From Vulture Funds to 100-year bonds: Has Argentina Turned Around?

Just a couple of years ago Argentina’s left of center government was besieged by foreign investors, the hedge funds known as Vulture Funds, that demanded full payment for their bonds acquired at heavily discounted prices in the secondary markets. The New York courts ruled in favor of the Vulture Funds, and Argentina was unable to borrow in international markets, even though during the successive governments of the late Néstor Kirchner and her wife Cristina Fernández de Kirchner the country had successfully renegotiated its debts with 93 percent of the bondholders, and the economy had recovered from the worst crisis in its history, growing at fast pace while diminishing inequality.

In November 2015, the left of center candidate associated to the Kirchners lost a close election to the center-right, neoliberal ex-mayor of Buenos Aires. Mauricio Macri, the new president, the heir to a private fortune amassed mostly during the last and bloody dictatorship and the ex-president of Boca Juniors, the most popular football team in Argentina, had promised reforms to reignite growth, that stalled in the last few years of Cristina Fernández’s administration, alongside with the slowdown of the global economy, and a collapse of the prices of commodities like soybeans, Argentina’s main export resource.

Macri’s administration devalued the peso, even though he had promised he would not do it during the campaign, promoted fiscal adjustment, eliminated export taxes that had been imposed by the Kirchners that affected the wealthy, and agribusiness interests in the country, and increased tariffs of public services, that were seen as distorting the functioning of markets. These market-friendly policies, were seen as the basis not only of a renewed process of growth, but also the fundamentals for establishing price stability. Yet, the economy stagnated and inflation run out of control.

The reasons are simple. A devaluation is generally both contractionary and inflationary, since a devaluation increases the prices of imported goods, directly affecting prices, and also, by increasing the cost of living it leads to a reduction in real wages. Lower wages, in turn, translate into lower consumption, and reduce demand, which leads to a recession. The increases in tariffs deepened the inflationary pressures, while the recession, which implies lower income and a reduction in tax revenue, together with the reduction in export taxes, lead to a worsening of the fiscal accounts. All of that was expected, including by Macri’s government. In fact, higher inflation that reduced real wages, and higher unemployment that weakened trade unions were central to the economic plans of Macri’s administration, as much as renegotiation with the Vulture Funds and reentrance into international financial markets. The US$ 2.75 billion 100-year bond issue is the crowing of these efforts.

The Argentinean bonds will pay around 8 percent per year in dollars for the next hundred years. One may reasonably ask why international financial markets would lend to Argentina, a country that has defaulted between four and seven times before, depending on who you ask. According to the Financial Times it is all a response to the smooth-talking telegenic new president and his market friendly reforms, even though Macri, very much like George W. Bush, was born with a silver foot in his mouth, and the reforms have backfired. In reality the reason for the renewed lending, is that, in spite of its several defaults, the country is a good payer. The very high interest rate implies that even if Argentina eventually defaults, a bondholder can make quite a lot of money. And there is always a chance of selling the bonds in the secondary markets, after making enough back with the high interest rates. Remember that interest rates have been close to zero in international markets, and sometimes negative in real terms, since the last global meltdown in 2008. On top of that, Vulture Funds can always make a buck if Argentina defaults again in the next hundred years. That is their business model.

The question you should really ask is why Argentina would borrow again and continue the long cycle of borrowing and defaults. Macri’s development strategy is a throwback to the Washington Consensus of the 1990s. In other words, the Macri administration is pushing for free trade, financial deregulation and a reduced role for the State at home, when these policies have been under attack and in retreat around the globe, more prominently in recent times with Brexit and the election of Donald Trump in the United States. The hope is that increased integration to world markets would bring investment and lead to growth, and that growth in the long run would make it viable for Argentina to repay its debt. The risks are evident.

