Compare and contrast

Michael Burke06/09/2010

Michael Burke: The yield on Irish 10-year government debt climbed to 5.7% by close of trading on Friday. This is shown in the chart here. This is back close to the high of 5.85% last seen before the multilateral €750bn bailout of European banks last seen in May. That bailout had the effect of temporarily pushing yields sharply lower- interest on Irish 10yr debt fell then by nearly a 1% as the immediate risk of debt default seemed to have been averted. The resurgence in interest rate costs implies the perceived risk of default has risen once more, back towards its peak.

The yield spread over Germany has widened to 350bps (or 3.5%). Other Euro Area borrowers who can still access the markets have also seen their yields rise and spreads widen; Italy (140bps over Germany), Spain (170bps), and Portugal (330bps). But none has quite the yield premium over Germany of Irish government debt. Only Greece, which cannot borrow in the market, has a higher 10yr yield premium (920bps).

These interest rates ultimately reflect the likely costs of sovereign borrowing in the market. As such, irrespective of any action by the credit ratigs' agencies, they are determined by the average market perception of the creditworthiness of the borrower.

A Wall Street Journal article earlier this year commending the government's austerity policies received much attention. It relied heavily on the fact that Spanish short-term yields were higher than Ireland's, although this is more an indicator of immediate default risk than ultimate creditworthiness. But Irish 2yr yields have since risen sharply and, despite a modest recent retreat, now stand at 3.25%. By comparison, 2yr yields in Spain are currently 2%. This indicates that both Ireland's creditworthiness is seen as lower and its risk of default is higher than that of Spain.

Supporters of the austerity policy have persistently claimed that there is no alternative; to do otherwise would cause yields to rise intolerably higher and increase the risk of being shut out of financial markets altogether. But it is the austerity policy, combined with repeated bank bailouts, that have created just such a situation. The policy has clearly failed, not least because tax revenues have not revived.

By contrast, in countries such as France, the budget deficit has fallen because tax receipts have revived by €60bn in the latest 3 months compared to a year ago. This reflects the prior stimulus measures the government had adopted. A similar pattern is evident in all the countries that adopted stimulus measures, as tax revenues have revived. In Germany, combined Laender and Federal tax revenues are up 2.1% in 2010 to data compared to the same months in 2009, which the Finance Ministry attributes to the prior government spending programme. Of course, all these government now have 10yr yields below 3% - fraction of Irish yields.

The mantra of the second-rate bookkeeper, that 'we can't afford a stimulus package' is the opposite of reality. The proof (negative in Ireland's case) arises from those countries that did adopt these measures; growth has resumed, taxes revived, yields lowered and the deficit has not widened with stimulus measures, it has narrowed.

Posted in: Fiscal policyFiscal policy

Tagged with: stimulusgovernment bonds



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