The billion euro trick

By Flossbach

One cannot blame the finance ministers for gratefully accepting the massive interest savings. Nevertheless, revenues that future taxpayers are actually entitled to are also being used in the process. If this inter-temporal redistribution (the older generation receives and the young generation pays) was performed by companies, it would be considered accounting fraud aimed at making current earnings look better to the detriment of future periods.

This is how the billion euro trick works: if a zero coupon bond is issued with a market yield less than zero, the issue price of the bond has to be greater than par value, for example 104 for a five-year bond with an issuing yield of minus 0.8 per cent. At maturity, however, only the nominal value of 100 has to be repaid. The German Minister of Finance records the difference of four per cent as profit for the federal government that flows directly into the current budget. The Federal Republic of Germany has collected around EUR 25 billion in profits from bond issues in this way since 2013. It will likely be EUR 7.5 billion in 2019 alone.

The effects are negligible for short-maturity bonds. It leaves a bad aftertaste, however, when long-maturity bonds that were still being issued with comparatively high coupons years ago are issued at prices far above par value and the large profits generated by the issues flow into the current government budget. A particularly stark example is given by the issue of a 30-year bond that was previously issued in 2014 with a generous coupon of 2.5 per cent. The yield was only 0.26 per cent when the bond was issued on 19 June and the bond had a correspondingly high price of 158.80. The federal government therefore received EUR 1.588 billion for issuing a bond with a par value of EUR 1 billion. The German Minister of Finance was able to immediately allocate the resulting issuing profit of EUR 588 million to the current budget. Taxpayers, however, have to pay the relatively high coupon of 2.5 per cent for 27 years. Although this is not illegal, it is not particularly fair to future generations. The issuing profits should be placed in a reserve instead and released in 27 annual installments of EUR 21.8 million until 2046 for the benefit of future budgets and taxpayers.

This trick is also popular in other eurozone countries. In September, for example, Spain issued a bond maturing in 2066 with a generous coupon of 3.45 per cent at a price of 168, allowing it to collect issuing profits of EUR 675 million. Italy issued a 30-year bond paying 3.85 per cent to generate an issuing profit of EUR 603 million. This profit also went directly into the current government budget, thereby burdening an entire generation with unnecessarily high coupon payments.

And the game goes on. Regardless of existing zero coupon bonds, the Federal Republic of Germany will issue a 30-year bond with a coupon of 1.25 per cent and a par value of EUR one billion on 16 October. The current price is 137, which means the Minister of Finance will likely collect further profits of EUR 370 million to add to the budget. In the interests of our children, we can only hope that issuing profits will one day also be allocated in a generationally fair way in Germany, Italy and Spain as is already the case in some EU countries such as Austria.