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Germany in the firing line as Greek default nears

Financial Events
By Paul Hodges on 12-Jan-2012

JUUGS Jan12.pngInterest rates are key to the direction of the global economy.

But not in the way that was true during the 1982-2007 economic SuperCycle. Then, there was a global surplus of savings, due to the vast numbers of people in the Wealth Creating 25 – 54 age group.

So interest rates reduced dramatically in most countries, with the USA leading the way. Its 10 year government bond rates reduced from 15% in 1982 to just 5% by 2007.

Today’s market is increasingly dominated by the New Old generation of people aged 55+. As one would expect, older people are more concerned about security rather than growth. They value ‘return of capital’ more than ‘return on capital.

Thus a new UK investor survey reports that “protecting the value of existing assets” was the main priority. In turn, this means that investors are very nervous about markets where governments are borrowing too much, and have no plan to repay their debts.

This is why investors now prefer the JUUGS (Japan, USA, UK, Germany, Switzerland) to the PIIGS (Portugal, Ireland, Italy, Greece, Spain). The chart above updates the position since the blog first launched the concept (today’s interest rates = red line; August 2011 = blue column) :

• In August 2010, rates in the PIIGS averaged 5.9%: now they are 14.5%
• Rates in the JUUGS were 2.05%, now they are 1.5%

These demographically-driven changes have confused even the world’s largest bond investors, PIMCO, who suffered a rare year of major under-performance in 2011. They worried (rightly, of course) about the rising level of debt in some of the JUUGS – but failed for a while to realise this was not investors’ primary concern.

The key question at the start of 2012 is what happens next in the Eurozone. As the chart shows, Greece’s interest rate has gone ‘off the chart’ at 38%. And now, the real threat is contagion to Germany. As the Financial Times warns:

“If the euro stays together, it will only be because Germany pays, one way or another – hurting their bonds. If the euro breaks down…German finances would be trashed by the need to rescue its banks”.

Nobody knows how this very serious situation may play out.

We can all hope for good sense and wise policy to prevail. But hope is not a strategy, and can easily turn into wishful thinking. The blog will continue to keep a very close eye on developments.