The Political Economy of the COVID-19 Crisis in Latin America

Following my talk on the same topic, on the same venue, now someone that might know a bit more about what's going on, particularly in Brazil. Professor Mazat will talk this Friday, and I highly recommend it. To register go here. Btw, Numa is Professor of Development Economics in the Institute of Economics at Federal University of Rio de Janeiro, my alma matter.

Debt default or negotiated solution?

An Argentinean default is neither new, nor a surprise, perhaps, even for a casual observer of the ups and downs of international bond markets. One may want to follow Oscar Wilde’s Victorian governess advice and omit the chapter on the fall of the peso as being ‘too sensational.’ But an Argentinean default now, after the Great Shutdown provoked by the coronavirus pandemic, would be the harbinger of a generalized sovereign debt crisis for emerging markets that would engulf the global economy, and make the recovery slower and more painful, including in the United States and other advanced economies. It may also undermine the US position in the global economy.

The Argentinean government’s debt restructuring proposal to the private creditors expired Friday, May 8th, with a limited number of adherents. In particular, large institutional investors did not accept the terms offered by Martín Guzmán, the finance minister, which would have implied a cut of about sixty percent of the principal, and a moratorium on payments for three years. This proposal, one might add, was for the most part designed before the coronavirus crisis, and the collapse of the global economy. The main preoccupation of the proposal was to put the external debt of the country on a sustainable basis, meaning in line with its ability to pay, which depends on its exports, the only secure source of dollars.

Black Rock, Fidelity, PIMCO and other investment funds that hold enough of Argentinean debt to preclude any rescheduling, want a cut of around forty percent, and have enough influence to hold out for a better deal (this guy here says Black Rock is the fourth branch of government). Since Argentina did not make a payment of interest of approximately US$ 500 million in April 22nd, today the country could be officially in default (grace period expires today, even if government extended negotiations). In the absence of a negotiated solution with the main bondholders the default is inevitable. The impasse is established, and the question is how can the stalemate be broken. Only the U.S. government holds the key for a negotiated solution.

The International Monetary Fund (IMF), the United States government, and other international creditor groups like the Club of Paris have been unusually supportive of Argentina. The IMF that had lent US$44 billion to Argentina between 2018 and 2019, has openly argued that the Argentinean debt is unsustainable, providing support for the rescheduling proposal. The U.S. government that has been a harsh critic of center left governments in the region, has had good rapport with the new government of Alberto Fernández, and his vice-president, the ex-president Cristina Fernández de Kirchner, with whom relations were considerably less friendly in the past.

As Jagdish Bhagwati famously implied with the notion of a Treasury-IMF-Wall-Street complex, the connections between the financial sector, the United States government and the multilateral organizations run deep. The current Treasury Secretary, Steve Mnuchin, as it is well-known, worked at Goldman Sachs, and he is the last of a long list of Wall Street connected government officials. Only the United States would have the clout to influence bondholders to come to the table with a reasonable counter offer. This would be of interest not only to Argentina, and its creditors, since a default would lead to years of litigious disputes that would only be sorted out by the courts, but for the United States and its global standing in the midst of the pandemic.

The collapse of international trade and of the price of commodities, the disappearance of remittances and revenues from tourism, coupled with the normal flight to safety will put other developing economies, that were not on the verge of collapse like Argentina, on unsustainable paths too. Most of these debts are denominated in dollars. The exorbitant privilege associated to the international position of the dollar comes with some requirements, as Charles Kindleberger famously noted. It requires acting as a global lender of last resort, providing counter-cyclical demand in times of distress. The U.S. is already doing some of these, with the Fed offering swap lines for central banks of a few countries, but it has blocked other initiatives like the expansion of the IMF’s Special Drawing Rights. Certainly not enough, and debatable whether it is enough even for domestic purposes (let alone other problems noted here, like the notion that the federal government would allow subnational units to go bankrupt)

Even more important in the context of the pandemic, particularly for the U.S. global standing, would be to allow countries that are indebted in dollars to default. These countries need the international reserve currency for the importation of essential medical equipment and pharmaceutical goods. The crisis has, if anything strengthened the position of the dollar in the short run, but there are dangers.

