With so many well flagged problems facing the country attempts by the new government to strike the right balance in this emergency budget was always going to be interesting.

Our initial thoughts are as follows:

Unsurprisingly the Chancellor emphasised the scale of the budget deficit and the worries of the international capital markets. It did not make easy listening but it was refreshing to see a politician telling the truth, however uncomfortable..

Following the last G20 meeting, where surplus countries were asked to spend more and deficit countries (like us) were asked to save more, the government is aiming to reach a balanced budget by the end of this Parliament. The question was how this would be achieved?

George Osbourne’s goal is that 77% of the deficit reduction will come from reducing public spending, with 23% coming from higher taxes.

Unsurprisingly the Chancellor told us that we will not be joining the Euro during this Parliament. As Prometheus is less than convinced the Euro will be in its current form in five years time this makes more sense than ever!

Pleasingly the Chancellor has recognised the importance of maintaining reasonable capital investment, which is clearly necessary, and will support jobs in both the public and private sectors. This was reflected later in the speech when infrastructure projects round the country, such as extensions to the Manchester Metro, system were discussed

As already disclosed health and overseas aid will be ring fenced but on average other departments will have to reduce expenditure by 25%. Part of this is coming from pay and pension. As the Chancellor points out the public sector has been protected from the hardship of the private sector during the recession. Now the axe falls. There is to 2 year pay freeze across the public sector (apart from the lower paid who will have a small fixed increase), while the public sector pensions will be independently reviewed. The retirement age will also be raised to 66 years of age.

With the welfare system becoming a massive burden on the state the system is to be revised to encourage people back to work (has been tried before, will be interesting to see how it works). Welfare payments will be linked to CPI, not RPI, as this is the Bank of England target inflation rate. This will save a lot of money, although it was a bit cheeky to suggest this is fairer as it will result in smaller increases.

There will be targeted reductions in universal benefits particularly those paid to the higher earners. There will be new assessment for medical disability and housing benefits will be reviewed and reformed.

Reforming National Insurance is seen as key and will actually be reduced for the lower paid to encourage new employment. Combined with schemes to support employment outside the South East, where private sector growth has been poor, this should be a welcome shot in the arm.

Corporation Tax will be reduced by 1% per annum, from 28%, down to 24% at the end of Parliament to try and draw in international businesses. Small companies’ tax will be reduced from 22% to 20% and a number of other measures will be introduced. This will benefit growth but will reduce the tax take. Rules on depreciation tax relief will help offset this although these look like they will be phased in.

Unsurprisingly the banks are not going to benefit from the lower corporation tax rates and they will be hit. The government is working with the IMF and international partners, but from January next year there will be bank balance sheet levies in place (with apparently the French and Germans agreeing to follow a similar plan).

Overall this was pleasingly pro-business, recognising that this is the key to growth.

Now the 23% of the deficit that comes from tax changes.

From 4^th January 2011 the main rate of VAT will be raised to 20% (no surprise really). This is expected to raise an additional £13Bn per annum. Zero rated items like food and children’s clothing will remain.

For the moment there will be no increases in the duties announced in the last budget, but there will be a root and branch review of certain duties, such as fuel and alcohol reporting in the Autumn.

As expected CGT was increased; but basic rate payers will still pay 18%, but higher rate payers will pay 28% from tomorrow, although the exemption remains at £10,100. How this will be applied, with a change two and a half months into the tax year remains unclear and we await more detailed analysis.

CGT for entrepreneurs will remain at 10%, with the lifetime lifted from £2Mn to £5Mn. There will be no return of complex taper relief or indexation.

Income Tax faces reform with an increase the personal allowance by £1,000, up to £7,475, with the goal of setting the figure at £10,000 by the end of the Parliament, with the goal of supporting the lower paid. Higher rate payers however will effectively pay more as for the moment the thresholds remain frozen, so in real terms more will find themselves paying higher rate tax.

Pensioners at least will benefit, with a link to earnings being restored and a guaranteed rise of 2.5% per annum being targeted, regardless of average earnings or inflation figures (should they be under the 2.5% level).

