Wednesday, 13 August 2014

Argentina's default - what's it all about?

Two weeks ago Argentina has once again declared default on its debt (the last time being 13 years ago during the infamous Corralito in 2001). This makes it their 9th default since they got their independence almost 200 years ago (Reinhart and Rogoff have the numbers: Argentina defaulted on its debt in 1827, 1890, 1951, 1956, 1982, 1989, 2001). In the slow summer months this is obviously the top story: New York Times organized a debate questioning the justice behind the default (since after all it was the New York federal court which ruled that Argentina must pay a small group of bondholders $1.5bn by the end of July), Kenneth Rogoff and Joseph Stiglitz propose solutions on Project Syndicate, coupled with the usual reports from The EconomistForbesWSJThe Economist (2), Financial Times, etc. 

What happened? 

After last minute talks being held in New York with a small group of its bond holders, colloquially referred to as "vulture fund" investors (see definition here) but usually called "holdout" investors, who demanded, by the order of the New York federal court, that the Argentine government pays them its $1.5bn debt obligation, the government refused to do so and was consequentially in default over its debt. 

The story gets more convoluted. The relentless group of holdout investors, led by US investor and hedge fund owner Paul Singer, represent only a small portion of Argentina's debt holders who didn't agree to a debt restructuring scheme after the 2001 default. Yes, the story originates in 2001. Back then Argentina defaulted on its debt during a major financial and fiscal crisis (the Argentine great depression, it was called). They simply stopped paying off their obligations to thousands of investors worldwide who were attracted to Argentine government bonds offering relatively high yields at the time (in the 90s). After facing an immediate credit halt, the government faced an enormous challenge in trying to refinance its debt and stand back on its feet. In 2005 they reached an agreement with the bondholders and began the process of debt restructuring. They exchanged 76% of their defaulted bonds for new ones with only 25% to 33% of face value of the old ones (investors had to agree to a huge cut). There was a second debt restructuring in 2010 which took the total to 93% of all defaulted bonds being restructured. The only ones who remained were the investors that were persistent enough in getting their money by court. 

So where do the "vulture funds" come in? In 2002 when Argentina stopped paying back their debts, many bondholders realized they were holding worthless assets and were trying to quickly get rid of them in order to cut their losses. Paul Singer, owner and founder of Elliott Management hedge fund bought off most of these bonds at only a fraction of their initial value, for $48 million. Today, they're worth over $800 million, provided that the Argentine government repays them in full. A hefty profit, isn't it? That's how the so-called "vulture funds" make their money - they buy worthless junk bonds for a cheep price from panicking investors and then get their money in court from the government who sooner or later has to repay them. It's standard practice actually. 

Which brings us back to July 2014 and the decision of the New York federal court for Argentina to meat its obligation to these investors. The problem was that the ruling of the judge Thomas Griesa forbade Argentina from paying its obligations to those creditors which accepted the debt restructuring of 2005 and 2010, until they meet their obligations to those who did not accept the restructuring (the holdouts and the "vulture funds"). The logic behind the decision is the "equal treatment" clause called pari passu, implying that borrowers need to treat all bondholders the same. It's not that Argentina didn't have the money to pay - they did, they've deposited $540 million in Bank New York Mellon which was supposed to transfer the money to the creditors. But the court ruled that Argentina could not pay the creditors which accepted the restructuring until it pays off those who rejected it. The court gave them a deadline of July 30th 2014 to arrange a way to repay these creditors. The Argentine government refused. 

Why did Argentina do this? It's not as if they don't have the $1.5bn to pay out to Paul Singer. The story is much more complicated. If they had repayed the money, thus respecting the court's decision, this would have encouraged other holdout creditors to demand full payment on their investment, which raises the price to $15bn. Furthermore other creditors who accepted the initial restructuring could do the same thing, and this raises the bill to over $140bn (30% of their GDP). It's easy to imagine if you're a holder of Argentine debt, and you see others being successful in getting paid in full via a court order, you might as well try it yourself. 

