Germany and France are Chasing Their Tails

Germany and France, the two big countries expected to shoulder the overwhelming Greek debt problems, have told Greece that it needs to undertake austerity measures before they can lend their controversial financial support (read bail out). In this Wall Street Journal article, it’s stated that while Germany and France have spoken of the possibility of future help, this pledge has come in a very vague tone. “No rescue is imminent, the document said, and the intervention would only be a last resort,” is written.

Apparently, the goal of Germany and France is to have Greece do a “market test” by trying to roll over the debt first and then see how the public responds. On Monday, Greece issued and sold 7-year bonds at the value of 5 million euros and managed to raise enough money to fulfill its April debt obligations. While this sale was successful, it was only so because the Greek cost of debt servicing is incredibly high at the moment. The current yield for 10-year bonds stands at 6.5% (double that of Germany) and with German and French support only visible in the far distance, this is unlikely to drop in the short-term at least.

The point, however, is that both Germany and France are failing to realize that their lack of commitment to dealing with Greece’s problems is directly affecting the future sale of Greek bonds. It is therefore irrational on their part to expect Greece to do well in the bond market if they abide by their current stance, because the reaction of the market is not a signal to what Germany and France should do, it’s rather a consequence of what they are currently doing. Buyers are demanding higher yields because the bonds are risky and this will continue to be the case as long as Germany and France remain silent on whether they will help Greece. In this sense, Germany and France are chasing their tails if they expect the market to reflect on Greece’s capacities to sell bonds, because the market is actually depending on their commitment toward Greece.

In a nutshell, Germany and France will bail Greece out because the euro will be history if they don’t. Many investors know this, and this is shown by the sale of credit-default swaps (CDS) that has risen considerably since Greece went public about their troubles. This will be probably done in a discrete manner (through IMF) where Germany and France will contribute with the biggest share followed by the other 14 eurozone members. Afterwards, stricter controls over EU members will be enacted with regulations particularly inhibiting debt expansion. This, however, is unlikely to be a successful scheme since Germany and France have been the first to violate the “3% of GDP” rule on debt and because they are all social-democratic public spending machines. For us, the euro holders, prices will rise as a wave of inflation will ensue and the distorted capital structure from the previous boom is exacerbated.

Greece will have to cut on their Marxist public spending (which stands at around 40% of their GDP) and will cause a lot of social turmoil in the process. The hope is that it will be mitigated by majority’s opinion which sides with the Greek government and their attempts to decrease the deficit. The high debt yields will, however, only postpone the current mess into the future and to what extent this will happen depends on the form as well as the quantity of the bail out. One thing is for certain though, government actions have a perfect record of producing failure.