It is unlikely, if not impossible, to think that foreign investment will come and promote growth. The narrow specialization of the Argentinean economy on commodities makes it vulnerable to recurrent crises when prices of its exports collapse. Also, the borrowing in dollars implies that only exports can provide the necessary resources for repaying the increasing foreign debt. This story cannot, and probably will not, end well. The only reason to promote this increase in foreign indebtedness is the short run gain associated to the higher interest rates that these 100-year bonds pay. Not only foreigners, and foreign pension funds will buy these bonds, but also Argentineans. For those that are wealthy enough to hold dollar denominated bonds in their portfolios the very high interest rates, even if risky, imply that Argentinean bonds are a good deal, an oasis of high remuneration in the midst of a financial desert.

It is worth remembering, in this context, that it is estimated that wealthy Argentineans hold assets abroad for about the total value of the country’s foreign debt. Macri and his friend are certainly among those that would benefit from his own policies. Also, one should not forget that Macri’s name appears in the Panama Papers, and contrary to what happened in other countries that had politicians implicated, he did not resign after the revelation that he illegally funneled funds to a tax haven. The 100-year bonds are not a sign that the economy is finally doing well, but a brief respite before the coming storm.

Neoliberalism in the Pampas

Soybean Republic

As promised, here are some brief reflections on the situation in Argentina, which I think is not as bad as in Brazil economically or politically, surprisingly, since Argentina had a balance of payments problem that is completely absent in the increasingly chaotic neighbor, and the left actually lost the election, which was not the case of Dilma (a coup was required to defenestrate her). As I suggested in my talk a year ago (for non Spanish speakers go to this text), the economy would experience a recession and higher inflation as a result of the likely (and effectively adopted) economic package of devaluation and fiscal adjustment.

Figure above shows that inflation accelerated from about 25% to about 40%, later figure from IMF estimates, and GDP moved from moderate growth (2.5%) to slightly less than 2% fall (again IMF estimates). It is worth noticing that many, including some that claim to be somewhat heterodox (in particular when they're not in Argentina), suggested that devaluation was not inflationary, and that it would produce significant growth of exports and lead to GDP growth.

Long term growth of exports depends essentially on the income of the trading partners, and the slowdown in China, the terrible collapse of the Brazilian economy, and overall gloomy perspectives of the global economy suggest that to expect growth from the external economy is wishful thinking. By the way, the notion that the problem is that the nominal devaluation (of about 100%) was not large enough and the real exchange rate is still appreciated (see here, in Spanish, Frenkel suggests that "we reedited the exchange rate lag") is outright delusional. The idea that if you devalue enough a country like Argentina would be competitive not just in the production of commodities, i.e. soybeans, but also in some marginal manufacturing sector, is based on a misreading of the East Asian experience, and the exaggeration of the idea that manufacturing exports respond simply to price signals (the right exchange rate) rather than industrial policy.

Also, there is no reason to expect a recovery next year on the basis of consumption, since real wages are falling, and the unemployment level went up from 7.2 to 9.2% according to IMF estimates. That also implies that private investment is not going to increase (yes, that's called the accelerator, and yes the IMF expects a fall of about 0.5% of GDP in investment).

However, contrary to what you might think all of this was expected. This is less of a surprise for the government that most analysts understand. As I said in the talk linked above, the objective was to get a recession and increase unemployment, reduce the bargaining power of the labor force, and reduce the real wage. That will be the basis of the future stabilization of the economy. Stagnating wages, and a relatively stable exchange rate. For that reason, and to avoid the continuous capital flight, the government did increase the interest rate. And also, since the Obama administration supported this neoliberal government (they are not populists after all) and the Macri administration was willing to do anything the Vultures wanted, Argentina finally returned to the international financial markets, and the external constraint was lifted. International reserves are up, from the low 20s to 30 something billion.

