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Argentina's default and what it means.

Ruminations, August 3, 2014

South of the border
Recently, there has been a lot of activity generated south of the U.S. border, the coverage of which has been overshadowed by other crises such as Ukraine, Iraq, and congressional action or inaction on an immigration bill. While the aforementioned news items are not without merit, their demand for attention sometimes causes us to ignore other important stories. Let’s take a look at one.

Cry for Argentina. Argentina has defaulted. Again. Well, maybe not technically a default – Standard & Poor’s calls it a “selective default.”

In 2001, Argentina defaulted on its debt. Subsequent to that, in order to gain wide acceptability of its bonds, Argentina chose to issue them under New York law. And, unfortunately for Argentine President Cristina Fernández de Kirchner, Judge Thomas Griesa of Federal District Court in Manhattan ruled against Argentina and for its creditors. (Argentina appealed the ruling to the United States Supreme Court but the Court refused to hear the case, leaving Griesa’s ruling intact.)

A little bit of background may be necessary. In 2001, Argentina defaulted on bond payments. They made agreements with some bondholders to take a “haircut” (i.e., to accept less than full payment on the bonds, which is better than nothing. In some cases, this haircut amounted to the creditors receiving 25 percent of the amounts due). One relatively small group of creditors refused to take a haircut and held out for the full amount due to them – a total of $1.5 billion. (The holdouts purchased the bonds at a discount after Argentina had defaulted, taking a gamble that they could get the full amount due and earn a pretty penny.)

Now, Argentina has some $16 billion in foreign reserves and it seems that they could follow the court’s directive, pay their creditors and that would be the end of that. Maybe not. There are a few things to consider – political, financial and philosophical. From a political point of view, Argentina has been fighting these holdouts for a decade and to acquiesce now would seem like surrender – it would be like President Barack Obama calling a news conference to say, “I was wrong on Obamacare and we’re going to rescind it.”

From a financial point of view, it’s a lot more serious than the numbers would indicate. First, Argentina has deposited $539 million in the bank of New York Mellon to pay those creditors who agreed to the haircut BUT (big “BUT!”) Judge Griesa has ruled that those who have accepted the haircut cannot be paid before those holdout creditors. So, the Bank of New York Mellon, wanting to avoid running afoul of the law, will not issue payment. And, not all the holdouts are party to the lawsuit that Griesa has ruled upon. If Argentina pays the $1.5 billion, then those other holdouts would probably file their claims (under a “Rights upon future offering” – RUFO -- clause that says that if some bondholders can negotiate better terms, then all bondholders can have those same terms) and that could run as high as $13 billion, according to JPMorgan Chase. And that amount of money could put a big dent in Argentina’s foreign reserves.

And then there is the philosophical aspect. Argentina’s Finance Minister is Axel Kicillof, a professor Marxist economics. As such, he has a natural predisposition to be in opposition to American banks, investors and courts. But bear in mind that the Justicialist Party of Cristina Fernández de Kirchner is Peronist – a mixture of populism, fascism and socialism. During her tenure in office, the Argentine government has confiscated private pension funds ($30 billion), abrogated contracts, nationalized companies (e.g., the Spanish owned energy company Repsol) and imposed price and currency controls. And now, some 60 percent of Argentines are below the poverty line and inflation is running at about 40 percent, according to most economists (officially, it’s at 11 percent – Kirchner replaced the lead statistician at the National Statistics Institute in 2007 and inflation figures have been better ever since, even as economists have grown increasingly skeptical).

But what does Argentina say in response? It says that it is not in “default” and it calls the holdout creditors and Judge Griesa “vultures.” (If it were officially in default, all of its creditors -- including those who had agreed to haircuts -- could demand immediate payment in full of up to about $29 billion.)

The Kirchner government seems to have read and absorbed Eduardo Galeano’s book Open Veins of Latin America (which we discussed on other occasions, most recently on December 8). The perspective of the book is that Latin America is perpetually being raped and pillaged by North Americans and Europeans. In support of this Argentinean perspective, on August 1, Business Insider translated an editorial from Uruguayan newspaper El Pais: “[Argentines believe] that all their problems have to do with a grand historic battle against imperialism, against domination, against some evil-doer’s power that is looking to destroy them. The images on posters in Buenos Aires … now say 'Griesa or Cristina.' They're eloquent in that way.”

