Jayati Ghosh

Almost everyone now knows that the world of international finance is not a particularly robust one, nor is it particularly just or fair. But it has just got even weirder and more fragile, if this can be imagined. A recent ruling of the U.S. Supreme Court, refusing to hear an appeal by the government of Argentine against a decision of a lower court on a case relating to its debt restructuring agreement with creditors over a decade ago, is not just a blow against the state and people of Argentina. It has the potential to undermine the entire system of cross-border debt that underlies global capitalism today

The case has its origins in the 1990s, when the government of Carlos Menem fixed the Argentine peso at the value of one U.S. dollar, through a currency board arrangement that restricted base money supply to the amount of external reserves and sought to increase its spending through the build-up of external debt. This was obviously an unsustainable strategy, which exploded in a financial crisis in 2001, bringing on a major devaluation of the currency and a default on around $100 billion of external debt.

In 2005, the government of Nestor Kirchner, which had then managed to revive the economy to some extent, offered its creditors debt swaps that significantly restructured the debts. Since Argentine bonds were anyway trading at a fraction of their face value in the secondary market, this deal, which reduced the value of the debt by nearly 75 per cent, was acceptable to most of the multinational banks and other creditors. (Since unpaid interest is added on to the principal and compounded, the actual face value of the debt in such cases is typically much more than the amount originally borrowed or lent out.) Indeed, creditors holding 93 per cent of government bonds participated in the debt swaps of 2005 and 2010.

However, a tiny minority of creditors held out and refused to accept the negotiated settlement. These then sold their holdings to hedge funds (in this case known as “vulture funds” that take on distressed assets in the hope of recouping a higher value from them). One of the most prominent of these funds in the Argentine case is NML Capital, a subsidiary of Elliot Capital Management, which is run by U.S. billionaire and major Republican party donor Paul Singer. This fund has a history of using aggressive tactics to force struggling sovereign debtors to pay the full value of debts that have already been deeply discounted by the market. In the past, it has successfully sued the governments of Peru and the Democratic Republic of the Congo.

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Matias Vernengo

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 [June 30]. 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.

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Matias Vernengo

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.

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Jeff Madrick

I have written about the deep and misleading flaws inherent in Congressional Budget Office (CBO) forecasts before. But given last week’s projections of job losses due to a proposed minimum wage hike, the inadequacy and misleading character of CBO pronouncements needs addressing again.

What particularly provokes me now is a quasi-debate between economist Jared Bernstein, former economic adviser to Vice President Joseph Biden, and Republican economist Douglas Holtz-Eakin, former head of the CBO, on CNBC. The CBO had issued its customary over-simplified statement that “Once fully implemented in the second half of 2016, the $10.10 [per hour minimum wage] option would reduce total employment by about 500,000 workers, or 0.3 percent, CBO projects.” They next point out that this is merely the midpoint of a range of possibilities they derive from existing research on the relationship between the minimum wage and jobs.

But why make the declarative statement in the first place? The damage is done. Politicians and the media pick it up as if it is a forecast, not a midpoint based on a wide range of conflicting research.

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Sara Hsu, Guest Blogger

In China, things are not looking pretty. Debt is high among corporations and local, provincial, and state governments—up to more than 25 trillion RMB among governments in 2012 and 60 trillion RMB among corporations in 2012. Some say debt is also high among households, but let’s face it: households still have a hell of a time borrowing from banks. Their debt load comprised close to 10 trillion RMB in 2012, and most of their income is put into savings as a cushion against adverse conditions.

Much of the debt that has gone to governments and corporations has been extended through loans, “entrusted loans,” or “trust loans.” Entrusted loans are loans from one party to another that use a bank as an intermediary, while trust loans are loans from trusts to one or multiple parties. Both of these types of loans can be securitized and sold off to bank customers, which they have been, in spades, as wealth management products.

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Mark Blyth

“Growth in a Time of Debt,” the much-touted paper by economists Carmen Reinhardt and Kenneth Rogoff, that suggested economic growth stalls once a nation’s debt hits 90 percent of its gross domestic product, has been debunked. But the austerity policies that this research helped undergird are still alive and well. Despite the on-going austerity-driven economic meltdown in Europe, and despite the International Monetary Fund’s recanting of the supposedly positive benefits of cuts, austerity continues, as John Maynard Keynes once put it, “to dominate the economic thought, both practical and theoretical, of the governing and academic classes of this generation.” Why is it so hard to shuck this notion that governments should cut spending and/or raise taxes in times of economic slack?

Two answers present themselves to us.

