New Greek bond says more about Germany than Greece

Stock Exchange displays show stock price movements in Athens, Greece.
Milos Bicanski/Getty Images
Stock Exchange displays show stock price movements in Athens, Greece.

The Greek government floated 3 billion euros worth of 5-year bonds at 4.95 percent on Thursday. While some may argue that this signals Greece is coming back, Europe is coming back, and the Eurozone crisis is finally over none of it is true.

Greece's auction signals two things: greed is outweighing fear in the market; countries with current account surpluses have to recycle that money somehow.

While there were gasps at the low rate at which Greece was able to borrow, it still isn't low enough; the cost of Greece's debt is still greater than its growth. As things currently stand, the country will not be able to repay its debts and a crisis – or a bailout – will have to occur again at some point in the future. (That's not to say things theoretically couldn't improve enough to put Greece on a sustainable footing, just that it's not there yet.)

The reason a crisis seems inevitable to me can be found in the following formula, which defines the necessary condition for the solvency of a country:

S ≥ (r-g)*D


S = the primary budget deficit (the country's budget deficit or surplus before interest payments)

r = the nominal interest rate on the government debt

g = the nominal growth rate of the economy

D = the government's debt/gross domestic product (GDP) ratio

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The right-hand side of the equation takes the starting point, the country's debt/GDP ratio, and multiplies it by the difference between the country's interest payments and its growth rate. That gives us the incremental increase in its debt every year. If the country's interest rate is higher than its growth rate, then r minus g will be positive and the debt burden will grow as a percent of GDP. If on the other hand the country is growing at a faster rate than its debt costs, then r minus g will be negative and the total debt will gradually fall.

The left-hand side is the primary budget surplus or deficit (as a percent of GDP) that the government has to run in order to prevent the debt from growing. Otherwise, the country's debt burden will grow and grow and grow in a "snowball" effect. Interest costs will rise faster than the government can raise revenues. Eventually, the interest-on-interest that the country will have to pay will cause the budget to collapse.

There are only three ways a country can dig itself out of this hole: run a large primary budget surplus; grow very rapidly; or have very low interest rates.

What's the case for Europe nowadays? Here's the result of r minus g for a number of European countries:

As you can see, Germany is OK and Portugal is nearly there but the other peripheral countries are still in trouble, Greece being #1 among them.

Greece borrowed Thursday at 4.95 percent and the International Monetary Fund (IMF) forecasts its nominal growth this year to be 0.2 percent. (Note that the economy shrank by around 5 percent last year, so 0.2 percent growth wouldn't be bad by comparison.) The debt/GDP ratio is forecast to be 174 percent.

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Plugging those numbers into the above formula, it turns out that Greece has to run a primary budget surplus of 8.3 percent of GDP in order to prevent debt from snowballing. Unfortunately the IMF predicts it will run a primary surplus of only 1.5 percent this year. Even using the IMF's "cyclically adjusted primary balance" of 5.9 percent of GDP, Greece is still just digging itself deeper into a hole.

In fact, I would argue that Greece's bond issue reflects more on the state of Germany's economy than it does on Greece.

Germany last year ran a current account surplus of 201 billion euros, or 7.5 percent of GDP, and this year is forecast to run a surplus of 6.8 percent of GDP. Its trade surplus with the rest of the EU runs some 50 billion euros a year. It has to recycle that money somehow. I think the fact that Greece can issue bonds at all demonstrates the unbreakable links between a country's current account and its capital account. A country with a current account surplus has to run a capital account deficit; that is, it has to export capital.

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Investors must be hoping either that the snowball can grow for at least another five years before it gets too big to roll further, or that they will have moved on to another job before the snowball finally stops.

The author is the Global Head of FX Strategy at IronFX Global, an on-line trading firm specializing in Forex, CFDs on U.S. and U.K. stocks, and commodities. He was previously Head of the Forex Committee at Deutsche Bank Private Wealth Management.