[A-List] Argument for Argentine Debt Repudiation

["Anyutka" <annewilliamson@xxxxxxx>]

http://www.mises.org/fullstory.asp?control=1472

Argentina's Paper-Money Mire

By Grant M. Nülle

[Posted March 19, 2004]

Argentina's descent from economic prominence throughout most of the 1990s to
purgatory by the end of the decade is a miserable tale instilling heartache
and frustration in all parties involved. More importantly, this tragedy
underscores the inherent hazards of state participation in capital markets.

On March 8, Argentina's government averted joining these pariahs as a state
in arrears to the International Monetary Fund (IMF) when it indicated the
country would shell out the $3.1bn due to the multilateral lender. Besides
evading complete ostracism from international capital markets, the moves
pave the way for a resumption of Argentina's access to Fund lending later
this month, the impetus for the apparent quid pro quo.

The tentative reprieve comes on the heels of escalating bitterness between
Argentina and its private and multilateral creditors. Tensions have
burgeoned since Jan. 28 when eight out of the IMF Executive Board's 24
members, including the trio appointed by Group of Seven (G7) countries
Britain, Japan and Italy, abstained from endorsing a $350m disbursement of
the Fund's 3-year, $13.5bn accord with Argentina. The withdrawal of support
testifies to the deep-seated reservations some countries harbor about
continuing to extend credit to the debt-ridden government in Buenos Aires.

The skepticism is in large part prompted by the combative stance Argentina's
president, Nestor Kirchner, has taken to restructuring billions of dollars
of defaulted principle and interest due to holders of the country's
sovereign debt. Not only do domestic and foreign bondholders wish to be
indemnified but also multilateral lending organizations, ultimately
bankrolled by governments, would like Argentine authorities to honor the
terms of the loans these institutions so lavishly heaped on the country over
the past decade.

>From boom to bust
In 1990, with the county in the throes of another bout of economic and
political turmoil, the incoming administration of Carlos Menem faced the
daunting task of subduing inflation, which at that time was running at 150%
per month. After inaugurating his tenure by transferring interest-bearing
bank certificates into government bonds-effectively pilfering the savings of
depositors-Menem appointed Domingo Cavallo to apply market-oriented
austerity measures to the economy[i].

At the center of Cavallo's reform package was the "convertibility law,"
which pegged the peso one-to-one to the dollar, thereby limiting the
Argentine government's ability to create money.

In nearly a single stroke, Argentina's battle with hyperinflation subsided,
as the annual figure plunged from 4000% at the advent of the convertibility
law to 4% by 1994. Concurrently real GDP growth exceeded 5% per annum each
of those years.

Another consequence of the quasi-dollarization of the Argentine monetary
system was the influx of foreign investment. Emboldened by the IMF's
endorsement of Cavallo's reform package, which implicitly constituted a
rescue pledge by the multilateral lending body, international creditors
returned in droves to derive their fortunes in another emerging-market
economy.

Akin to the East Asian countries that were also fashionable investment
venues throughout the 1990s, the Argentine central bank's coffers filled
with dollars from abroad, enabling the institution to expand the country's
monetary base. Additionally, the country's private firms deposited loan
disbursements from foreigners into domestic banks, further swelling the
money supply.


The twin financial scourges of fractional reserve banking and a central bank
abetted fiat currency pervaded the Argentine economy, making a boom and bust
possible.

Thanks to the financial chicanery of central and fractional reserve banking,
Argentina's money supply burgeoned at an average annual rate of 60% between
1991 and 1994. Notwithstanding Mexico's tequila crisis in 1994 and 1995,
which prompted Argentina to post negative GDP growth in the latter year and
nearly scotched the convertibility law, M1 money growth was still positive
at 5% in 1995 and increased by 15% and 20% in 1996 and 1997,
respectively[ii].
By 1998 the accretion of money in the economy had taken its toll,
exacerbated by neighboring Brazil's-Argentina's largest trading
partner-currency devaluation. Foreign capital infusions petered out as a
hopelessly overvalued exchange rate, brought about by rising domestic prices
and Argentine authorities' devotion to the one-to-one, peso-dollar peg
appeared unshakeable. The heady boom of the 1990s, where GDP growth averaged
4.5% between 1990 and 1997, turned to bust as the Argentine economy lurched
into recession.