That implies that even with a current account deficit, which is at a bit more than 2% of GDP (slightly lower than before as a result of the recession), fiscal stimulus would allow for a recovery. Note that this could be done without increasing significantly the governments degree of indebtedness in dollars. There is no reason to borrow abroad to finance domestic spending. But in essence that's what this administration is doing, since they self imposed limits on the ability of the central bank to finance the treasury, which they misguidedly saw as the source of inflationary pressures. The more pressing short run question is whether they will accelerate public investment to promote growth and perhaps have a recovery in time for next year's election (something I suggested they might do in my talk last year). It seems that the degree of fiscal conservatism of this administration (there is no way you can call Prat-Gay Keynesian, even if the term has suffered with semantical saturation; or call the neoliberal Macri government heterodox, for that matter) is so extreme that they would prefer to continue with the recession. And yes, without external expansion, private demand, or government expansion there cannot be any recovery.

There are other more preoccupying issues with this administration,* and I'm not even talking the corruption that concerned so much the critics of the previous government (Macri's name is in the Panama papers, for one, or the fact that his energy minister worked for Shell, and the many other conflicts of interest between the government and private corporations) that are now silent, or the fact that the statistical office (Indec) has also left a gap in the data and has actually increased the uncertainty about the macroeconomic numbers, including inflation (something that critics of the previous government also, correctly, complained about, but interestingly enough they are silent now). I mean the cuts in spending on research and development, and the reversion of the very few initiatives that promoted national technology, like the cancellation of the manufacture of communications satellites, after the launch of two (ARSAT 1 and 2) in the last couple of years. Those were the kind of policies that would have the possibility of leading to some degree of manufacturing export dynamism. But for this government the plan is the return of the old 19th century commodity export model, and if they could reverse the external policy to colonial times (with the US instead of Spain as the metropolis) they probably would.

* And I mean just the economic stuff, leaving aside the record on human rights.

Vultures, bottom feeders and the debt collection business

John Oliver's story on debt collection is very instructive. It looks only at the domestic practices, but these are essentially the same as the ones used by Vulture Funds in international financial markets.

So respectable businessmen like Paul Singer, a top GPO contributor that owns the Elliot Vulture Fund that buys debt of developing countries and sues them in New York courts, or the international organizations like the IMF that impose conditionality on poor indebted countries are not much different from the bottom feeders described by Oliver.

Moody's upgrades Argentina credit rating status

Mainly because of their "expectation that Argentina will settle holdout creditor claims which will result in a lifting of court injunctions and clear the way for Argentina to access international capital markets." Fair enough, access to capital markets would lift the balance of payments constraint, even if the agreement is a complete surrender to the Vultures demands. But the most interesting argument for the improvement in the credit rating is that it results from "economic policy improvements since the Macri administration took office last December." So what happened since December (btw, mostly what I said it would).

The figure above from The Economist shows that inflation went up, and the economy was thrown into a recession. Fiscal deficits will likely increase, in spite of spending cuts, and reduction in public employment, since with the recession revenue will fall (Moody's expects the deficit to be about 5% GDP).

And yes fiscal deficits in domestic currency are mostly irrelevant for the discussion of ability to pay foreign obligations in dollars (the only reason to care is if the deficits are caused by more spending, and lead to current account deficits, which do increase the needs for foreign currency, which is not the case in Argentina now). Actually, I also think that the economy will eventually improve (that was the plan all along), just in time for the next presidential election.

The problem of course is that growth will accelerate very likely with an increase in current account deficits, as much as it happened during the Menem years in the 1990s. A more depreciated currency will do very little to solve that problem, which will likely be possible because the government will push ahead with international borrowing. Foreign debt driven growth essentially. But we know what tends to happen with this kind of policy.

There is a long history of external debt cycles in the country. This kind of frivolous economic policies, that push short term political gains (Macri's reelection like Menem in the past) at the expense of sustainable policies (it's the current account, not the fiscal idiot!) is what should be termed populism. Current account populism that is.

PS: Moody's does not even say anything about Macri's name appearing in the Panama papers.

Stiglitz (and others) on the Vulture Funds

From yesterday's panel on "Reforming the Future: Lessons from Sovereign Debt Restructuring" held at the Atlantic Council. Close to the 11 minute mark Stiglitz says that Griesa's decision on Argentina and the Vulture Funds was "very peculiar" and that it made restructuring almost impossible.