Overall not as harsh as feared but we are sure there will be plenty more detail that comes out in the wash in the coming days

After a period where the fraught markets rather commanded attention Prometheus has had time to reflect upon events and hopes to provide some useful thoughts as we approach the first budget of the new government with a mix of curiosity and concern.

Monday’s report from the new independent Office of Budget Responsibility (OBR) brought some relief because while it indicated that the deficit was going to remain elevated for some time, the figures were a little less scary than we had seen before. Furthermore this was in conjunction with future growth estimates that are somewhat more realistic than those of the previous administration, although to be fair they are still at the optimistic range of projections.

If these figures are correct, however, it means that we may bring things under control a little earlier than predicted, and hopefully with a little less pain, particularly if the private sector can pick up the growth baton as the public sector suffers under the weight of the inevitable cutbacks.

This is not to say we will avoid pain. That unfortunately is inevitable after the years of excess; however at least, all other things being equal, we have a reasonable chance now of avoiding a double-dip or worse. However we are in a truly global economy and in our weakened state we remain extremely vulnerable to external risks, and unfortunately all other things are unlikely to remain equal.

We have covered many times before the problems confronting the Eurozone: that the politicians are burying their heads in the sand and that the maths no longer works. The very fact that we are told by Euro’ heads that the breakup of the Eurozone is inconceivable says it all. They are inevitably, totally, irretrievably wrong. It is perfectly conceivable. I’m doing it right now.

China meanwhile is facing testing times, with growing discontent forcing big wage increases across the country. This will add to the building inflationary pressures that have caused the government to withdraw much of the recent stimulus. This may seem inconsequential when underlying growth rates remain well above anything we can hope to see but with so much development based upon cheap funny money a property and general asset collapse remains a real risk. While this would not de-rail the long term story there may be consequences elsewhere, particularly among mining stocks.

Whatever happens to China it is important to remember that while it is growing rapidly it is still much smaller than the Eurozone or US economies. With Europe stuck in the slow lane the progress of the US becomes all the more important to the extent that we have discovered that a leading Asian fund manager currently spends much of his time analysing fundamental US data, such is its import to global growth. Again, however, the picture remains unclear.

On the positive side there seems to be evidence of a steady, self fulfilling recovery in activity, building confidence which in turn encourages more activity. It is to be hoped this continues and on balance this may well be the case; however there are a number of issues that still trouble. Firstly the trend in increasing employment appears to have stalled, with the May non-farm payroll figures very weak after the subtraction of new part-time census jobs. Likewise consumer spending has hiccupped and there are increasing fears that markets will eventually revisit the US budget deficit, which is comparable to our own. Perhaps the most worrying indicator however is the following chart on the money supply in the US (using the broad figure of MZM, which is similar to the M3 measure we would use in the UK), which despite the unprecedented stimulus thrown at the economy, is deeper into negative territory than at any time over the past ten years.

 (Unfortunately due to a technical problem the chart is not currently displaying, but trust us, it looks bad)

In an economy trying to reflate into a recovery this is a worrying indicator that is garnering little attention. With so much riding on the US recovery perhaps Prometheus will shift focus a little bit as we watch events unfold, although Eurozone politicians will undoubtedly soon make fresh contributions for our amusement and horror.

A reminder not to pay too much attention to the opinions of those in authority:

During the Battle of Spotsylvania in the American Civil War Union commander General Sedgewick looked over the parapet at distant Confederate snipers and said “They couldn’t hit an elephant at this dist...”

During the fictional “Great Moderation”, which was actually the “Great Delusional Bubble”, the apparent stability of financial markets and the underlying economy made it easy to dismiss the nay-sayers against the consensus. However the world we find ourselves in a few years later continues to confound, surprise and disappoint in equal measure and after analysing a broad range of economic and market views it is a little troubling at the moment to see all the big hitters who went against the consensus and called the downturn right are, almost to a man, starting to get very concerned (from simply troubled) again. As somebody who has followed them in the days they were ridiculed Prometheus takes these people’s views very seriously but we will leave an examination of specific thoughts for another day. There is more than enough going on right now to occupy our minds.