A financial crisis in the middle of a pandemic could have enormous human consequences, and it could also create the conditions for an eventual reduced role for the dollar. The pandemic has exacerbated the dispute between the United States and China, and the latter has already expanded its global lending in renminbi for years. It is also trying to provide medical support for affected countries in the region, to reduce criticism about its role in the pandemic, and now has stepped in to provide medical support. Argentina too has received medical equipment from China. If the U.S. is perceived as unresponsive, it is not inconceivable that China, if it follows a more generous credit policy, could be favored by the crisis.

The best possible outcome would be a negotiated solution, which would probably fall somewhere in between the Argentinean government offer and what would make the big institutional investors not loose money in the short term. Somewhere between a forty and a sixty percent haircut. That would allow the Argentinean government to deal with what really matters, the pandemic, and perhaps expand its spending without fear of external consequences. The U.S. Treasury and the IMF should back more vocally such a solution. Time is running out.

On the Argentinean debt renegotiation (in Spanish)

My interview on Led.fm with María Iglesia and Cecília Camarano for the program Reperfiladas (in Spanish, obviously) on the Argentinean debt restructuring.

Restructuring Argentina’s Private Debt is Essential

JOSEPH E. STIGLITZ, EDMUND S. PHELPS, CARMEN M. REINHART

Argentina's creditors are being asked to accept a proposal that would reduce their revenue stream but make it sustainable. A responsible resolution will set a positive precedent, not only for Argentina, but for the international financial system as a whole.

Read rest and list of signatures here.

The Economic Consequences of COVID-19 in Latin America

The video of my talk can be seen here.

Some brief thoughts on the Great Shutdown

First GDP numbers of the Great Shutdown were out yesterday. As it can be seen in the graph, GDP shrunk by about 4.8%. The data reflects only the first weeks of the stay at home lockdown of the economy in March, as the BEA report points out. Numbers will get considerably worse.

You must add to this the increase in unemployment insurance claims, which since the crisis started has gone up by more than 26 million, as reported by the Labor Department. Note that the unemployment rate is still at 4.4% and that it would take a while for numbers to reflect the collapse in jobs. Also, the series are measured in different ways, so many that lost their jobs, and filed for benefits (and might not even have received them) will not look for jobs (what would be the point), and, as a result would not count as unemployed. Expect the participation rate to fall. At any rate, the true unemployment rate as we speak, 26 plus another 5 million or so unemployed before the crisis, would be closer to about 19%. This is a crisis of biblical proportions.

But that is not my main concern. There are many ways in which fiscal and monetary policy could mitigate the worst effects of the crisis. The problem for me is that almost nobody is talking about the size of the effort that would be required for the economy to get out of this deep hole. Imagine that unemployment does get to something like almost a third of the labor force, as suggested by some Fed officials.

I've been playing around with some scenarios. This is not forecasting, which I don't consider a particular useful approach. This scenario is based on very simple assumptions using a simple Keynesian (yes, as in Keynesian cross) model, and some simple stock-flow accounting definitions, even though I don't have a fully consistent accounting model (on that and Godley and stock-flow models see this old post). I also assume certain parameters and sizes of shocks (even though I played with different numbers; on Godley and his view of the role of parameter estimation and model architecture see this other old post). Other than the simple multiplier (in this scenario of 1.2) and Okun's Law (3:1 ratio in this case), there are only assumptions about autonomous spending (government in this case, with some assumptions for this year at least informed by current events), and my concerns are essentially about what those mean in terms of the political economy of fiscal policy.

So, in my scenario output falls by about 8% next year, and recovery starts immediately, but GDP only surpasses the previous level in 2022/23, in the third year of the crisis. That's with a lot of fiscal stimulus, by the way. And in part the result of that is that the debt-to-GDP ratio goes to, in this scenario, about 180%, after 9 years (I had others with considerably more). Japanese levels of debt. I see no problem, but not everybody agrees, and, of course, that's the problem. Since the social forces that push for austerity are still around.