Now its easy to see why the Argentine government had no choice but to declare an unusual default.


This creates problems for other countries in debt restructuring schemes. Namely Greece and certain other European countries. Who is to say that Greek creditors wouldn't follow the example of Paul Singer and bring the whole thing to court. When it comes to your money, vast sums of it, you hardly care of the problems you're imposing on the economy of the debtor country. Just ask George Soros and does he care about the pains he caused Britain in 1992 (one can say that he does, he's into philanthropy now, isn't he?).

Argentina PD From 5Y CDS Spread Updated

But the moral hazard issue is much, much deeper. On one hand you're breaking an essential commitment in the debtor-creditor relationship - an obligation to pay the money back. If someone takes someone else's money and doesn't pay him back, that's called theft. This was what the "vulture" investors are counting on and this is why legally they're 100% right. No doubt about it. 

But on the other hand, if the government does pay to this small fraction of investors it creates a whole plethora of unwanted effects. Payment to them implies paying money to all other holdout investors and possibly those who already accepted the cut on their investment. And after all the "vultures" themselves didn't actually borrow the money to Argentina, they just bought highly undervalued bonds of those who did borrow money to Argentina. But legally, the obligation to pay is mandatory.

The "vulture" investors know this, the Argentine government knows this, all other investors are standing by, so we enter a very interesting bargaining game between the first two. And in this case it's fair to say there is no winner. The holdout "vultures" aren't happy as they're still not getting paid. The rest of the bondholders are being prevented by court to get their money. And as for Argentina, yet another default only pushes their country into further problems.

So what next? More negotiations between Argentina and the holdout investors where some settlement must be reached. In the meantime, the bonds are earning an 8% interest on missed payments which is only to the benefit of the bondholders. Apparently, they can wait. The law is on their side, no matter how President Cristina Kirchner tries to describe it. 

Saturday, 9 August 2014

Week links (9)

Some texts that caught my attention over the past few weeks:

1. Argentina's default
As you may or may not noticed in these summer weeks, Argentina has declared a bankruptcy for the second time in 13 years. They place the blame on a US (vulture) hedge fund and its owner Paul Singer. A "vulture fund" buys cheap debt (bonds) of countries in financial distress for a discounted price and then profits by suing the debtor country, usually striping it of its assets. The coverage: The EconomistForbesWSJWashington PostNew York TimesKenneth Rogoff, etc. 

2. Inheritance flows in Sweden, 1810-2010, VoxEU
An impressive database covering a very sensitive issue of inequality based on inheritence, one of the topics emerging through the works of Atkinson, Piketty and Saez.
"Overall, our analysis of inheritance flows in Sweden since the early 19th century point out two major lessons with respect to the development of capital and its impact on inheritance. Historically, Sweden does not fit the picture of a country where, despite a long history of aristocracy, accumulated capital was large in relation to income (even though inequality and capital concentration might have been high). In more recent times, Sweden stands out as a country where the return of capital has not automatically translated into a return of inherited wealth. It remains to be seen whether this is just a delay based on new wealth being accumulated mainly among the relatively young, or whether inheritance will remain low due to aspects of how intergenerational transfers of wealth are organised in Swedish society."
3. Chris Patten: What I've learned from Vladimir Putin, Project Syndicate
Bottom line is he is not to be trusted.

4. Tyler Cowen: Political booms and financial crisesMarginal Revolution
Cowen finds a very interesting paper showing how abrupt rises of government popularity in emerging economies predict financial crises better than any other warning indicator such as a credit boom.
"We show that governments in emerging economies are more concerned about their reputation and tend to ride the short-term popularity benefits of weak credit booms rather than implementing politically costly corrective policies that would help prevent potential crises."
A sort of a political business cycle, isn't it? 

5. John Cochrane: Work and jail, The Grumpy Economist
Cochrane points out to a staggering relationship between black male high school dropouts and their risk of imprisonment: 
"Nearly 70 percent of black high school dropouts will spend time in jail. And pretty much end their hopes for conventional employment as a result."