Yesterday's inflation figures were certainly an unwelcome surprise, although the VAT changes and weak sterling were bound to have some impact. Nonetheless the size of the increase was unsettling. The common theory over the recent spike is that it has been led by “cost push”, rather than “demand pull” inflation. In short this is not an overheating economy, just one facing external pressures. Certainly as the currency stabilises, or strengthens, and if commodity prices possibly weaken in the face of slowing global demand (or less speculative demand) inflationary pressure should subside. However if it doesn't this does ask some awkward questions of BoE interest rate policies and we may see a rate hike sooner rather than later. Of particular concern was seeing car insurance rising by around a quarter, which in a competitive market should not be happening. It raises the question of semi-cartel pricing in certain industries whose products may be considered necessities as industries try to claw back profits lost in other operations.

Persistent inflation does have one benefit, however, in that it erodes the relative value of your debt. This may ultimately become a creeping fear of financial markets if UK inflation remains high; however from our point of view we are the best positioned to allow this to happen. This is because (as we have mentioned a few times before, it is important) we have the longest debt maturity timetable of all developed nations at about 13.5 years (as opposed to 4-7 years elsewhere; indeed the US has to roll over about 40% of its massive debt over the next couple of years). The reason that this is so useful is that if markets begin to believe inflation is growing in a nation then they will demand a higher yield on that nation’s debt, driving up borrowing costs ever higher, replacing a possible deflationary spiral with an inflationary one. As such the common notion that a country can simply inflate away its debt burden doesn't work as advertised as it has to refinance its debt at higher rates. However we have a window where we could get away with it for a while before it becomes crippling. This is not a policy we would advocate but it gives us some wriggle room.

The sad truth is the Western world is facing a real tightrope between deflation and inflation with massive risks on either side, and meddling ideas like the sudden German ban on short selling will not help deal with the fundamental problems. Incidentally a very sound point Mervyn King made at his conference last week was that the markets which Eurozone governments are now up in arms about are the very ones which have been funding their fiscal incontinence for years. So it is a little bit rich to complain when they suddenly start doing the maths and realise things don't add up. Indeed to Prometheus the surprise is that the markets were so generous, sorry I meant astonishingly complacent, for so long.

One bit of good(ish) news is that the Greek bail-out package has achieved its first success, supporting the roll-over of € billions of debt that had threatened to bankrupt the country. Apparently the market stayed away, meaning the EU now owns lots of debt that it will have to take a haircut on at some point (meaning billions thrown away) but at least the immediate crisis is averted, as planned.

Looking at our own problems the new coalition government continues to throw up surprises that please the optimist, the most notable being the new Chief Secretary to the Treasury, the Liberal Democrat David Laws. Looking into his past this man received a Double First in Economics from Cambridge and rapidly rose up through JP Morgan’s ranks before becoming Head of US and UK Treasuries at BZW (the forerunner to Barclays Capital) before retiring before his 30th birthday. It is this last job that is a key point because it means Mr Laws was on the very coalface of the dreaded sovereign bond markets and I doubt he took Liam Byrne's jokey letter “I'm afraid there's no money - good luck” very well. This man now understands where we are. This is good. This is very good. Not often can we say that these days.

And finally, just to prove Angela Merkel only wants markets that will accept Europe’s debt addiction unthinkingly (which they have, quietly and stupidly for years) the following quote says it all:

"The lack of rules and limits can make behaviour in financial markets driven purely by the profit motive destructive and lead to an existential threat to financial stability in Europe and even the world. The market alone won't correct these mistakes."

She doesn’t get that the mistake was to act like sheep to the rhetoric of ignorant politicians for years, not to react in panic when their plans start to crumble.

No, not the new Morecambe & Wise of Politics, it’s “Behind the curve Merv” as I may have, well did, call him in the past; showing that perhaps he really isn’t so far adrift. Amazing what happens when the Governor of an independent Bank of England genuinely feels independent of political control.

In his press conference on Wednesday he raised a number of key points, which also draw the spotlight onto other events this busy week. The issue of our own fiscal deficit and growing national debt was raised: “It is the single most pressing problem facing the United Kingdom; it will take a full parliament to deal with and it is very important that measures are taken straight away to demonstrate the seriousness and the credibility of the commitment to dealing with that deficit.”