Borrow and Spend
Argentine politicians' propensity to borrow and spend accelerated in tandem
with the country's GDP and money supply growth during the 1990s. Unable to
reside within the limits of a balanced budget the government tapped domestic
and international capital markets to plug the shortfall in tax revenues
vis-à-vis spending.

National government borrowing sprees were matched by the indefatigable
spending tendencies of Argentina's provinces, which benefited from a
constitution that permitted subnational authorities to splurge relentlessly,
with a correspondingly feckless central government stuck footing the bill.

>From 1993 to 1998 Argentina's entire public sector posted an increase in its
indebtedness-to-GDP ratio from 29.2% to 41.4%. The rapid clip at which loans
were accumulated was altogether more substantial considering that throughout
the 1993 to 1998 period-save during Mexico's tequila crisis-GDP growth and
the attendant cyclically spurred upsurge of tax receipts were impressive. At
the same time, the central government was engaged in privatizing moribund
state firms and assets, which supplemented the treasury's revenue intake. In
sum, Argentine authorities could not run budget balances even amid robust
economic growth and one-off collections of privatization proceeds.

As one would expect, the necessity of borrowing to sustain public spending
in even the best of economic conditions portended fiscal travails for
Argentine politicians as recession beset the country in 1998. Declining tax
revenues coupled with rising demands for social spending (the other side of
the cyclical coin) made fiscal consolidation more difficult to enact.

By late 2000, with one out of every five emerging market bonds worldwide
issued by Argentina and its economy tanking, international investors began
to question whether the country's mushrooming public debt would continue to
be serviced.

Notwithstanding two last gasp attempts spearheaded by the IMF (discussed
below)  in January and August 2001 to ward off an impending default, the
political unfeasibility of fiscal tightening amid a protracted bust phase
generated by fractional reserve banking proved too much for Argentine
officials to surmount.

Faced with rising public discontent over a protracted recession, escalating
interest rate spreads over US treasuries, and overwhelmed by rampant bank
runs, Argentine officials abrogated the convertibility law and terminated
regular payments on its domestic and external debt obligations of over
$132bn-the largest sovereign default in history.

Settling Up
After nearly a decade of consistently positive GDP growth, privatizations
and trade liberalization, Argentina was again a financial leper. After
another year of penury in 2002, when GDP contracted by 11.2%, the economy
grew by 8.4% in 2003 (the second highest rate in the world after China).
Higher commodity prices, a revival in domestic consumption and an upswing in
manufacturing stoked by a sharply devalued peso prompted the
resurgence[iii]. GDP growth for 2004 is expected to remain vibrant, albeit
slightly lower, from 4 to 6%.

The political picture has become more stable, relative to the raucous 1990s,
as the former governor of the Patagonian province of Santa Cruz, Nestor
Kirchner, has stamped his authority on the presidency since assuming office
in mid-2003, taking to task the political actors that helped precipitate the
country's boom and bust.

Corresponding to the revival of the country's economic fortunes, Argentina's
tax take posted a 32% augmentation over 2002, with the government's revenues
as a percentage of GDP back to its pre-recession level of 20%.

Despite the unanticipated resilience of the Argentine economy during 2003,
the country's GDP is still 14% smaller than it was five years ago. Foreign
financing of domestic firms is scarce, typically short-term in duration and
subject to punitive interest rates. As private firms absorb the available
stock of indigenous capital equipment and surfeit labor, these enterprises
will become increasingly reliant on foreign lending to sustain the
expansion.