He blames the war on drugs for this. An interesting read.

6. Scott Sumner: Economics: Truer than it seems, EconLog
"One thing that economists and non-economists have in common is that they underestimate the power of economic theory. More specifically, they aren't able to accurately connect the predictions of economic theory with the behavior that they (wrongly) think they observe in the people around them. There are many examples of this. For instance, most people (economists and non-economists) underestimate elasticities. They underestimate how strongly people respond to changing incentives, such as tax changes, wage changes, price changes or interest rate changes."
A recommended read to a prospective economist. He offers a very good explanation of the logic behind the Ricardian equivalence. 

7. Acemoglu and Robinson: "Why Lebanon has a very ineffective state" and "The will to make legible" - both on the problems of state formation, Why Nations Fail blog

8. How the year you were born influences your political preferences, NY Times
This one is from the beginning of July, but it's still very amusing - the authors (of the paper not the article) claim that you form your political preferences between the ages of 14 and 24. These are the most formative years, whereas events that happen after you turn 40 don't change your opinion by much. Apparently if you were born in the 1940s your preferences were formed during the Eisenhower administration making you relatively more pro-Republican, while the baby boomers born in the 1950s were influenced by administrations of Kennedy, Johnson and Nixon making them relatively more pro-Democratic. Makes sense.

Well, would you look at that, if I was born in America, I would have been (on average) a Democrat by now, with my political views forged mostly by the Bush and Obama administrations. Interesting...

Tuesday, 5 August 2014

"The state of humanity is improving"

In my previous blog post I called upon some of the evidence from a very interesting website called Human Progress. Once you go to their website the first thing that welcomes you is the sentence from the title. So let's look at the evidence to evaluate is this really so: 

Before you do, have in mind that I'm looking at aggregate numbers and trends of some of the main development indicators of human progress in (mostly) developing nations. 

1. Poverty is declining worldwide 

Looking at the four chosen regions, all of them are experiencing a decline in the headcount of people living below $1.25 a day (adjusted for inflation and PPP, and in relative terms). This is particularly obvious for East Asia (the orange line), and in general for all low and middle income countries (light blue line). Even though this hardly suggests that their living standards are now better, the process of globalization and rapid growth of international trade in the past 30 years has indeed made people in poorer countries better off (as expected).
Globalization (Trade) 1 : Protectionism 0 

2. More food is being consumed in the poorer countries (and worldwide)

This chart only shows selected poor countries, which were near
the bottom of the list in 1990, to show their relative progress. 
The US Food and Drug Administration recommends an average person should eat at least 2000 calories each day. For an increasing number of people this is now a reality as compared to only 20 years ago. In 2008 in only eight countries people on average eat less than 2000 calories (Angola, Burundi, Central African Republic, Comoros, Eritrea, Ethiopia, Haiti, Zambia; between 1600 to 1960), however almost all countries in the sample feature a positive trend, where people have more food at their disposal today than 20 years ago. 
Globalization (Trade) 2 : Protectionism 0 

3. Infant mortality is falling rapidly 

Again the selected countries were those from the bottom of the list,
including the total World figures. In every country this rate has been
on a steep decline since the 1960s. 
A comment from the Economist:
"According to Gabriel Demombynes and Karina Trommlerova of the World Bank, 16 of the 20 African countries which have had detailed surveys of living conditions since 2005 reported falls in their child mortality rates (this rate is the number of deaths of children under the age of 5 per 1,000 live births). Twelve had falls of over 4.4 percent a year, which is the rate of decline that is needed to meet the millennium development goal (MDG) of cutting by two-thirds the child mortality rate between 1990 and 2015. Three countries--Senegal, Rwanda and Kenya--have seen falls of more than 8 percent a year, almost twice the MDG rate and enough to halve child mortality in about a decade."
Lower infant mortality suggests improvements in health and basic medical care, which suggest rising living standards for most of the developing world. Even though most of these developing countries are still far from decent health standards, the trend is certainly positive as it improves the human capital of most of these countries (and hence creates a better chance for achieving economic growth). Better health standards can also be attributed to countries opening up to trade and flow of goods.
Globalization (Trade) 3 : Protectionism 0 