The vulture passes

Yep, not the condor. So it's my short note in Página/12 (in Spanish), the Argentine newspaper, on the future of the external debt negotiations. Note that the short summary on top suggests, since this is a debate, that the return of a neoliberal project would lead to increasing external debt. And that might be true, yet, as I note in my piece it is not true that external debt is always bad, since one can use it for diversifying exports (and reducing structural heterogeneity), reducing imports (the old import substituting industrialization strategy) and making the balance of payments more sustainable in the long run.

I might add then that the use of foreign debt, with caution, is not necessarily neoliberal. At any rate, neoliberal is a complicated term, often used to refer to things one does not like. Unlike neoclassical economics (or marginalism more properly) it does not have a precise meaning. I would imagine that in this context is used to refer to pro-business, pro-liberalization, laissez-faire policies that characterized the Washington Consensus and the 1990s in Argentina. And yes that would be a terrible model to go back to.

Economy-Sapping Patent Trolls or the other Vultures

The question of whether patents promote or hinder economic progress is unresolved and probably divides the profession. Not always according to orthodox/heterodox lines, I might add. I'm a patent agnostic, as you would know from a few posts (see here or here), in particular because I'm skeptical about the role of property rights in general in promoting innovation, and because I tend to believe in the role of expanding demand in technological innovation.

My reading of the evidence is that patents delayed the development of the steamboat, for example, often considered the first major American contribution to technological progress. The thing is that the notion that patents stimulate innovation is based on a sort of hero or great man theory of history, the god like figure that invents a solution out of nothing and transforms the world. This does not describe the messy, incremental process of technological development that seems to be behind every economically significant innovation.

At any rate, two CEOs wrote this piece for the Wall Street Journal (yes, my favorite kind of people, in my most cherished news source). They do note that their: "companies [Cisco and JC Penney] alone have spent well more than a third of a billion dollars in the last five years defending [them]selves against cases brought by patent-assertion entities." Patent-assertion entities are companies that file for patents, and do not produce anything. Like the Vulture Hedge Funds, they make their money in litigation. I love the nickname, Patent Trolls. And this would be additional evidence on the limitations of the patent system.

Argentina and the Vulture Funds

A short piece that appeared in the last issue of Challenge. From the conclusion:

"a rhetoric of debt forgiveness has been disseminated but indebted nations are still punished, and austerity measures are encouraged. Argentina’s fate in the hands of the vultures, like the countries in the periphery of Europe facing the austerity policies of the Troika (the European Central Bank, the European Union, and the International Monetary Fund), is just the most recent example of the limits of the globalization cum financialization process, and of the need to reform the international financial system. For now, the lesson of the Argentinean conflict with the vultures is that the American justice system asymmetrically favors the claims of creditors, and should be avoided at all costs."

Read here.

Even the IMF thinks Vulture Funds are a problem

Since I criticized recently the IMF on its timid changes on macroeconomic policy advice, and the persistence of austerity based programs, it is worthwhile noticing that on the question of debt restructuring they have come clearly on the side limiting the power of Vulture Funds. In a new report on Sovereign Debt Restructurings the IMF suggests that:

The recent litigation involving Argentina has generated significant concerns regarding the impact that the New York court decisions may have on the overall restructuring process. In light of these concerns, there has been considerable progress in both the design and use of a modified pari passu clause that explicitly excludes the obligation to pay creditors on a ratable basis. It is recommended that the Fund support the widespread use of such a modified pari passu clause in international sovereign bonds.

Note that this might have an impact on future debt renegotiations, but is of little help for Argentina right now. But if the IMF is doing this, it means that the US Treasury is not particularly happy with judge Griesa's decisions.

PS: Here and here two parts of an interview for the radio program Debates Económicos of the Universidad Nacional de Colombia (in Spanish). 