The scenario also implies that unemployment spikes (less than the number I gave above; so I guess a lot of discouraged workers and disguised unemployment), and it takes almost a decade to come down to reasonable numbers.

As with Godley, my interest in this is NOT to make predictions. I have no clue if this is going to happen or not (most likely not). My point is that in all my scenarios, huge fiscal stimulus was followed by moderate stimulus (not austerity*), and yet in all the debt-to-GDP ratio would go considerably up. It shouldn't be a surprise. In a crisis with a collapse in demand, that destroys jobs and income, and that workers and corporations are heavily indebted, it is unavoidable that the federal government would be required to pick up the tab, run higher deficits, and accumulate debt.

But are we prepared for that scenario? Republicans already called for less government, less taxes, and reduction in all types of spending (particular social spending, which is frankly nuts in the context of a pandemic). More surprisingly, Mitch McConnell seems to want States and municipalities to go bankrupt, that is, not do the normal thing in federations, which is to make the only entity with ability to borrow in its own currency to borrow (at zero rates really) and transfer resources. He basically wants the US to look more like Europe, and not the more social spending part, but the absence of a federal fiscal pact part. That's dangerous. And a Biden presidency (oh man, this hurts!), if it happens (consider the alternative; is it too early for a beer?), would have to deal with that and discussions about the debt ceiling (am I glad a grabbed a beer?). Oh well.

* In my scenarios, austerity makes things worse, making the recovery slower, and tax revenue growth too, btw.

PS: The other post on Godley's approach to macro modeling here.

Das Adam Smith problem

A short lecture on Adam Smith's problem for a Principles class. This might be of more general interest, and perhaps something to watch during the quarantine. The book I used for the lectures on history of economic ideas was Heinz Kurz's Economic Thought: A Brief History, a book that I highly recommend. The discussion here is heavily influenced by Tony Aspromourgos' book The science of wealth: Adam Smith and the framing of political economy, another one you should read if you have the opportunity.

The Economic Consequences of Covid-19 in Latin America

For more information go to their website.

COVID-19 Crisis: More Like the 1920-1921 Recession

By Ahmad Borazan, Fresno State (Guest blogger)

Economic commentators are struggling to find a historic precedent to the current COVID-19 caused economic crisis and the possible path of recovery. Majority of economic downturns are dominantly an aggregate demand driven phenomenon. But with the current crisis there is an imposed constriction in both supply and demand sides of the economy. Looking at the aggregate supply and demand forced contraction there is a compelling analogy between the current crisis and the Federal Reserve induced recessions such as that of 1920-1921.

During a recession caused by a Fed’s hike of interest rate both the supply and demand sides of the economy are brought to a halt. The higher cost of borrowing impedes spending resulting in a chain reaction of contracting production and spending. Similarly, social distancing measures curb spending and production as people stay home, unemployment rises, and non-essential businesses closed.

The Fed increased interest rate in 1920 to bring down inflation and attract gold inflows to restore the gold standard. The hike started in January 1920 and caused severe contraction of industrial production, consumption, and investment. Combined with government spending cuts due to WWI defense spending demobilization, the interest rate hike was high enough to cause the unemployment rate to go up from 2.3% in 1919 to 11.3 in 1921 and nonfarm unemployment rate rose up to 16%. With the economy in a deep recession and unemployment high, prices declined in the biggest deflation of the American economy in the last 120 years.

Then as the high interest rate attracted gold inflows and the price level significantly declined, the Federal Reserve started cutting interest rate in mid-1921. Soon enough the economy recovered through spending booms of debt-driven consumption and residential investment. Usually, the recovery out of recession takes long, hence the argument for government intervention. But as Keynes explained in the General Theory, under extraordinary circumstances that “could only be accomplished by administrative decree and is scarcely practical politics under a system of free wage-bargaining.”