This clear statement (and I’m sure recent events in Greece) made it much easier for the new coalition government to get straight down to business on the deficit reduction, although from watching the news I am still less than convinced that some in the government get it.

Still, listening to Radio 4 on Wednesday morning comments from William Hague on the rapport struck between negotiators from the two parties started to provide a little hope that partisan rubbish might be put aside for a while. This hope was reinforced by seeing the leaders working well together in front of the press. Prometheus generally avoids discussing politics (not to avoid upsetting various sensibilities, just a general dislike of the species) but it is worthy of a paragraph this week. Anyway, back to Merv’ and the co-ordinated Greek bailout package that was announced on Monday.

“I do not want to comment on a particular measure by a particular country, but I do want to suggest that within the Euro Area it’s become very clear that there is some need for a fiscal union to make the Monetary Union work.” Well that has always been obvious to the sceptics. No sorry that’s wrong, not sceptics, those that didn’t buy into the idealistic nonsense, understood economics and had an eye for history. Still the optimism engendered by the bail-out effort (which ultimately WON’T WORK without debt restructuring/default and will throw good money after bad and result in even more debt being generated) appeared in even the most surprising corner.

On Wednesday the highly respected Martin Wolf wrote in the FT that the EU appeared to have accepted that to avoid the massive chaos of default, and the exit of a member from the Euro, that the inevitability of some central fiscal control had dawned as the alternative was too awful. Ah, the sad belief in human rationality. Gets you every time! The EU apparatchiks may happily try to enforce what would effectively be a single unelected government, but the populous at large, as they struggle under renewed recession, may have other ideas. See how the Spanish opposition is already angrily talking of Spain being a European “protectorate”. Niall Ferguson, writing in Newsweek (before the bailout announcement) headlined his article “The Death of the Euro”, which may be going too far but tough times are ahead.

The problem is that the rescue simply buys time at the expense of raising funds from other indebted countries to finance the debt of even more indebted countries. Genius. Economic restraint alone in Greece will not save it from having to restructure its debt eventually, with all the knock-on consequences and pain across the global banking system. Ireland after all is busy doing the right things and its deficit still grows because the cuts hit GDP, which lowers tax receipts, which offsets the spending cuts, so more spending has to be cut, which ....you see where this goes. There is a slim chance Ireland can work its way out of this hole, particularly if global growth picks up, but don’t place any bets.

The bigger picture across the Eurozone looks tricky and frankly adding more debt won’t help. Worse the sudden removal of planned tax cuts in Germany, that could stimulate their internal demand, that are having to be made to pay for the debts generated by the rescue package, will suppress domestic spending and add to the deflationary pressure facing the continent. And if that wasn’t enough the most positive element of the rescue package, a form of ECB QE, is likely to remain watered down under German anti-inflation pressures. Looking past the optimism of recent days (even very poor rebound EU growth figures were received with joy) it is hard to see how things won’t ultimately get a lot worse for the Eurozone, and that is bad news for us as we face years of austerity while they remain our main trading partner.

In place of an “and finally”, below is a quote from an economist for whom we have a great deal of respect and who fears German led ECB policy is likely to lead to depression: “The British tradition within which we work allows us to be quite rude about public figures, more so than is normal on the continent or in the US. But to describe accurately the conduct and mental abilities of German policy makers over the past decade would even exceed my limits. Anybody who thinks that either Europe or Germany requires fiscal deflation as a response to recent events needs a brain transplant.”

And if you need a real chortle read the deluded pro-Euro piece by Tommaso Padoa-Schioppa in today’s FT for it almost defines political LSD.

A short note today; as you may imagine life is quite busy at the moment as markets tank, with traders de-risking their books for the weekend and the inter-bank market wobbling.

First up is the good news from the US as the benchmark non-farm payrolls showed job growth of 290K in April, well above market expectations and hopefully pointing the way to self sustaining recovery. Although before we get too excited it is worth pointing out that the headline unemployment figure is actually up to 9.9% from 9.7% in March.