4. In developed countries people are working less

This suggests of a trend where leisure is becoming increasingly more important in the age of consumerism. It's not just about earning money, it's about spending it on an abundance of goods. 
Globalization (Trade) 4 : Protectionism 0 

5. Life expectancy is higher

Arguably the best indicator of human progress is life expectancy. Are we living longer, i.e. have our living standards improved so as to make us more robust to injuries and illnesses. This also improves the quality (and arguably quantity) of human capital, which is the necessary presumption for robust economic growth. Looking at some of the poorest nations, the improvement is significant: from below 40 in the 1960s (btw, this is a very similar life expectancy as in ancient hunter-gatherer societies), to around 55 today. Notice the huge increase for East Asian countries in the 60-ies followed by Middle East and North Africa in the 80-ies (which could also arguably be attributed to their opening up to international trade, particularly for the later group in oil exports). The lowest income countries still haven't experienced the upward bump in living standards, but have gradually followed the trends of higher life expectancy. As their economies start trading more, standards will rise. 
Globalization (Trade) 5 : Protectionism 0 

6. Rich countries pollute less 

This indicator suggests that countries are becoming more aware of the pollution issue. However as the West is decreasing its pollution, the newly industrialized Asian countries have increased it over the past decade. 
The scoreline is unclear in this one (does globalization lead to more pollution, if so, shouldn't the rich countries pollute more? Or is this an effect of anti-pollution regulation?)

Apart from these, the Human Progress website offers a number of other indicators confirming the pattern of this story. Literacy rates are rising significantly in the poorer regions, as are health standards and the availability of water supply. Disposable income of the population is higher than 40 years ago, less people live in slums, and more energy is being consumed. People are travelling more, visiting more places, the transportation infrastructure has improved and is connecting more people, internet and mobile phone users are growing rapidly, while, as reported before, violence in all forms is dropping. The only thing that could be improved is good governance, in terms of corruption, rule of law, civil liberties and press freedom. However with globalization leading to drastic changes in information availability and living standards over the decades, this will be the key factor for inclusive economic institutions to destabilize the politically extractive ones and overrule the dictators and the sovereigns, thus freeing their populations from the poverty trap. Progress, in the upcoming age of informational abundance, cannot be halted by anyone. 

Wednesday, 30 July 2014

Is the World a safer place?

A bit of international relations and foreign policy this time (a slight digression from economics).

Consider the following recent events:

A passenger flight gets shot down by a surface-to-air missile in the middle of Ukraine by pro-Russian separatists amid growing concern and discontent over the country's future. The global superpowers have been flexing their muscles over Ukraine far too long without any positive solution near the horizon. The EU and US are blaming and sanctioning Putin, with further frictions bound to happen.

Israel is issuing a full-blown attack on Gaza aimed at destroying the Palestinian terrorist group Hamas, with again hundreds of civilians being killed in rampant bombings. Israel seeks to destroy underground Gaza tunnels, frequently used by Hamas for terrorist attacks. Almost 90% of Israelis support the attacks.

The situation in Syria is still far from being resolved, Iraq and Afghanistan are in shambles for the past 10 years, Iran's nuclear program is a new boiling point of international diplomacy, Egypt is still in post-revolution mode, while the situation in Sub-Saharan Africa is, as always, in either economic or political chaos.

The Western nations aren't immune to violence either; reports have been on increased crime due to the negative consequences of the crisis, in addition to a multitude of protests and anger among the population fed up by a woeful response of their political elites to the crisis. 