Eileen Appelbaum on the Argentine Technical Default

By Eileen Appelbaum There is no way to construe as fair the United States court ruling that Argentina cannot pay 93 percent of its creditors, unless it first pays a small group of hedge funds. It's not fair to the 93 percent of bondholders who negotiated a restructuring of Argentina’s debt in 2005 and 2010 with reduced payments. What gives Judge Thomas Griesa the right to take them hostage in order to force payment to the "vulture funds" that still demand full payment? It's not fair to the government of Argentina, which cannot pay the vulture funds without facing demands from other creditors to be paid in full, a move which would open the country up to many billions of dollars of claims that it cannot possibly pay. Although the news media reports that Argentina has defaulted to the restructured bondholders, this is not clear. The government did make the latest $539 million payment to these bondholders, but Judge Griesa is not allowing the New York bank that received this money to pay the bondholders. Griesa is defaulting, not Argentina. This is unprecedented and wrong. Read rest here. For all the entries in the NYTimes debate go here, including the entry by Alan Cibils.

*For other NK posts on the situation, see here, here, here, here, here, here, & here.

Per S&P & Bloomberg, Argentina Defaults... So What Now?

From a matter of fact point of view, even though Argentina has made the payments to bondholders, Judge Griesa's decision precludes them (the bondholders) from receiving payment, and so Argentina is technically in default (Argentine Finance Minister, Kicillof called it: "default Griesa. Griefault." This is NOT like in 2002 the result of lack of funds, but direct consequence from a judicial decision backed by the US Supreme Court. From Bloomberg:

Standard & Poor’s declared Argentina in default after the government missed a deadline for paying interest on $13 billion of restructured bonds. The South American country failed to get the $539 million payment to bondholders after a U.S. judge ruled that the money couldn’t be distributed unless a group of hedge funds holding defaulted debt also got paid. Argentina, in default for the second time in 13 years, has about $200 billion in foreign-currency debt, including $30 billion of restructured bonds, according to S&P. Argentina and the hedge funds, led by billionaire Paul Singer’s Elliott Management Corp., failed to reach agreement in talks today in New York, according to the court-appointed mediator in the case, Daniel Pollack. In a press conference after the talks ended, Argentine Economy Minister Axel Kicillof described the group of creditors as “vulture funds” and said the country wouldn’t sign an accord under “extortion.”

Read rest here.

And for recent NK posts on the situation, see here, here, here, here, here, and here.

More on Argentina and the Vulture Funds

This week will be key for the Argentine debt renegotiation drama. If no agreement is reached then default might take place. Here is a short note in Spanish for the Argentine newspaper Página/12, in which I suggest that in spite of the costs of an agreement, and the fact that on a simple technical basis Argentina should not pay them (after all they would still profit if they accepted the terms that 93% of bondholders agreed to), it might be the only solution that would allow economic growth to continue.

Who should negotiate with the Vulture Funds

A bit of World Cup humor.

Si mandamos a @Mascherano a negociar con los fondos buitres trae vuelto !!!!!
— Toro Palladino (@Toropalladino) July 10, 2014

Translation: If we send Mascherano to negotiate with the Vulture Funds, he will bring back some change!!!!!

If you read in Portuguese, here is an interview with yours truly on the Vulture Funds.

More on Argentina and the Vulture Funds and the sanctity of contracts

So the Argentine government decided to negotiate with the Vulture Funds to avoid a default, which is eminent if no agreement is reached, well, basically today. This is not necessarily bad news, given the potential consequences of a default. It is also one of the frustrating results of the decision of the very Conservative (and pro-bussiness) Roberts Supreme Court. To preside over the negotiations Judge Griesa chose a Wall Street lawyer (who boasts in his CV to have sued Elliot Spitzer for exceeding his authority in investigating Wall Street fraudsters). Argentina is trying to pay today to the ones that renegotiated, but whether that will happen is still not clear (apparently without success).

