Your editor is in Australian Small-Cap Investigator mode again this morning, so we may be brief with today’s Money Morning – unless we get carried away…
“Oh stop grumbling and just hand over the money.” That’s in effect what the German government is being told to do with its taxpayer euros.
According to the Associated Press (AP):
“A 45 billion euros ($A64.45 billion) bailout package from other eurozone countries and the International Monetary Fund (IMF) should see Greece through its borrowing needs for this year. But the bailout is complicated by German grumbling, which continued on Monday, about the burden of the bailout on its own finances.”
Do you know what, if your editor was German we think we’d grumble a bit too. In fact if we were German we’d tell the Greeks to stick a Banane^ up their Kokospalme.*
We’ve long thought the Euro currency was doomed to failure. Whether the debts piled up by Greece and other Eurozone countries is enough to cause its collapse is another matter.
But one day – probably sooner rather than later – it will fail. Just like all fiat currencies are destined to collapse.
For an indication of how bad things have gotten in Greece you need look no further than current Greek interest rates and compare them to German interest rates.
First take a look at this chart from Bloomberg:
The worst thing is, that yield is only as of close of business on Friday. In overnight trade the interest rate on the 2-year bond increased to over 13%. A full three percentage point increase on Friday’s rate.
Make no mistake, that’s an absolutely massive move.
And as you can also see from the chart above, the yield has more than doubled during the past month alone.
But what this shows is that if you mess around with debt and interest rates it’ll eventually bit you on the bum.
It shows you that the attempts to manipulate interest rates by central bankers are doomed to fail. Because while the Greek government should hang its head in shame for criminally burdening its citizens with debt, the central bankers are equally culpable for drugging them up on cheap money.
Let me show you an example. Below is a chart for the same 2-year Greek bonds, except it’s showing the rolling yield going back five years:
And remember, this chart only goes up to last Friday. Based on the prices from overnight, the current yield would be where I’ve placed the big red blob on the chart.
Now, we won’t claim to be an expert on Greek government debt. But the reaction of the bond market tells you what the problem is.
It’s telling you that the government has over-exposed itself to debt over a long period and that investors are no longer willing to accept a yield of between 2% and 5% that they were prepared to accept for the previous four years and eight months.
Importantly, the problems in Greece aren’t something that developed overnight. The Greek government didn’t change from an Ebenezer Scrooge type miser at the beginning of this year to a Paris Hilton style spendaholic yesterday.
The markets have obviously known about the Greek debt for some time. It’s only now that the realisation has dawned on investors that there are perhaps better places to stick their money…
Hence why the Germans are “grumbling” over sending some of their hard-earned southbound to the Mediterranean.
This is the sort of event the saps in the mainstream insist could never happen in Australia or the US. They’re mistaken.
You see, as our Slipstream Trader editor Murray Dawes wrote in Money Morning yesterday:
“I really believe that you can never succeed in the markets long term if you’re not constantly aware of the effect your psychology has on your results.”
A large part of the reason why investors are fleeing Greek bonds is psychology. Sure there are some mug punters that are prepared to buy Greek debt on a 13% yield, but that yield shows you just how risky the punters believe it is.
The main role of interest rates is to provide a visible price of money, another role is to indicate the supply and demand for money, and finally it provides an indicator on the relative risk of money and other investments.
To use an example. While the Greek 2-year bond is trading at a yield of over 13%, the German 2-year bund has a yield of just 0.88%. That’s a spread of over twelve percentage points!
The interest rate is now telling investors that German debt is low risk and Greek debt is super high risk.
Of course it’s all relative. And you shouldn’t forget that the German rate has been manipulated much lower than it otherwise would be by the European Central Bank. But you get the point.
Keeping interest rates low gives the false impression that no one needs to save. Low interest rates over the previous four years gave the market and investors the false signal that there is already enough saving and therefore there’s no need save.
The low interest rates also made the incentive to save a lot less too, even if they were inclined to.
So, what do governments and individuals do? They heed the signals from the interest rates and spend. Only it turns out that the signals were false. The signals were like faulty traffic lights stuck on green in all directions.
Investors were happy to drive through them and luckily they missed the carnage. But eventually their luck ran out and they’ve run head on into a semi-trailer.
Which is what makes headlines such as this sent in by Money Morning reader Karl all the more worrying: “Lifting rates will not stem rising market.”
The article opens with, “SOMEWHERE amid the fuzzy logic that drives the Reserve Bank’s interest rate policy is the notion we have a housing price bubble and that raising interest rates will deflate it.”
Sadly, in the short term the writer Terry Ryder is probably right. For a time investors and people will ignore higher interest rates because they assume it to be a sign of a positive economy. But taking that attitude is no different to what’s happened to the Greeks.
Whichever way you look at it, it’s a manipulation of interest rates. And despite the fact that interest rates are rising you shouldn’t forget that they are being kept much lower than the free market would otherwise have set them.
Rising interest rates should mean that it’s time to stop spending and it’s time to save. However, because of the entrenched idea that rising interest rates means a positive economy, individuals have been brainwashed by the mainstream commentators into believing that higher interest rates is also a good time to borrow and spend.
But don’t forget, despite Australian interest rates being higher than the official cash rate in other economies, they are still being kept artificially low.
And because the Reserve Bank of Australia (RBA) is keeping rates low, it’s masking asset bubbles and convincing investors and individuals that more can be borrowed – especially as rates are below ‘normal.’
Just as the Greeks were convinced to borrow more when their interest rates were kept artificially low.
The five-year chart above provides a perfect example of how a bubble can only be suppressed for so long before it eventually bursts.