With securing outside financing becoming imperative and the central
government awash in tax revenues, the time for restructuring the
approximately $100bn of total debts and $700m of interest in arrears accrued
monthly has come to the fore.

Mutual Recriminations
On March 10, Argentina's cabinet chief reaffirmed the government's
negotiating position, unaltered since it was first unveiled in September
2003. For every dollar (or foreign currency equivalent) worth of defaulted
bonds held, Argentina will exchange it for a new bond with a face value
worth approximately a quarter, bearing a coupon of one to two percent and
maturity of 20 to 40 years. Put succinctly, Buenos Aires has demanded a
write-down of approximately 92% of the obligations' net present value.
Compensating lenders beyond these terms would not come at "the suffering and
hunger of the Argentine people," according to President Kirchner.

Foreign creditors have responded to Kirchner's hard-line bargaining position
with dismay and obstinacy, rejecting the offering outright and countering it
by advocating a net present value write down of a more modest 50 to 60%.

Despite efforts to consolidate bondholder representation, including the
January 12 announcement of the Global Committee of Argentina Bondholders
(GCAB) and its steering group, which has brought aggrieved institutional
investment firms and hundreds of thousands of European, East Asian and other
retail investors together, the restructuring task remains acutely complex.
Indeed, the existence of more than 100 separate bonds originating in eight
jurisdictions and denominated in seven different currencies testifies to the
daunting nature of the world's largest debt restructuring ever[iv].

Consistent with the hardened quality of his inaugural restructuring offer,
Kirchner's administration had refused, until March 8, to recognize the
legitimacy of the recently constituted GCAB. The dispatch of an Argentine
official to attend the 24 February meeting of the bondholder organization in
New York City as a mere observer had demonstrated the government's
unwillingness to seriously engage a body collectively comprising $37bn in
defaulted debt. The GCAB subsequently reciprocated the gesture by
withdrawing from the consultative mechanisms instituted by Buenos Aires,
thereby aggravating already rancorous relations.

Before Argentina's recent recognition climb down, the GCAB and other
shortchanged lenders have resorted to and will likely continue to pursue two
avenues utilized by creditors to extract payments from deadbeats: reliance
on the court system to seize assets and calling on strongmen to exact
payment.

Earlier this year, U.S. courts froze Argentine assets in Maryland and inside
the Beltway, at least opening the door for lender confiscation. But as
Thomas Griesa, one of the judges adjudicating these legal maneuvers
observed, seizing Argentine assets in America or in any other country is
largely ineffectual, saying, "I do not imagine that the Republic of
Argentina has a lot of commercial activity in the United States."

Bereft of a fighting force capable of appropriating government assets,
Argentina's creditors have increasingly relied on the financial muscle of
the IMF to intervene in the dispute, assertively, if necessary.

Disciplinarian or enabler?

The only means to exorcise the debt demon is to deny government access to
credit, namely by repudiating all outstanding obligations to multilateral
and private lenders alike.

Throughout almost the entire period spanning the advent of the
convertibility law to the present Buenos Aires has been subject to Fund
assistance and oversight. From the outset the relationship can best be
portrayed as one between an alcoholic and bartender, with the latter (the
IMF) unwilling or unable to temper the former's (Argentina) zeal for binge
drinking (borrowing).
 In 1995 when government borrowing began to exceed stipulated targets, the
Fund lifted the fiscal deficit ceiling rather than penalizing its errant
pupil. During the episode of rapid economic growth (1995 to 1998)
Argentina's consolidated budget balance breached quarterly targets more than
half the time, despite being revised upward more than once in the country's
favor and swelling tax coffers. The Fund did little more than pardon the
transgression officially with a waiver, or simply turned a blind eye to the
indiscretions[v].

