The Tour de Debt

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The epic Tour de France hasn’t got long to go. Tonight, it’s heading up to Galibier-Serre-Chevalier, which, at 2645m, will be the highest finishing point in the Tour’s history.

Then on Friday night, Australian time, the riders endure the last of the mountain stages, finishing at the infamous Alpe-d’Huez. It’s pretty much all down hill from there, with the Tour finishing up on Sunday with a few leisurely laps around central Paris. With a bit of luck, Cadel Evans will taste victory for the first time.

It’s been a gruelling Tour, especially trying to watch live from the other side of the world…

But perhaps it’s not as long and gruelling as Europe’s other great Tour – the Tour de Greek Debt. Europe’s politicians and the bankers that help fund them have been touring the continent for over a year now, trying to find a solution to the region’s problems.

Out in front in the maillot jaune (yellow jersey) is French President Nickolas Sarkozy. He made a dash to Berlin on Wednesday to meet face-to-face with German President, Angela Merkel. The aim, as it’s been for some time now, is to work out just how Greece will be able to default on its debts without it actually being called a default.

An article on the Financial Times website – posted late Wednesday night, British time – suggests a solution, the nth one, may have been found. We’re not holding our breath though. Like all the other solutions, chances are the consequences haven’t been well thought out.

The FT reports that a Greek rescue plan could include:

€71bn (£63bn) in bail-out funds from global lenders and a €50bn tax on eurozone banks, proceeds from which would be used to buy back 20 per cent of Greece’s €350bn in outstanding debt.

‘The proposals, included in a plan circulated by the European Commission ahead of an emergency summit on Thursday, also include a bond exchange programme under which private owners of Greek debt would be encouraged to swap their holdings for new 30-year bonds. The swap plan could reduce Greek debt by an estimated €90bn. It would be offered, with credit sweeteners, to owners of bonds due in the next eight years.’

The French banks must really be up to their necks in all this. Sarkozy is showing more determination that his bike-riding compatriot, Thomas Voeckler, in trying to engineer a default without their being a default.

The FT might have rushed the story, but already the numbers don’t add up. €71bn equates to 20 per cent of Greece’s supposed €350bn debt load. Adding the €50bn from the bank tax would represent 34 per cent of Greek debt.

Anyway, that’s not really the issue.

The problem here, as always, is making the many pay for the irresponsible lending decisions of the few. The only improvement we can see is the acknowledgment of the role ‘the banks’ had to play in all this. The fact it has taken so long it a testament to their power and influence.

Will the rating agencies buy it?

Is debt forgiveness a default? Without debt forgiveness there will be a default so in a way it is. But if the lobby groups work hard enough, they might be able to convince the agencies otherwise.

If you want to know whether the plan is workable, look to the European bond markets over the next weeks. Yields on peripheral country debt have soared recently. Greece, Portugal and Ireland are already locked out of the bond market – their borrowing costs are just too high.

They are currently being sustained by cheaper loans from the IMF. But their existing debt, which is traded on the secondary market, continues to fall in value – in theory inflicting greater losses on the owners of that debt.

In Spain and Italy, borrowing costs have risen precipitously in recent weeks. Check out how much it costs Spain to borrow for ten years.

10-year borrowing costs for Spain

And it’s not much better for Italy…

10-year borrowing costs for Italy

The issue for each country is that when their existing debt matures, they must renew it at these prohibitive levels. The problem is they can’t afford it.

So this latest rescue package is all about getting bond yields across Europe’s periphery back down.

But here’s the question. If this latest Greek rescue gets the OK, won’t Ireland, and probably Portugal too, want some debt forgiveness? Would the banks be willing to agree on another round of taxes?

This latest ‘solution’ will probably calm markets for another few weeks or months. But what it doesn’t do is resolve the issues of economic imbalances, moral hazard and debt being the foundation of our monetary system.

France’s famous bike race will finish early Monday morning our time. Europe’s debt problems will persist for years.

Regards,

Greg Canavan
Daily Reckoning Australia

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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Ross
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Funny how all those blistering climbing accelarations have until now ebbed as the drug allegations have lately started arriving at the doors of the front runners. Go Cadel!

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