Now the bad news, because being correct about unfortunate issues is rarely satisfying; however, at least we now believe that the market is starting to get it. More and more commentators are stepping forward and pointing out that Greece will have to default on or restructure its debt as the current position is unsustainable. The current rescue package (ironically just approved in the German Parliament) would leave Greece with Debt to GDP at 140/150%. The idea is that robust growth will then help them balance the books. Really, how? When Latvia tried something similar growth just dried up after all the cuts they had to make to balance the books, and as for Greece the market for olive oil is only so big.

To be fair we have just had a meeting with the chief strategist at a major international fund management group and he believes the problems are rationally solvable and will be. And while we agree with the first point we are very sceptical on the second, we just don’t have much faith in human rationality in the face of crisis.

Anyway, a recent note from New York scares us as it points out that Spanish Cajas (think building societies) has outstanding loans to property developers worth 23% of Spanish GDP, held at book value. In light of the Spanish property crash, if that was written down by 50%, that is 11.5% of GDP. As I said, scary.

Finally the UK election: a hung Parliament is the result. How this will feed through to policy is now completely open and the pound and UK government debt have been sold down as a result. This is not the outcome we needed when capital markets are facing the possibility of seizing up.

In the meantime the FTSE 100 has been oscillating between flat and about 200 points lower as the bears fight the bargain hunters. We are not sure who will win but some of those bears look mighty grizzly.

(*The Random House definition of the phrase “Nero fiddled while Rome burned” is: heedless and irresponsible behaviour in the midst of a crisis.)

Well, this is getting interesting, and Greece is finally starting to garner the headlines it deserves. Now the yield on Greek bonds with 2 year maturities has risen to just short of 20% (UK 2 year bonds yield around 1.4%), indicating that the market is now anticipating a restructuring of Greek debt. Whether this happens or not is still uncertain but this afternoon we hear that the German government will seek parliamentary approval for aid to Greece of up to €8.4 Bln in 2010, and for an unspecified amount for 2011 and 2012, according to a draft bill.  However what is clear is that the EU/IMF “rescue package” of €45 Bln, if ever implemented, is not enough as it does not begin to cover the refinancing needed over the next two years and was only supposed to be three years in duration, creating another refinancing issue. However, IMF Managing Director Dominique Strauss-Kahn has been cited on German TV saying that the cost of saving Greece could be as much as €120 billion. If so it asks some very awkward questions about the Eurozone and whether these funds will be genuinely forthcoming in light of the fiscal position of other EU nations.

Put simply, if you look at the most optimistic Greek government figures on debt and deficit reduction they don’t compute without depression. Something has to give and within the legal confines of the EU it is hard to see what. In the meantime a crisis meeting has been pencilled in for May 10^th (conveniently after the German regional elections) but the way things are developing this may be far too late, and is representative of an EU response which almost perfectly defines “heedless and irresponsible behaviour in the midst of a crisis”. Hopefully the stories emerging that we will see an agreement reached this weekend will prove to be correct, although we remain sceptical.

Some Good News

The exposure to Greek debt across the EU banking system is perhaps not quite as bad as thought. France in particular looked very dicey; however reviews of the figures indicate that much of the exposure is actually a result of the two major French banks having subsidiaries in Greece, while German exposure looks manageable in the short term. This at least reduces the risk of a systemic crisis like Lehman’s. However, should other dominoes fall this may change.

And in the US

There are some hopeful indications that the US recovery is becoming self sustaining with April consumer confidence figures beating expectations on the upside, with the number coming in at 57.9, up from 52.3 in March.

This pleased us, and briefly we felt good. Then we looked at a chart, which looks back to the levels since the mid sixties, and, well, were a little depressed to see that 57 is lower than most recessionary bottoms (apart from last years), while boom times go up to 140. It's all about the level. 

(Apologies for not including the chart, apparently Bloomberg charts don't want to work with this blog!) 

 On the upside this low level means that we are unlikely to see the US Fed take a tightening stance this evening (our time), which should keep equity markets reasonably happy as many strategists see the beginning of fed tightening as a key indicator to take profits and reduce equity exposure.