It may not look like a bubble bursting because the chart shows the yield going up. But just remember, the higher the yield the higher the risk. And also remember that bond prices react inversely to bond yields.
So if you were to see the price of bonds as opposed to the yield it would look something like what we’ve magically created using the expensive software package known as – hehem – Microsoft Paint:
You can see the bubble being artificially expanded by low interest rates, reaching a crescendo in late 2009.
But then the market reached a tipping point if you like. Investor psychology took over. It begins where one by one investors start to dislike the risk profile of a particular asset class.
Eventually one by one becomes ten by ten, then one hundred by one hundred, until the flood of investors exiting an asset is unstoppable.
You’ve seen that for yourself in the stock market.
And now you’re seeing it with Greek government bonds.
There’s no reason why this can’t and won’t happen in the UK, the US, or more troublingly in China.
And there’s absolutely no reason why it won’t happen to Australia’s asset bubbles either.
Cheers,
Kris.
^ Banana
* Coconut tree
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GB.. do you really think that this wasn’t “planned” and that it was a random act that was purely due to the foolish behaviour of the Greeks?
That no one stood to gain from their demise? Do you seriously feel that the culprits who orchestrated all this care less about what currency they destroy? To see the opportunity to make billions and say NO just due to their good conscience?
http://www.youtube.com/watch?v=deDDwBj0ZlQ&feature=youtube_gdata
Is it just me, or is there a trend. I used to listed to the gold price being reported at the end of the news on the radio. Now, this last two weeks or so I hear all the financials, including Oil, but not gold?
Enjoy our conversations while we can folks. First they take our guns, then our wealth, and now our freedom to talk about it.
http://www.youtube.com/watch?v=NkeXJ11geas&feature=youtube_gdata
GB – Greed has always been part of the picture, from corrupt, greedy politicians who signed up their nations to unpayable debts, to German, Swiss, French and Austrian banks who loaded up small and vulnerable economies with debt, to Goldman Sachs, who secretly aided these corrupt politicians to hide the mounting debt burden from the ECB and the people. Indeed, the blame extends even to German and other policy makers who were willing to include weak economies in the monetary union, while imposing debilitating conditions on them, so that they had become little more than consumers of German and generally Western European exports.
For example, in countries like Hungary, the EU would subsidise people to destroy their vinyards, and commit not to replant that parcel of land with grape vines for a minimum of 50 years. This sort of policy is aimed at destroying one of the viable export industries in an already vulnerable economy, so that it will pose no competition to Western European producers. I could go on, but the point about greed and fraud have been well made now even in the MSM.
Nick @ 19
Yes I am still leaning toward insanity and stupidity over a ‘planned’ attack but of course not ruling out the planned attack theory.
From the link all I got was Wall Street bankers are immoral unethical greedy buggers out to make a quick buck no matter who gets hurt. Thats not motive to destroy a country thats motive to line your pocket with gold, i.e. greed!!!
Nick, “they” can try to censor the Internet, but these attempts are bound to fail, providing “we” are not complete idiots.
You can easily and legally bypass filtering in China and will be able to do so in Australia. Technically, there are myriad ways to bypass them, undetected. If one legislates to make them all illegal, it is a nightmare to police and a magnet for young hackers to break.
There is still no reliable way to stop virus makers. Stopping firewall bypasses is much harder.
cb @ 22
When I worked in Bulgaria a few years ago the EU gave them a huge amount of money to buy new farming equipment to increase productivity. They went out and bought second hand equipment and pocketed the rest. They were also given a large pot of cash to upgrade the roads – when I left they hadn’t done much.
Using your theory then the following must be true. Western European countries gave Bulgaria billions of dollars which was meant to increase the productivity of their countries but secretly they gave them the money to make the Bulgarian politicians rich.
GB – I have been following the likes of Keiser, Celente, Faber, GATA, etc., for quite some time, and they all make the points you emphasise about people everywhere being drunk on debt. So, there is no disagreement there. The only difference is that some of these analysts go further and talk about the debt pushers, the way they have been using debt to entrap individuals and entire nations, and making big money both through the good times while debt was flowing and money was plentiful, and then when they decided to push them over, and burn down their houses so that they could also cash in big time on their scam CDOs and similar, insurance-like shorts they have invented, and looting the mutual funds and pension funds in the process, who were dumb enough to take the other side of those trades.
Seriously, if you want to understand how their scams work, and why Goldman Sachs is now being charged with fraud, you would need to listen more to the likes of Keiser and Celente. Otherwise, like Sayce, you are getting only half of the story. You only see the druggies, and the devastated families who are on the receiving end of the drug trade, and not the dealers and pushers, and the corrupt cops and politicians behind the trade. That is a fairly good analogy, actually.
Nick – I sat through the Crash of 29 link you offered. Most of it I knew some of it not. In any case I would now call on anyone to not pick the similarities but the differences. It’s all about people, always has been. We can now go to great lengths to complicate finances, credit and funding products and accounting theories and methods but ultimately it’s all about the good and bad people do. Unfortunately as a species we are predisposed to being bad.
GB – I would much appreciate your comments on this “Does Germany now possess the perfect hedge?” “Are they in a WIN-WIN position.
GB – I do not follow that reasoning, and dare hope that it does not follow from anything I have said. Vulnerable countries have been exploited and set up by the dominant ones within the Eurozone. There is no question that it has been a predatory relationship, resulting ultimately in unpayable debts and perpetual enslavement through it.
Greed has been the principal motive, debt has been the main instrument, with generous sprinklings of shady dealings and corruption along the way. The net result is widespread enslavement and impoverishment of entire economies and masses of people into perpetuity. The rest is small detail, which interesting and important to understand, but which, on its own, will never explain the most important aspects of what is going on.
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