However, despite these stories the broader evidence on wars, crime and violence seems to suggest otherwise. The data comes from the Human Progress website (HT: Cato)

The death rates from wars have gone down significantly, as have those from genocides. The rape and homicide rate in the US have dropped significantly since the early 90-ies (the data is similar to some European countries as well). However on the final graph, even though terrorist attacks seemed to have dropped, there is a slight spike by the end of the series (this includes only terrorist attacks in non-war areas). Overall by exploring additional data on e.g. child abuse, conflicts, assault and even gay rights, violence does seem to be declining. 

So to answer the question from the title: "is the World a safer place?" - as always: that depends. Compared to 30-40 years ago, I would say definitely. This is however highly related to increasing personal wealth of the population and the benefits of globalization. The culture of consumerism creating the perception of abundance is a powerful weapon against violence. On a wider level, international trade is arguably a very useful mechanism to prevent inter-country conflicts. Whenever the economic motive prevails, wars are the worst preferred outcome. 

However is the World actually safe, I would say not really. It's certainly safer than before (at least in the West), but this doesn't imply we're at our best behavior quite yet. As the opening paragraphs of this post remind us there are always frictions, wars, violence and killings. Using economic motives such as trade helps curb these conflicts, but there's still a long way of using such incentives effectively. Actually, the sanctions imposed on Russia will be an interesting case study of this mechanism (unless they can hold it out until the winter, that is). 

Tuesday, 22 July 2014

Graph of the week: The misery index

Recently I came across a new interesting index of economic development measuring the opposite of the usual wealth, prosperity, happiness and income p/c. This one ranks countries in reverse order, it measures their relative "misery" with respect to their unemployment situation, inflation and bank lending - so all the stuff that makes people poor and hence miserable.  

Steve Hanke of the Cato Institute and John Hopkins University, used the data from the Economist Intelligence Unit ranking 89 countries. He applies a very simple methodology: sum of inflation, bank lending and unemployment rates minus year-by-year per capita GDP growth (so as to offset the temporary negative effects of the former variables). He got the intuition from Arthur Okun and Robert Barro who used things like inflation, unemployment and government bond yields to measure relative misery levels in the US during different Presidential administrations.

The first apparent criticism to such an approach is relatively scarce usage of variables to put into the index. Furthermore these are all aggregate and very broad macroeconomic categories, which can send a signal of how the country is doing but fail to distinguish for other institutional characteristics of countries that do make a huge difference with respect to how the adverse event hits the population. For example, losing a job in Spain, Portugal or Greece is arguably not the same as losing a job in Iran or Venezuela. The macro category of high unemployment tells you nothing of the state or the flexibility of the labor market (btw, recall that unemployment rate isn't even the most precise indicator of the labor market) nor does it say anything about the unemployment compensation the unemployed receive. This factor alone biases many countries upwards on the list. 

Perhaps he could have included more stuff (such as what the Legatum's Prosperity Index uses) and weight them all differently, but for the sake of argument let's call it a decent indicator as it does seem to capture the relative levels of temporary misery in many countries. Even if we accept the argument that the aforementioned European countries may be more stable than non-European ones, it's still hard to dispute the fact that many people in these countries feel very miserable at the moment. Finally, taking a glimpse over the index rankings, it does seem to paint a pretty similar picture as many other indexes out there, except in this case the scale is reversed (what's up is bad, what's down is good). 

However by looking at it in greater detail, you can spot some of the apparent biases - like the zero inflation biasing Japan downwards, or the fact that Scandinavian countries (which usually top all the prosperity and happiness based indicators) tend to be quite far from the bottom (and bottom is good here), probably due to unemployment biasing them upwards. And this isn't really realistic. Are the people in China, Malaysia, Panama or Thailand really less miserable than their Scandinavian and Western Europe counter-parts? I doubt it. In these cases the high growth rates of some Asian countries bias them downwards on the index.   

All in all, an interesting indicator, but not really too precise in actually measuring the people's relative misery. In any case I would rather refer to the Economic Freedom Index or the Legatum Prosperity index