However even after yesterday’s sharp downward movements in share prices, with so much uncertainty around, stock markets continue to look complacent compared with bond markets. Indeed the whole Greek debacle appears to be taking investors’ minds off exactly what it shouldn’t: namely the true implications of fiscal tightening in the developed world. With the high debt growth model of the last decade dead, how can we expect to see robust growth as government spending is cut to the tune of several percentage points of GDP, per annum, across the developed world? Still, that is enough worry for today so we will return to this shortly, perhaps after Thursday’s debate.

This morning we found out how much the UK economy grew during the first quarter of 2010. Analysts’ consensus had been around 0.4%; however, on the day the figure came in at a disappointing 0.2%. Oddly enough rather than being disappointed the market rallied on the back of this news. We assume this is because it had already decided that if the figure were to be too low it would be a false signal and would be revised up anyway (evidence, if any more were needed, that the theory of efficient markets is nonsense. If you expect the figure to be too low and the market to rally in expectation of revisions, the market should rally before any data is released. Still, best not to let logic get in the way of a good theory).

Anyway the market is probably correct; the first release is always based on a limited data set that is extrapolated out, with most of the hard data coming from the beginning of the period, which in this case was marked by the chaos of a real winter. Politically the read across is interesting. If taken at face value, after all the stimulus that’s been thrown at the economy, it continues to beg the question of why DC doesn’t just point at GB and shout “he’s bankrupting us”, whilst also allowing GB to argue that stimulus can’t be removed as the economy is still too weak. On the positive side industrial output is up but this cannot disguise that overall GDP remains more than 5% below its peak in 2008.

Greece

After prevaricating for weeks the Greek government has finally admitted defeat and formally asked for the joint EU/IMF rescue package to be rolled out. If implemented (not a guarantee as court action against it is almost guaranteed within Germany) this at least buys some time as it funds Greece for a year. This had to happen after Greek 2 year bonds were pushed to a yield of 10%, imposing a crippling rate of interest. Already this news has had a positive impact on the US market, with the newswires continuing to take a panglossian view of the world, but so many questions remain unanswered.

For instance, we discovered yesterday that Greece’s deficit was worse than stated after the figures were re-examined, as were Ireland’s, which had a whopping 14.3% deficit last year. This begs the question that with a number of other EU states on the verge of needing rescue, how can these nations contribute to the Greek rescue package? Furthermore, as discussed in a previous entry, by dragging all the states in together we have seen yields on German Bunds increase as the markets start to price in higher risks.

Worse still, after all the grubby allegations surrounding Goldman Sachs, commentary this morning indicates some Greek banks and other market counterparties were buying Greek debt aggressively prior to the announcement of the rescue plan, indicating that some may have been tipped off and given time to front run the market. Just rumours at the moment but they may have legs.

In the end most of the fundamental issues discussed in the past have not gone away. Although this step may buy time it feels a bit like a very slow motion version of the desperate attempts of the UK government in 1992 as it tried to stave off the inevitable departure from the ERM and the devaluation of the pound.

And just to make sure we don’t feel too clever watching from the UK, a leading fund manager yesterday announced he had crunched some figures and reckoned that without massive government cuts and radical steps (going further than DC’s idea of increasing the retirement age by a year) the UK will have to begin defaulting on its pension, health and welfare commitments within two decades. Sobering stuff!

And finally....

A little boy wanted £100 badly and prayed for two weeks but nothing happened.
Then he decided to write GOD a letter requesting the £100.
When the postal authorities received the letter addressed to GOD, UK, they decided to send it to Gordon Brown.
The PM was so impressed, touched, and in total agreement, that he instructed his secretary to send the little boy a £5 note.
Gordon thought this would appear to be a lot of money to a little boy.
The little boy was delighted with the £5 and sat down to write a thank you note to GOD, which read:

Dear GOD,
Thank you very much for sending the money, however, I noticed that for some reason you had to send it through Parliament and, as usual, that lot deducted £95!

