus the next Greek elections are no later than 2016, and could be earlier. With such a distressed economy, and understandably grumpy voters, there is always the risk of a big political swing to parties that are less friendly to Europe.

Put another way, the risks to bond investors remain high in relation to the chance that foreigners will keep riding to Greece’s rescue from here to eternity. A 5% or 6% annual return simply doesn’t make up for that risk.

Imagine that a friend came to you asking for money. Not a close friend, but someone that you’ve hung out with, and who you know liked to live the high life in the past.

He tells you that his income has fallen by a quarter in the past seven years (equivalent to the fall in Greek GDP). He can only find work for three and half days a week (equivalent to the Greek unemployment rate). He’s cut his spending a bit, but his debts just keep racking up, and are now four times his income (equivalent to the ratio of Greek government debt to tax income). He already spends around a quarter of his income to pay interest on his debt.

Would you lend this person money for five years at 5% and expect to get it back? I don’t think many would.

This is not just about Greece. This is about the global bond bubble. Bond investors are accepting little reward to take on big risks, whether it’s in developed or developing country government and corporate bonds.

My recommendation, fellow OfWealthers, is to steer clear of pretty much all bonds. And if you need some time to work things out, do the Greeks a small favour and take a summer holiday on a Greek island. They could use your money, and you’re likely to get a bargain. You’ll be far away from the bombs, and the beaches are just as spectacular as ever.

Stay tuned OfWealthers, 

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.