This permissiveness was duplicated in late 2000 and early 2001 as the
ongoing economic recession continued to take its toll on commercial activity
and the government's fiscal position. Again, the central government's
habitual failure to meet even lax deficit targets in that quarter was
ignored by an equally incorrigible IMF. On January 12 the Fund released $3bn
(the first tranche of a revamped $14bn Stand-by package) in what was seen as
the last internationally supported package designed to help Argentina avoid
sovereign default, a possibility that had been openly discussed since the
autumn of 2000.

However, the Fund caved in again in August as the first last-ditch bailout
faltered. This time a $6bn check from a multilateral lender found its way
into the hands of the Argentine government. The transfer was achieved
through a fait accompli orchestrated by none other than Domingo Cavallo (who
had been recalled from America's Ivy League to rescue the economy and
subsequently resigned prior to the default), which enabled a sovereign
borrower to dictate the amount and timing of Fund support, a first in IMF
history.

What is so chintzy about this feat is that the debt default that occurred in
December of 2001 was already inevitable: $6bn in internationally-lended
(taxpayer-funded) assistance was wasted on an abortive undertaking.

Over the past two years the spineless bartender-binge drinker
analogy-notwithstanding the most recent events-has been reinforced. After
effectively blackmailing the Fund in January 2003 into rolling over
Argentina's defaulted debt to multilateral lenders through August 2003 by
deliberately suspending a payment to the Inter-American Development Bank,
the economy minister, Dr. Roberto Lavagna, wielded the metaphorical broken
bottle again in September of 2003. Refusing to stump up $2.9bn owed to the
Fund-the largest nonpayment of a loan in that organization's history-Lavagna
and his boss, Nestor Kirchner, won another deal on extremely generous terms.

Besides refinancing $21bn in debts to multilateral lenders, Argentina
committed to run a modest primary surplus (tax revenues before interest
payments) of not more than 2.5% of GDP in 2003 (which Buenos Aires has
easily exceeded) and only 3% in 2004. After clinching the deal, Kirchner
magnanimously countenanced rescinding the suspension of the $2.9bn
repayment.

Clashing interests

Presently Argentina owes the IMF approximately $16bn (15% of total Fund
lending outstanding) along with another $18.3bn and $1.9bn to the World and
Inter-American Development Banks, respectively. As if Argentina's debt, far
exceeding the cumulative borrowing limit member states are permitted to
access under Fund rules, was not enough, Buenos Aires's principally
implacable and mean restructuring offer to private lenders may breach its
commitment under September's IMF Letter of Intent to negotiate in "good
faith."

To meet this requirement the Fund has asked that Argentina acknowledge the
GCAB as a de jure interlocutor, lift the acceptable threshold of investor
participation rates and formally ink the investment banks tapped by Kirchner
to negotiate on the government's behalf. In addition, Fund paymasters, the
G7, have stipulated that debt repayments owed by Argentina to the
multilateral lending institutions take precedence over reimbursing private
creditors.

In spite of repeated bouts of intransigence, Buenos Aires seems willing to
comply with G7 strictures, for paying off debt owed to the IMF and the other
multilateral lending organisations, only 20% of Argentina's total debt
burden, rankles private creditors, sewing discord between the Fund and the
bondholders it has been called on to assist. After all, the more Argentina
earmarks to the Washington D.C.-based organizations, the less it has to
offer everyone else.

By pledging to pay the IMF $3.1bn in obligations due, acknowledging the GCAB
as a legitimate emissary, and agreeing to constructively negotiate with all
creditor groups by the end of March-enshrined in a letter of intent inked on
March 10-Argentina has conveyed mixed intentions to rival creditors, likely
driving a wedge between multilateral and private lenders.

Blame game

Who then is to blame for the current state of affairs, where a country's
populace-50% of Argentina's 36m inhabitants dwells in poverty-is recovering
from a protracted recession, bank failures and political upheaval? Where
should accountability be allocated when private lenders are not receiving
timely payments of interest and principle and taxpayer contributions the
world over were squandered by a spendthrift government ultimately bankrolled
by other states?