Note that the consequences of the default could be dire indeed. It would put more pressure on the exchange rate, lead to further depreciation that would be both inflationary, and contractionary, since it would basically reduce real wages. The economy would be forced to continue to grow at very low levels, as it has done since 2011, to avoid a current account crisis. In part, the problem exists even if Argentina does NOT default. Meaning the current account is already close to its limit and the reserves are not sufficiently high (around US$ 28 billions or so), and that's the reason the government has tried to finish negotiations with creditors that did not enter the previous debt reschedulings, including the Paris Club.

The notion is, arguably, that in a world with significant amounts of liquidity, and the chance that low rates of interest in international markets will continue for a while, access to international financial markets would be a reasonable solution for the Argentinean current account constraint. In fact, Brazil has financed a larger current account deficit with little or no problem (maybe the rate of interest is too high, and could be lower, but that's another discussion).

This does not necessarily mean that the Kirchner government has backtracked on previous policies, at least not completely. Reducing foreign indebtedness, after the default and the renegotiation, was the rational choice, and the commodity boom basically provided the policy space for it and for the accumulation of reserves. But borrowing in international markets, when the current account and reserves do not allow for continuous growth, might be fine too if borrowing is done on a sustainable basis. In other words, if the Argentinean government manages exports and imports (import substitution here plays a role as much as export promotion) to allow for the service of debt.

Also, renegotiation of debts (and default might be just a phase in a renegotiation process) are common, and do not show that (as some angry and, quite frankly, not very informed readers suggest in comments on posts on the default, not just in this blog) Argentina is a "deadbeat country and nobody should ever lend to them again." Note that defaults are actually quite common in history.

For example, Cipolla (1982) describes the bankruptcy of the banking houses of a developed country associated to the default of a developing and 'deadbeat' country. What countries are these, you ask. England and Italy, and of course England is the deadbeat one. According to Cipolla (1982: pp. 7-8):

“The large companies of the dominant economy (Florence), which operate in the underdeveloped country (England), have a vital interest in securing the local raw material (wool) for the home market. By logic of events they are led to grant increasingly larger credits to the local rulers, on whose benevolence the licenses for the export of raw material ultimately depend. The rulers of the underdeveloped country, however, instead of using the credit to finance productive investment, squander the funds in war expense and are soon forced to declare bankruptcy.”

So in the mid-fourtenth century the banking houses of Bardi and Peruzzi were brought down by the sovereign default in England and, hence, Florence, more accurately than Italy, was hit by the default. And there are several other countries that would now be considered developed (e.g. Germany) that defaulted before, without being excluded forever from financial markets.

Most countries that default do pay eventually, just at a new rate with extended periods. Renegotiations are normal, and the basis for them is the ability to repay, since it would be better for creditors to receive something. Note also, that creditors (as a whole, not an individual creditor per se) seldom make losses, and that is why all countries after a shorter or longer spell come back to international financial markets. The reason is not difficult to understand, since developing countries pay risk premiums well above the safe assets (Treasury bonds), the advantage of holding developing country debt even for a short while is sufficient for compensating default risks. And besides most savvy investors try to get out before the default (or in the case of Vultures, enter afterwards, to buy debt at the bottom, and make a kill in the courts; it is a good business model, if nothing else).

Changing the terms of contracts, which is basically what a default and renegotiation does, is not new and not the privilege of debtors. In fact, when the credit card company sends a "change of terms notice" to their cardholders, increasing fees or directly the interest rate, it is basically renegotiating unilaterally your contracts. So that is a normal market practice, and Argentina is not violating the sanctity of contracts, and is at least trying to honor its debts, as it has done for the last two hundred years.

Finally, beyond Argentina the consequences of the Robert's Court for international financial markets have been well summarized by UNCTAD, namely:

• First, by removing financial incentives for creditors to participate in orderly debt workouts, the rulings will make future debt restructuring even more difficult, in particular for outstanding bonds without a Collective Action Clause, the actual amount of which is unknown but is likely to be large.
• Second, obligating third-party financial institutions to provide information about assets of sovereign borrowers will have a significant impact on the international financial system as it forces financial service institutions to provide confidential information on the sovereign borrower's global financial transactions to facilitate the enforcement of debt contracts for the creditors.
• Third, the ruling will erode sovereign immunity.