When there is an anchor of expectations that raise the expectation of higher income, then recovery of spending can follow swiftly. During the early 1920s recession, we could argue, this anchor was the Federal Reserve monetary policy. The Fed’s interest rate cut raised expectations of higher future income and an end to the monetary-tightening caused recession. Furthermore, as I argue in a forthcoming paper, the increase in demand was also facilitated by a jump in private spending that was pent-up due to WW-I rationing and the subsequent recession.

As the management of the economy was still in the era of laissez-faire, the high unemployment rate was tolerable and forced as a fair price to purge the economy of inflation. Benjamin Strong, the chairman of New York Federal Reserve refused to cut of interest rates before wages had gone down as much as prices. In the post New Deal era, a high unemployment rate around 10% is less tolerable.

Similarly, we could argue that loosening up social-distancing measures would kick in an increase of spending though as reports from China show this will not be fast as people would still be worried about going back to pre-crisis spending level. The last few days we saw protests in multiple US cities with crowds demanding to reopen the economy. Although the drivers of these protests could vary from legitimate economic pain to partisan politics, the US government should enhance its fiscal measures to sustain households’ incomes and jobs. Paycheck protection program for workers in small businesses should be expanded and extended to workers in large enterprises, in addition to state and local governments.

Government spending expansion when social-distancing measures are enforced and when relaxed would help us avoid a drastic depression as it would ensure sustained demand during the recovery. Furthermore, public deficit driven recovery would enable us to avoid risky private debt-driven rebound which characterized the era of the Roaring Twenties and contributed to the severity of the Great Depression.

Any concerns about expanding the debt are unjustified. The US debt to income ratio is currently less than half that of Japan which is capable of borrowing at extremely low cost while it has a smaller economy and lesser role in global financial markets compared to that of the US. If the Japanese experience proves anything it is that we have ample room for more debt to fund expansionary fiscal policy and avoid a depression. There is no reason to repeat the policy mistake done with the American Taxpayer Relief Act of 2012 which cut discretionary government spending when the unemployment rate was 8%. More generous European economic fiscal and monetary reactions to the current crisis prove the capacity of advanced economies governments in relieving its citizens of economic hardship. One hopes these responses would bring the order of mythological fiscal scarcity to an end.

Donald Trump commenting on rescuing affected workers, kept saying we will help them so they "don’t get penalized for something that’s not their fault.” As if in normal times being unemployed or working for below a living wage is usually an individual’s choice and fault; not a result of the "naturally optimal" markets and other human-made structures.

My talk on the Great Shutdown (in Spanish)

For those that understand Spanish my talk on the crisis (Keynesianism versus Socialism) organized by the university in Puebla (BUAP) by Juan Alberto Vázquez. Link to a piece published in an Argentinian newspaper on the topic here. My part goes up to minute 29 or so, then it's the talk by good friend Ignacio Perrotini on "Milton Friedman and the Plague."

At the Rick Smith Show on the Corona Crisis

I appear between minutes 39 and 59 approximately. Rick's show is always worth listening to.

Virtual Forum: Economics Perspectives and Challenges in the Current Context

Virtual seminar in México, and in Spanish. To attend go to the Zoom page and register. And, yes, it should be Vernengo, with e.

New issue of ROKE is out

The April Issue of the Review of Keynesian Economics is now out. The issue contains a collection of articles covering a spectrum of important issues. It opens with a debate over New Developmentalism which pits development relying on macro prices (especially the exchange rate) against historical state-led development policies. Next, there is an article on the role of the wage share in determining exchange rates. Thereafter, there are several articles on Post Keynesian growth theory. One addresses the evolution of income and wealth inequality, while others empirically assess alternative approaches to theorizing demand growth.

Two paper are open: "A Structuralist and Institutionalist developmental assessment of and reaction to New Developmentalism" by Carlos Aguiar de Medeiros and "Making sense of Piketty's ‘fundamental laws’ in a Post-Keynesian framework: the transitional dynamics of wealth inequality" by
Stefan Ederer and Miriam Rehm.