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It was not so long ago that markets nose-dived on the threat of a Greek debt default. It took some last minute negotiation to kick the can further down the road. And while the can was rolling, other threats to the European Union like Brexit took centre stage.
But it seems the can has been stopped, and while Grexit may not be front and centre, the country’s debt is back in the headlines. And despite further assistance from the IMF and European Central Bank, the Greek government still needs to find close to €300bn to pay back over 30 years.
Investec’s Brian Kantor says this particular odyssey has however moved beyond the Aegean Seas. Kantor assesses the global debt crisis and how the stimulus provided is a deflationary, rather than inflationary environment. Great insight. – Stuart Lowman
By Brian Kantor*
Greek debt was back in the news last week. The news that Eurozone finance ministers had overcome an impasse with the IMF and will disburse €10.3bn to enable Greece to meet its immediate commitments to the IMF and the European Central Bank (ECB) of about €4bn. This still leaves Greece with close to €300bn of debt to be repaid over the next 30 years.
A surely impossible task of fiscal adjustment – despite debt relief to date that has amounted to close to €200bn. One can only wonder all over again how Greece managed to run up such debt and why it has so little in the form of productive infrastructure and additional human capital to show for it.
But this particular odyssey has moved on beyond the Aegean Seas.
The Euro debt crisis seems to have faded into the background. Eurobond yields for the most vulnerable of the Euro borrowers are now well below pre-GFC levels, as we show below.
The relief for the bond markets came partly in the form of some modest fiscal austerity but largely, and more importantly, came from the European Central Bank (ECB) doing “whatever it took” to rescue the bond market with its quantitative easing programme – buying bonds in the market place in exchange for deposits placed by banks with their central banks.
It was following the example of the US Fed, the Bank of Japan and the Bank of England in providing extraordinary supplies of central bank money to their banking systems via purchases of government and other debt instruments in the debt markets.
According to the Bank Of International Settlements (BIS) the total assets of global central banks has grown from about $9trn in 2007 to well over $20trn today and is still growing.
The debt of developed economy governments (the Euro area, UK, US and Japan) has grown from about $13trn in 2003 to over $32trn in 2015. Of this debt (foreign and domestic) about $13trn is held by central banks. Up from about $3trn in 2003.
As a result, central banks have become major sources of demand for government bonds and as such, have not only relieved the banks of any lack of liquidity but have also, through their actions in the bond markets, have directly led interest rates lower. We rely on the Bank of International Settlements (BIS) Annual Report 2015 for these details and balance sheet outcomes.
These central banks are government agencies and so their assets and liabilities should be consolidated with those of their respective government treasuries. In effect, the net debt of the government (net of central bank holdings) has been to an ever greater degree funded with deposits (cash reserves) issued by their central banks.
In the case of the ECB and the BOJ, these deposits are now penalised with a negative rate of interest. In other words, with cash that is now an interest bearing liability of the government. The US Fed provides its member banks with a positive rate of interest on its deposits at the Fed.
So far, most of the extra cash issued by central banks has been held by the banks rather than used to supply bank credit. Hence aggregate spending by households and firms has remained highly subdued.
Deflation rather than inflation has become the feature of the developed world, despite the unprecedented increase in the supply of central bank money. Deflation and, more important, the expectation that inflation will remain highly subdued for the next 30 years at least, has meant persistently low interest rates.
In parts of the developed world like Japan and Switzerland, nominal interest rates offered by governments for 10 year loans have turned negative.
In other words, lenders are now paying governments to take their savings for an extended period, rather than receiving interest income from them.
Another way of explaining such circumstances is that issuing long-dated debt at negative interest rates is even more helpful to governments and their taxpayers than issuing zero interest bearing notes or deposits at the central bank, unless bank deposits held at the central bank also attract a negative interest rate (as they may well do).
Accordingly while government debt has grown – though much less slowly for debt held outside central banks – interest rates have receded and government’s debt service costs have declined rather than increased.
The debt burden for taxpayers has become less rather than more oppressive. Moreover, the global economy continues to operate well below what may be regarded as its growth potential. These conditions make for an obvious political response. They make the case for more government spending, funded by issuing very cheap debt rather than higher tax rates or tax revenues. A call, that is, for government stimulus rather than austerity now that the debt crisis has been dealt with.
The major central banks, other than the Fed that has tapered off its bond buying programme, are still doing as much as they wish to do to add to the money stock and to reduce interest rates across the yield curve.
The ECB has been adding €80b a month to the money base in Europe while the QE target for the BOJ is to purchase government bonds at a monthly rate of between 8 and ¥12trn and in addition intends to purchase three ¥450bn tranches of corporate paper in June and a further 3 times ¥350 such purchases in July.
But despite these injections of cash into the banking systems the lack of demand for, as well as reluctance to supply, bank credit has meant persistently weak demand of goods and services by households and firms. The temptation for governments to popularly spend more and raise more very cheap debt (rather than raise taxes) would seem to be irresistible.
The Japanese government has just issued a very long 40 year bond paying a positive but minimal 0.4% p.a. The Japanese government, with a gross debt to GDP ratio of as much as 400% (though with much of the debt held by the Bank of Japan and the Post Office Bank- part of the Japanese government) is not resisting.
It is very likely to postpone an intended increase in sales tax previously intended to close the large fiscal deficit. Where Japan leads with fiscal stimulus, other governments will be encouraged to follow. If so can inflation be expected to remain as low as it now does? Will growth rates remain as slow as they now? Were both growth and inflation to pick up, equities will offer much more value than long dated bonds that have become so expensive.
• Brian Kantor is chief economist and strategist at Investec Wealth & Investment.
• The views expressed in this column are those of the author and may not necessarily represent those of Investec Wealth & Investment.
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