In other words, reduces the chances of debt renegotiations, and of sovereign governments to manage its international reserves, reducing policy space. The question here is not if or whether Argentina should pay, which it was already doing, but at what cost, and who would benefit. The Robert's Court went with Wall Street, and that's no surprise. Interestingly this might hurt even Wall Street. Oh well.

Reference:
Cipolla, C. (1982), The Monetary Policy of Fourteenth-Century Florence. Berkeley: University of California Press.

Mark Weisbrot - Who Shot Argentina?

By Mark Weisbrot

When Cristina Kirchner first ran for president of Argentina in 2007, she had a campaign commercial with adorable young children answering the question, “What is the IMF (International Monetary Fund)?” They offered cute little ridiculous answers like “The IMF is a place where there are many animals,” and the punch line from the narrator was: “We have succeeded in making it so that your children and grandchildren won’t know what the IMF is.” To this day, there is no love lost between the IMF and Argentina, since the fund presided over Argentina’s terrible economic collapse of 1998-2002, as well as numerous failed policies in the years prior. But when the U.S. Court of Appeals for the Second Circuit ruled in favor of vulture funds trying to collect the full value of Argentine debt that they had bought for 20 cents on the dollar, even the IMF was against the decision.

Read rest here, and for another piece by Weisbrot, see here, and for posts on the issue by Matias, see here & here

Mark Weisbrot - The Debt Vultures' Fell Swoop

By Mark Weisbrot

Last week, the United States Supreme Court decided not to review a ruling in the Second Circuit Court of Appeals whose effect is that Argentina must pay “holdout” creditors who refused to participate in debt restructuring agreements that Argentina reached with the majority of bondholders following the 2001 default on its sovereign debt. Argentina’s lawyers warned that the court’s decision created “a serious and imminent risk” that the country would again be forced to default. But the ruling also has profound and disturbing implications for the functioning of the international financial system, and even the United States would most likely be adversely affected. Parties as diverse as the International Monetary Fund and leading religious organizations wanted the Supreme Court to overturn the decision, and briefs supporting this position were filed by the governments of France, Brazil and Mexico, as well as by the Nobel Prize-winning economist Joseph E. Stiglitz. The I.M.F. — which has had mostly sour relations with Argentina since its involvement in that country’s 1998-2002 recession — was also planning to file a brief on Argentina’s side to the Supreme Court, but was blocked by the American government from doing so. This action may have influenced the court’s decision not to hear the case.

Read rest here, and for recent posts on the topic by Matías, see here & here

Supreme Court Sides with Vulture Funds in the case of Argentina

Very briefly, since I've to go teach (more later today this week). The Supreme Court has sided with the Vulture Funds and denied Argentina's appeal judge's Griesa's infamous decision requiring it to pay the last holders of bonds on which it had defaulted (almost 93% had already renegotiated, after Argentina's agreement with the Paris Club). The problems this will cause transcend Argentina, and are a blow for any debt renegotiation worldwide. Who will accept a renegotiation knowing that the Supreme Court can decide that some have to be paid according to the original agreements?

In the case of Argentina, the efforts to finalize the renegotiation with debtors, that culminated with the Paris Club agreement, and which intended to normalize the relation with international capital markets, and allow a reentry of the country into those markets on a more favorable footing are gone. A very likely outcome will be a technical default, that is, for lack of payment even though the Central Bank does have funds to pay.

On an interesting note, 'liberal' judges Breyer and Kagan voted with the conservative majority, and only Ginsburg dissented (Sotomayor did not vote).

The Paris Club, Vulture Funds and global debt restructuring

Argentina has finalized a deal with the Paris Club two weeks ago. And tomorrow, if I'm not wrong, the case against the Vulture Funds will be finally decided by the Supreme Court. On the first one, Argentina signed an agreement with the Paris Club that implies the country will pay around US$9.7 billions in the next 5 years.