It’s not that Argentina has no support. Nobel laureate economist Joseph Stiglitz supports them as does Obama. Stiglitz said to the New York Times that “We’ve had a lot of bombs being thrown around the world and [the Griesa decision] is America throwing a bomb into the global economic system.” Hmm. Doesn’t it seem more like Argentina’s throwing a “bomb into the global economic system?” But even so, since Argentina has been in a virtual state of default for the past 10 years, its impact on the global economic system is likely to be slight. Stiglitz goes on to say that the creditor holdouts “have already done a lot of damage,” but not as you would notice.

On the other hand, Paul Singer, CEO of one of the holdout creditors, wrote in 2005, “Imagine how much capital a country like Argentina might attract if, instead of defaulting seriatim and affecting a pose of anger towards its creditors, it borrowed responsibly and honored its obligations.” Singer has a well reasoned argument but considering the current situation, it seems a little late for that now.

On the plus side, as a result of Judge Griesa’s decision, creditors may be more inclined to loan funds, in as much as the borrower could be forced by the courts to pay back the borrowed funds. And it might force more caution on the part of borrowers who, knowing that they would be forced to pay back loans, may exercise more caution in the borrowing and use of funds.

Given Argentina’s other economic ills, however, many people were predicting that Argentina would devalue its currency this year as it has over 20 times in the past 200 years. That prediction was before Judge Griesa’s ruling. If Argentina devalued now, that would effectively raise the amount of money Argentina owes (since the payback is in dollars and not pesos) and make repayment, even to those who agreed to the reduced payments, even more difficult.

There is no bankruptcy court for sovereign nations (although the International Monetary Fund, ever looking for ways to increase its relevance, would be willing to serve in this function.) Even if there were an international bankruptcy court, it is doubtful that Argentina, given its political and attitudinal bent, would avail itself of the court’s service.

In the long run, economic reform, however painful, is the only remedy – albeit politically difficult – especially for a populist government. One of the other tactics that Argentina could employ is to delay any settlement until the end of 2014 when the RUFO clause (see above) expires. Of course, for the short-term problems, Argentina could begin serious negotiations devoid of polemics. And it could demonstrate its seriousness by showing up on time for its meetings. If that does not happen, Argentina may find itself shut out of the credit markets and in deeper difficulties than it envisions.

Still relevant
(The following article appeared in Ruminations, March 26, 2006)
What do David Duke, the PLO and the Muslim Brotherhood have in common with Harvard?

Remember the anti-Semitic screed called "Protocols of the Elders of Zion?" The 1903 forgery by the czar's secret police talked of an 1897 clandestine meeting of world Jewish leaders who planned for Jewish "invincible...sovereignty over all the world." The document claimed that Jews planned to establish a "Super-Government Administration" that would "subdue all the nations." The Protocols, according to historian Norman Cohn, was used by the Nazis as a "warrant for genocide."

A recent paper published by Harvard's Kennedy School purports that the Israel Lobby (read Elders of Zion) has assumed control of American foreign policy through a network of journalists (including George Will), think tanks (including the liberal Brookings Institution and the conservative American Enterprise Institute), newspapers (including the New York Times and the Wall Street Journal) and high-ranking government officials (with ties to Israel's rightist Likud party) and that this cabal caused the United States to invade Iraq.

The Harvard paper is not without supporters. Among the luminaries who endorse the findings are David Duke (former Ku Klux Klan leader), Abdulmo'em Abulfotah (a senior member of Egypt's Muslim Brotherhood), and the Palestinian Liberation Organization. Is this what former Harvard President Larry Summers warned about when he cited growing anti-Semiticism on college campuses?

Quote without comment
Michael Boskin, professor of economics at Stanford University and senior fellow at the Hoover Institution, writing in the London Guardian, November 22, 2013: “Can an Argentine president promote disinflation and retain voter support during a period of slower growth, or even recession? It happened in the US. President Ronald Reagan supported US Federal Reserve chairman Paul Volcker's disinflation, despite a deep recession, a temporary spike in unemployment and midterm election losses. The economy soon rebounded, and Reagan was re-elected. Price stability enabled a quarter-century of strong growth and low unemployment, interrupted by two brief, mild recessions – the best macroeconomic performance in American history.”