The Latin American Crisis

Downhill

I have not written on the problems in the region for a while now (last stuff that is more comprehensive here in the talk at Keene, for example), in part, because the whole theme is a bit depressing (more recently the Honduras crisis, and the return of the right in Chile). As I have noted before, there is no doubt that the collapse of commodity prices has played a significant role in the downturn in the region, but it is also true that a lot of the problems are political in nature, and the resurgence of neoliberalism (with the support of the US, btw) has played a significant role too. In my view, the latter is far more relevant.

Two recent issues that I wanted to note, and that prompted my return to the issue of the crisis in the region. One is the downgrading of the Brazilian public debt by Standard & Poor's (I've written on credit rating agencies before here, and on the  previous downgrading of Brazil too). As I noted before, the Brazilian economy didn't face any significant fiscal or external problem. Figure below, from IMF WEO data, shows that the primary balances were actually positive until Dilma decided to cave and do a fiscal adjustment in 2015 (which did not save her from the coup, btw). And the external (current account) deficit was small, and manageable given the humongous external reserves and the great amount of global liquidity.

At any rate, why the new downgrading, you ask. The reason is to force the Brazilian government to push once again for pension reform. The whole point is that the crisis was caused to create the conditions for the dismantling of the old remnants of the very incomplete welfare state, if one can speak of one in Brazil, that survived the neoliberal onslaught of the 1990s under Fernando Henrique Cardoso. One should not minimize the importance of the soft power of US institutions, including the credit rating agencies, and how they can be used to promote certain political agendas.

The other issue is related to Venezuela (see my two previous posts here and here). I noted before that Venezuela's democracy (very problematic one, as I noted, before you complain; read the posts in the links please) is under attack, and that right wingers should not be seen as pushing for democracy against an authoritarian regime. That rhetoric, that still permeates most of the coverage in the US, is simply incorrect. I was somewhat shocked to read the recent op-ed by Ricardo Hausmann asking for military intervention by foreign powers (meaning the US). By the way, this comes from someone with the authority of being a Harvard professor (not that Harvard is supporting the coup, as far as I know). The role of the soft power of US institutions again.

If there were any doubts about their (right wingers that supported the 2002 coup) commitment to democracy I think this clears it up. I'll leave a discussion about the accuracy of the claim that elections have been rigged and the extent of the 'famine' for another post (something old on the latter here). I just wanted to note that here there is that step that is always there in the authoritarian argument about the justification for violence and the removal of the democratic institutions. Unacceptable.

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.

From BBB-razil to BB+razil or the meaning of investment grade

So Brazil (or here about Petrobras, the State oil company) lost its investment grade status with Standard & Poor's. You would think this is huge given the media attention in Brazil. If you read S&P's actual rationale for the downgrading (here) it is essentially about the fiscal situation. They say: "We now expect the general government deficit to rise to an average of 8% of GDP in 2015 and 2016 before declining to 5.9% in 2017, versus 6.1% in 2014. We do not expect a primary fiscal surplus in 2015 or 2016." They do discuss the political problems too, the corruption investigations,* and the political instability that has plagued the government. There is a discussion of the external vulnerability, but here they are quite sensible and know there is no problem. The report says that: "despite the wider current account deficit, Brazil has low external financing needs compared with its current account receipts and its high level of international reserves compared with some of its peers." So this is a fiscal problem in their view.

And therein lies the problem. They had years ago also revised the outlook of US debt negatively (my comments here), also on the basis of fiscal, and political, factors. As much as the US then, Brazil now has no risk of not paying its internal debt in domestic currency. And yes, the fiscal outlook has worsened, and the reasons are no secret. It's austerity. If you cut spending, output falls, and the recession leads to lower revenue and higher deficits. It's part of the problems caused by policies that S&P's analysts actually favor. Austerity also is the cause of the recession, and the worsening of the growth outlook in the next couple of years, which are also discussed in S&P's rationale for the downgrade. So the fiscal problems that are the main cause for the downgrade are self-inflicted wounds (see Serrano and Summa), and the cause of the lack of growth and the worsening of the future fiscal balances.

But more importantly, the downgrade itself is kind of irrelevant. S&P doesn't think, as I quoted above, that the external situation is particularly problematic. The recession will actually reduce the current account problems, by reducing imports. So there is no external crisis. The devaluation of the real has been part of a global trend, and in part has been reinforced by the government that seems to believe, incorrectly in my view, in the New Developmentalist philosophy that fiscal adjustment (to control inflation) and devaluation (to promote export-led growth) are part of the solution. If the downgrade cannot worsen the external situation, certainly it cannot have an effect on the ability of the government to pay its bills in domestic currency.

At any rate, even if in this case the downgrade is kind of irrelevant, it is important to remember that credit rating agencies were, and still are, one of the worst citizens in international financial markets. They were co-responsible in the bubble, that preceded the crisis, and in the meltdown of the financial sector in the 2008 Global Financial Crisis. The fact that they complain about corruption in Brazil, while they profited giving triple-A ratings to subprime junk is outrageous. And as they say, their views are just opinions. I would add biased and not particularly accurate. They should be put out of business with a public rating agency.

* I could go on on the corruption stuff, but I'll post something later.

Srinivas Raghavendra on Credit Rating Capitalism

Here is an interesting paper by Srinivas Raghavendra on how the current crisis has led to the consolidation of orthodoxy as the dominant paradigm, and the role of credit rating agencies.

We need a Public Rating Agency!

So Standard & Poor's has revised the outlook of US debt, which is still triple-A, to negative. The reason according to their report is that: they “believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges.” Basically, the economic rationale is simply that the fiscal consolidation (read contraction) plans are not strong enough. Somebody should explain to them that the US cannot default on debt denominated in dollars. There is always recourse to monetization of debt in your own currency. And yes monetization may have consequences. But, monetization would only lead to inflation if the economy were at full employment. I wish we were there, and excess demand could lead to inflation. But at this point it’s pure delusion.

Note, however, that all the Rating Agencies (S&P's, Moody’s and Fitch) argue, to protect against lawsuits, that their ratings are nothing more than opinions. By the way, the opinions of people that rated subprime CDOs (Collateralized Debt Obligations) as triple-A. These are the opinions of highly unqualified people at best, or worst just completely dishonest. It would be nice if we could just dismiss their ‘opinions’ as the ranting (not ratings) of lunatics and common thieves, but that would be dangerous.

In fact, their views are not just opinions, and their argument is disingenuous at best. The problem is NOT that investors actually pay attention to their ratings, which they do. Worse than that, financial regulations incorporate their ratings and require, for example, that money-market funds have to invest in instruments with high credit ratings. Several laws require pension funds to meet certain credit-rating requirements, and banking regulations determine regulatory capital requirements based on the credit ratings of the securities the bank owns. In other words, the credit agencies have a semi-public status, but they are profit-making businesses, which have a proven record of incompetence (when it comes to risk assessment, not profit-making). This is the strongest case for creating a public rating agency that would be free from the conflicts of interest that the private agencies are so obviously entangled into.