The obvious answer is the Argentine government itself. Despite nearly
uninterrupted economic growth, a burgeoning tax take and supplementary
income from privatizations, the country's public sector (both central and
provincial) could not match expenses to revenues.

The twin financial scourges of fractional reserve banking and a central bank
abetted fiat currency pervaded the Argentine economy, making a boom and bust
possible. Taken together, excessive borrowing during the expansionary years
obviated Argentine authorities capacity to service the massive debt, which
became irredeemable as tax revenues dried up amid the recession.

The IMF was well aware of these perilous trends throughout the 1990s but did
little to admonish, let alone take action, to discipline the prodigal
politicians in Buenos Aires. Institutional impediments, the Fund's area
departments' remit includes cultivating relationships with the borrowers
they are charged with monitoring, as well as image concerns-the IMF took
flak throughout the late 1990s about its performances in East Asia and
Russia-prevented the Fund from chastising one of its success stories.

Furthermore, the multilateral lender's approval of Argentine policy since
1990-lax surveillance throughout and a propensity to continue lending
regardless of adherence to program targets-emboldened private foreign
entities to maintain lending and investment activities in Argentina even as
government finances unraveled.

For its part private creditors should have known better than to bankroll a
government and economy as ill starred as Argentina's. Frequent changes of
government, alternating between civilian and military since 1930 coupled
with a parallel rise of state intervention in the marketplace, have sharply
attenuated Argentine capital formation and savings. From 1960 to 1994 the
economy averaged an annual inflation rate of 127% and received between 1980
and 1994 15 ineffectual adjustment loans from the IMF and World Bank
combined[vi].

Like the Fund, international and domestic investors blithely dismissed the
rapid accumulation of debt by Argentine authorities and continued to lend on
generous terms even as government debt dynamics began to appear
unsustainable. Allured by the high-yielding bonds on offer in the Americas,
especially after the East Asian "miracles" succumbed to contagion,
undaunted, risk-tolerant creditors were willing to redirect capital to
Argentina, the star of the emerging-market debt arena.

All too eager to accommodate investors, Buenos Aires managed to float a
sizeable amount of debt in late 1999 through early 2000, notwithstanding a
severe economic contraction.

Taken together, profligacy, carelessness and the inability or refusal to say
no, conspired to produce the miserable situation the troika of Argentina,
private lenders and the IMF confront today.

Abolishing sovereign finance
Of course the licentiousness and pliant stance towards reckless lending and
borrowing are mere symptoms of the root cause of Argentina's tragedy. The
ability of governments to borrow enables politicians, bureaucrats and the
constituencies that receive succor at the public trough to live beyond the
means they seized from taxpayers, knowing full well that the exploited,
productive class will also foot the bill due to investors keen on purchasing
government bonds.

In the case of Argentina, the only means to exorcise the debt demon is to
deny government access to credit, namely by repudiating all outstanding
obligations to multilateral and private lenders alike.

To the casual observer this suggestion is anathema for it violates the
sanctity of contracts. However, as Murray Rothbard correctly explained,
there is a fundamental distinction between private and public debt[vii].

In the former case, where a low-time preference creditor lends money to a
high-time preference borrower in exchange for repayment plus interest, to
repudiate one's debts is tantamount to depriving the lender of his property,
which is indefensible.

In regard to public debt, governments do not pledge their own assets, but
taxpayers' instead, with creditors cognizant that the principle and interest
will be paid through the involuntary confiscation of private
property-taxation. In effect, both sides are complicit in the violation of
property rights of a third party in the future, which scarcely deserves to
be acknowledged as a contract.

Beyond the dodgy status of sovereign borrowing, debt repudiation is
beneficial in two respects. Immediately it alleviates the citizenry of
onerous repayments on obligations issued by previous governments. More
importantly, by denying the Argentine government credit altogether, as
lenders will be liable to do, it will be compelled to operate within the
constraints of a balanced budget, a novel notion in that country's history.