While I write, a note has come from a major Wall Street office discussing the negative action today on European Bourses. The big negatives: Credit Default Swaps (bond insurance, see earlier blogs for details) on Greek and Portuguese debt blowing out due to growing default worries and an undersubscribed German sovereign bond issue as global appetite falls for all European debt on contagion fears. More on that below, but first the UK.

A busy week for economic data releases, with yesterday’s inflation data coming in above expectations for both CPI and RPI. While today’s unemployment figures were not bad the big test comes at the end of the week when we get the first estimates of 2010 Q1 growth figures. Despite the bad weather there is hope we can post some decent growth (long overdue after such a sharp contraction) however some remain doubtful. If the figures come in on the low side this could point towards the risk of stagflation (stagnant growth with high-ish inflation) which is difficult to deal with as it is tough to raise interest rates to counter inflation when this will kill off anaemic growth.  Thankfully if you strip out autos and fuel from the figures they look less bad, although still far from perfect.

Frankly whoever wins the next election has some impossible choices to make (they’re all lying by the way, or worse, staggeringly ignorant) but stagflation is a gate crasher we really don’t need. Let’s see what Friday brings. Stay posted.

Greece

We continue to be amazed at how little attention this is now getting, with everyone apparently assuming there is a rescue in place, even when the Greek government is wriggling like mad to avoid accepting rescue package MK3 (or is it 4?). All the while protests grow within Greece about the austerity cuts that haven’t even been made yet. Mmmm.

If a bail-out goes ahead (still far from certain) it can only buy time (at great cost both financially and to EU political harmony) and as Wolfgang Munchau wrote in the FT on Monday:  ”The bail-out prevents a default this year, but makes no difference whatsoever to the likelihood of a subsequent default. Just do the maths”. But nobody is paying attention to this, or the implications. A research note found me yesterday, ironically from the New York office of a major German Bank, anticipating that a restructuring was inevitable and more likely than a simple bail-out. It argued well that an organised 50% “hair-cut” was likely and slowly being priced in by markets. While a very credible outlook it still leaves massive question marks about the state of the Euro, the downgrading of other European debt and most importantly European banks.

It is well known that European banks have been far slower than US banks in recognising bad debts and many are thought to be technically insolvent, but it is European banks who will suffer further massive losses if any default/restructuring takes place, which it almost certainly will. Worse the research also indicated that a similar Portuguese debt restructuring was also inevitable and again it is European banks with the most exposure. Yesterday’s IMF report on Global Financial Stability (235 pages of joy for financial geeks) points to slowly reducing bad debts globally, with the caveat those sovereign debt problems could upset the applecart.

And this brings us back to the UK unfortunately as we face a future with no easy answer to our own problems and the fear of a hung parliament starting to weigh heavily on many, indeed the head of a respected economics house said to me yesterday “we are in danger of having the IMF at our door if we aren’t careful”.

And finally...not a joke but some thoughts from FDR, taken from his famous “the only thing we have to fear is fear itself” inauguration speech in 1933:

“Only a foolish optimist can deny the dark realities of the moment...The rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence...Faced by failure of credit they have proposed only the lending of more money...They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish.”

A Greek rescue or simply tragedy delayed. The markets gave a tentative thumbs up to the weekend announcement of a rescue package, although as predicted the word fudge is writ large across the details.

In short the rescue package underpins Greek debt at 5% by offering a lifeline of EU and IMF funds at that rate, although confusion reigns about who stumps up first. If it is the IMF how happy can members be if they can't see any realistic plan for deficit reduction, while devaluation or debt restructuring is off the table. Meanwhile if EU funds are used first there are already rumblings of legal action in Germany as this plan seems to ignore the "no bail out clause" of the constitution. And to be fair you can see why.

As Jennifer Hughes points out in today's FT if there is now an implicit guarantee behind all EU soveriegn debt then you should buy Spanish, Italian and Portuguese debt as it is very cheap. But you should sell German & French debt as it is far too expensive as underpinning the rest of the Eurozone undermines its financial position. You may recall from the last entry this is a problem because both Germany and France have significant deficits (and what is more with a much shorter maturity profile than our own) so this adds a significant burden to them, particularly if they are shouldering the lions share of bailout costs and coping with subdued growth.