The first is politics. Few of the Republicans who fret so much about today’s allegedly crushing debt burden did so in 2006, at the height of the boom, when the U.S. debt to GDP ratio was steadily climbing above 60 percent and the deficit was at then-all-time high – and when a Republican was in the White House.

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C.P. Chandrasekhar

If the international media are to be believed the world, still struggling with recession, is faced with a potential new threat emanating from China. Underlying that threat is a rapid rise in credit provided by a “shadow banking” sector to developers in an increasingly fragile property market. Efforts to address the property bubble or reduce fragility in the financial system can slow China’s growth substantially, aggravating global difficulties.

The difficulty here is that the evidence is patchy and not always reliable. According to one estimate, since the post-crisis stimulus of 2008, total public and private debt in China has risen to more than 200 per cent of GDP. Figures collated by the World Bank show that credit to the private sector rose from 104 per cent of GDP in 2008 to 130 per cent in 2010, before declining marginally in 2011. The evidence suggests that 2012 has seen a further sharp increase.

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Arjun Jayadev

One of my favorite lines from recent economics papers is the following one from this paper by Thomas Phillipon, who in talking about the performance of the financial sector suggests that “the unit cost of intermediation is higher today than it was a century ago, and it has increased over the past 30 years. One interpretation is that improvements in information technology may have been cancelled out by increases in other financial activities whose social value is difficult to assess.”

The claim that the financial sector has been ‘functionally inefficient’ was made 30 years ago by James Tobin, and it’s great to have a quantitative basis to make this sort of judgment. Another way to have some sort of handle on the degree to which intermediation has become more expensive is to look at the spread between funding costs and lending rates.

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C.P. Chandrasekhar

Early February, the Department of Justice (DoJ) of the US government—represented by the United States attorney general and supported by attorneys general from 16 states—filed civil fraud charges against the ratings giant Standard & Poor’s (S&P). S&P is the largest of the big three agencies—the other two being Moody’s and Fitch—which, for a fee, take on the task of assessing how risky and robust securities of different kinds issued by financial firms are.
The charges were not minor. The DoJ argues that for more than three years between September 2004 and October 2007, S&P “knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors” in mortgage-related securities. This was the period when S&P was raking in huge earnings by granting high ratings to complex and opaque derivatives named “collateralised debt obligations” (CDOs) based on mortgage bonds. The DoJ’s case reportedly focuses on 40 such CDOs created at the height of the US mortgage bubble, the rating of which gave S&P $13 million in fees. These bonds went bust, resulting in losses to investors. The DoJ not only claims that S&P knew this could happen when it gave them high ratings or left them unrevised, but also that it misinformed investors by arguing that its ratings “were objective, independent, uninfluenced by any conflicts of interest.”

Progress on punishing institutions seen as responsible for the 2008 crisis has been slow. So it has not just been business as usual for these firms, but license to do things that seem substantially aimed at regaining the credibility they lost in the aftermath of the crisis. The most controversial of these was its decision to downgrade the long-term credit rating of the United States from AAA to AA+ in August last year during the standoff between the Democrats and Republicans over ratifying an increase in the prevailing ceiling on US public debt.

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Erinc Yeldan, Guest Blogger

Two Latin American style economies, Argentina and Turkey, shared a common history until very recently.  This “commonness” included a prolonged history of import substitution industrialization (ISI) with inward-looking, state-led development paths.  Both economies had relatively high rates of growth during their respective stages of ISI and yet, found out that these paths reached their limits by late 1970s (Argentina perhaps half a decade earlier than Turkey).

Both countries had also witnessed a lost decade, respectively; Argentina the 1980s, Turkey 1990s.  For both countries the period after was one of active reform.  Both countries suffered from an almost identical type of financial crisis in 2001, while both of them were following an IMF-led disinflation programme that rested on exchange rate-based stabilization adventures.  The contraction of the GDP and the burden of adjustment through rapid currency depreciation, banking collapses, and a severe rise of unemployment were also at comparable scale across the two countries.  However, the two had divergent paths of adjustment subsequently. Turkey followed a strict orthodox adjustment programme under the auspices of the IMF, while Argentine chose to set its own course with debt default and an adherence to what is commonly referred to as a heterodox adjustment programme, while maintaining a strong anti-poverty and pro-employment stance.

Almost a decade into this divergence, Argentina was in the international news once again, now with a ruling by the district court of New York that the Argentinian government ought to pay $1.3 billion to a “vulture fund”: Elliott Capital Management.  The ruling further contained a statement that prohibited third parties to aid Argentina in its efforts of debt re-structuring.

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