There is an interesting twist in the agreement with the Paris Club. The agreement was reached without accepting an IMF program, which have traditionally been part of all such negotiations. The Club and the IMF used to be joined at the hip. Two Paris Club chairmen, Jacques de Larosière and Michel Camdessus, became later managing directors of the IMF. So in a sense, the idea was that austerity at home was essential for repayment abroad. Here it is important to note a traditional confusion in the conventional view about the role of austerity.

Note that fiscal austerity can only have an indirect impact on repayment of a debt in foreign currency. You don't need more revenue in pesos (from taxes) to pay interest on foreign denominated bonds, but external revenue from exports, or capital inflows, or accumulated reserves. So austerity helps if it leads to reduced demand for imported goods and services, and more dollars left for repayment.

In all fairness, not having an IMF program is good, but it is NOT a sufficient condition to guarantee that austerity measures will be discarded altogether. I had discussed this before here, but it is far from clear that the Argentinean government will continue to promote a fiscal strategy associated with expansion, which more or less characterized the 2003-2008 boom, and the fast recovery from the 2009 crisis. And while the agreement is also good from the point of view of closing the mess caused by the 2002 default, the problem will not be completely resolved until the Vulture Fund issue is sorted out.

The dangers associated with the Supreme Court's decision are difficult to exaggerate. The Supreme Court may lead Argentina to a new default, not so much because the country can't pay, but because it will not pay (correctly so, in my view). At any rate, worth remembering that creditors have a Club and negotiate from a position of strength, while debtors negotiate one at a time, without the force of collective power. Perhaps the time has come for a Club of Debtors; the Club of Athens might be an appropriate name.

On the Argentine crisis again

This week the Supreme Court heard the case of the Vulture Funds against Argentina. I wrote a while ago about that here. The paper on the more recent crisis and devaluation is available here.

Is Argentina on the verge of an external crisis?

There is for starters the question of what causes external crises. As I have noted in other places (chapter 7 here or here, for example), external crises are NOT caused, in general, by fiscal deficits (quite the opposite, fiscal crises are the result of balance of payments crises). External crises result from the inability to service foreign debt (and to import intermediate and foreign goods), which are caused by a shortage of foreign currency (i.e. dollars).

As it can be seen in the graph above (data from Orlando Ferreres for those concerned with the sources), the current account surplus as a share of exports has shrunk and is now negative (at around 4% or so of exports). Note, however, that the level is far from desperate, and well below the crises levels when the current account deficit is above 60% of the exports.

Part of the anxiety is associated to the fall in the central bank's reserves, which stand at around US$33 billions now, down from slightly more than US$50 in 2011. The European crisis and the negative real rates of interest explain the drain on reserves, which are also not at a critical point right now. A combination of exchange controls, that have been in place (and have not been particularly efficient), and higher rates of interest might stop the outflows.*

Sure enough a balance of payments crisis could ensue, if say Vulture Funds eventually force a default, or if an external shock like a worsening of the crisis in the central countries followed by flight to safety, or a collapse of the terms-of-trade lead to a sudden decrease in the value of exports. But those do not seem to be necessarily intrinsic to the Argentine situation, and a slow recovery in the center, with significant amounts of international liquidity, and no incredible collapse of the prices of commodities seems as likely as the alternative.

In other words, the problem in Argentina, which is relevant for many countries in the region, is the long-term development strategy, and not the short-run balance of payments position. What the shrinking of the current account surpluses, and the resulting constraints on policy space, suggests is that the continuous dependence on commodity exports (manufacturing exports go mostly to the region, i.e. Brazil, and produce a deficit), and the absence of a more coherent policy of import substitution and of industrial development, continues to be relevant, as predicted more than 60 years ago by Prebisch and ECLAC.

* Higher rates can be compensated by subsidized credit by the public banks if demand for credit increases, but that would require demand expansion.