Indeed, many of Argentina's economic ills throughout this and the past
century can be attributed to politicians' insatiable appetite to borrow and
spend, with the attendant annihilation of the citizenry's savings and
capital as the central bank's printing press has often been utilized to
ameliorate substantial government debt burdens.

A harsh, but necessary remedy

Initially, private Argentine firms will likely suffer rebukes from
international capital markets due to government debt repudiation. However,
when the citizenry is relieved of massive tax-funded repayments on these
obligations and no longer saddled with a credit-worthy government, foreign
lending will return to invest in promising private enterprises. Likewise,
indigenous capital formation can emerge as the profligate public sector is
reined in. Fortunately, Argentines are estimated to have stashed close to
$100bn of savings abroad, hopefully a substantial portion can be
repatriated.

With respect to private creditors, as shameful as the blatant deprivation of
the funds loaned to Argentina may be, such arrangements clearly infringe
third-party property rights and are an affront to liberty. Hopefully
Argentina's debt repudiation will serve notice to prospective lenders that
states, the only entity in society-save criminals-that exist at the expense
of others, are parasitic and wasteful consumers of capital undeserving of
investment.

Alternatively, as Rothbard suggested, a government mulling unilateral
cancellation of its debts may at least partially allay creditor contempt by
selling state assets and channeling the receipts to servicing its
obligations. The plight of small investors in Italy (450,000 people,
including pensioners, hold $12bn-worth of Argentine bonds), Japan (40,000
possessing $3.02bn) and elsewhere is especially dire and may merit such
attention.

Concerning the IMF, debt repudiation would be a fitting lot for an entity
culpable in precipitating Argentina's boom, bust and default. The Fund was
instrumental in engendering Argentina's present woes through lax oversight
and an implicit bailout guarantee, which was actualized when Buenos Aires's
fiscal fiasco became insurmountable.

Essentially a nascent central bank charged with rescuing feckless
governments and the private international financial institutions that
underwrite sovereign debts, the IMF accomplishes its mission by funneling
member state contributions (quotas) to distressed borrowers, in the process
imbuing moral hazard in both parties.

In other words, this international organization lends contributions supplied
by governments, whose quotas are met via the involuntary confiscation of
property (taxation), to recipient states in order that the beneficiaries
continue to service public debts to private lenders, also a nefarious
compact that entails violating the property rights of a third party. This
facet of the international financial architecture is nothing more than
systematic pilfering.

As a lender reliant on stolen goods as its source of its capital, the IMF
warrants scant recompense for its haphazard lending practices, let alone
deserves precedence over other creditors. At least private institutional and
retail lenders staked their own fortunes, however imprudent, when investing
in the Argentine government, an inherently loss making proposition.

In sum, Argentines would be wise to petition the politicians in Buenos Aires
to repudiate the public debt-though perhaps compensating small retail
investors via the sale of government assets-ultimately divesting the state
of the prerogative to borrow.


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Grant M. Nülle is a Research Fellow at the Council on Hemispheric Affairs in
Washington D.C. He can be reached at grantn007@xxxxxxxxxx See his archive
and discuss this article on the blog.



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[i] Skidmore, Thomas E. and Peter H. Smith. Modern Latin America. 5th ed.
Oxford UP, 2001.

[ii] Salerno, Joseph T. "Confiscatory deflation: The Case of Argentina."
Mises.org. 13 Feb. 2002.

[iii] "Argentina bounces back from recession."  Financial Times. 20 Feb.
2004.

[iv] "Argentina on the edge."  Financial Times. 7 March 2004.

[v] Mussa, Michael. Argentina and the Fund:  From Triumph to Tragedy.
Institute for International Economics, 2002.

[vi] Easterly, William. The Elusive Quest for Growth. MIT Press, 2002.

[vii] Rothbard, Murray N. "Repudiating the National Debt."  Mises.org. 16
Jan. 2004.

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