In short don't yet count on the bailout working. As we have said before we are playing a new game and the outlook is far from certain, largely because we still don't know the rules.

And finally....

A City bond trader has set up a charity page to raise £100m for Greece. As he says:

"Greece is in a deep financial crisis. Donating here will go a long way to helping these poor people who have lived beyond their means for the last 10 years and are now struggling to pay their bills. Please think of them as they avoid their taxes and then blame evil speculators rather than face up to the fact that lying about their national statistics was probably more of a factor. Please donate in pounds as all euro payments will soon be subject to a 50pc haircut.”

Donations include £15 from someone calling themselves Angela Merkel with the touching comment “Greek swine”.

A certain Anthony Chisnall has promised £10 but only if they stop smashing all their crockery. Mr Turkey said he would donate £10 in return for an island.

Even the British Museum is reported on the site to have stumped up a tenner along with the message: “Have you lost your marbles.”

While the Greek debt crisis continues to garner some headlines there appears to be a growing complacency among commentators (and more worryingly the markets) that all will be right in the end and life can go on as normal.

Well sorry to upset the applecart but that view is utter balderdash as it is becoming increasingly clear that this is a game-changer and whether the ultimate denouement is postponed by fudge for a few years, or comes crashing upon us over the coming weeks, it will not be pleasant and throws a harsh light on our own current situation.

The recent EU-IMF rescue that was heralded by EU politicians is clearly nothing of the sort. At German insistence it only provides funding for Greece at market rates. Well those rates have blown up to between 7% & 8%and if Greece actually reaches the point where it can't get market funding the rates are likely to have gone higher still. Bearing in mind Greece faces deflation to get its fiscal house in order, this could lead to crippling real rates of 10% or more, on debt that is already out of control. Hardly a rescue.

However the alternative to a rescue is inevitable default as not only does Greece have to issue plenty of fresh debt it has a significant amount of existing debt rolling over before the end of May. Some optimists have been saying that at current yields the new dollar issue of between $5-$10 Bln that the Greek Government is hawking across the US will whet the appetite of Emerging Market Debt (EMD) investors. Well although some may step up to the plate (with BCA Research recently suggesting Greek debt looked attractive at those yields) it is hard to see why when you look closely.

Speaking as an actual investor in the asset class one of the key attractions of EMD is not just its high income yield it is the fact that the underlying finances of many of these economies are very strong, completely unlike Greece. To highlight the point lets look at some debt to GDP predictions for 2011 (figures from the OECD and IMF): Japan 204%, Italy 130%, Greece 130%, Ireland 93%, Portugal 97%UK 94%, US 100%, France 88% and just so they don't feel too smug, Germany 85%. Compare these figures to the following regional averages: Asia 41%, Central Europe 29% and Latin America 35% (no really, and that is with Argentina in risk of default again, showing how strong the finances of other nations are). Why would you want Greek debt?

Intervention this weekend?

With things so difficult one UBS analyst says "external intervention may be unavoidable and could happen very soon as the situation is untenable. We think an intervention over the weekend is a distinct possibility". But at what rate and what terms? In an effort to save the Eurozone Germany may bow to pressure and allow financing at 4-4.5% and stave off collapse (ignoring the legal action some Germans are preparing to stop any such move) but this will only delay the inevitable as Greece will not do an Ireland and make the necessary cuts (We would take the just announced 40% deficit cut for the first quarter with a handful of salt. This is the nation that massaged its GDP figures by including the economic impact of money-laundering and prostitution to help gain entry to the Euro). What is more Greek banks are already facing massive difficulties as their rich have withdrawn up to €10Bln since the start of the year (remember this is a country where only 6 people admit to earning €1m+ per annum) and are already receiving government support.

In the short term it is probable that a further fudge will be found but recent talk from Trichet that "default is not an issue for Greece" sounds like talk we heard before the sub-prime collapse, Bear Stearns, Lehman Brothers, AIG, RBS, HBOS and others. Talk is cheap, the fundamentals look horrid and the risks massive, although we will perhaps delve further into the specifics another time.

The stock market? It's up again.