When one car slides down an ice path, that could result in fifty cars crashing. This is what is happening with the international financial markets: Mexico’s default in 1982 led to the accumulation of debts of dozens of countries.
The devaluation of Thailand in July 1997 caused the Asian financial crisis. The bankruptcy of Lehman Brothers in September 2008 also triggered the Great Recession worldwide.
International financial institutions must be smarter than they start to collapse in 2020 because of “Covid 19”. Her wisdom will soon be tested.
Argentina was experiencing a debt crisis again, even before Coved-19 plunged the world economy into its worst economic recession since the Great Depression. As has often happened in the history of Argentina, which suffers from the problem of defaults, an ill-conceived agreement with rebel creditors in 2016, which was followed by a rapid return to bond markets, proved to be a dream of the then president of Argentina, and the country’s creditors.
The fiscal deficit undermined stability, as the 2018 bailout failed to succeed with the International Monetary Fund, and Argentine debt, which has very high interest rates, proved unsustainable.
However, Argentina was not the only borrower, with lenient lending standards thanks to financial markets, and as a result of ample liquidity pumped by the Federal Reserve and other central banks, many developing countries to borrow heavily in recent years, and it was recognized that sovereign debt distress represented Major overall risk.
In the context of “Covid 19”, the collapse of oil prices in March, the start of the near-global closure, and the decline in government revenues led to a global financial crisis unprecedented in peacetime. The US budget deficit will rise to about 18% of GDP, or higher.
For many emerging economies, the financial picture cannot be darker. But even in this context, Argentina made a realistic and appropriate offer to restructure its debt to its creditors, and its creditors must respond positively. Here are the details of the offer.
Argentina’s current debt has an average interest rate of 7%. Argentina rightly noted that a 7% interest rate would necessarily result in default. The International Monetary Fund has agreed that it is unsustainably high.
Argentine creditors say they need an interest rate of 7%, or even higher, because of the possibility of default. But they seem to be unaware that if Argentina’s interest rate is lowered to approach the US interest rate, default will not necessarily happen. Also, a high interest rate of 7% is a self-fulfilling prophecy: it makes defaults inevitable, while this will not necessarily happen if the interest rate is low.
Argentina proposed to refinance the existing debt at low safe interest rates, thus avoiding the need to impose a “reduction” on the capital.
Similar to the mortgage refinancing process, existing bonds will be replaced by bonds that reflect lower interest rates today. However, instead of an interest rate equal to the price of US treasury bonds, Argentina offers an interest rate of 2.3%, higher than the treasury yields in its creditors ’portfolios.
But the phases of creditors are strange. They claim that Argentina is imposing a significant reduction in the value of the debt, although it is essentially non-existent.
Creditors calculate the alleged debt undervaluation in Argentina’s offer using a 10-12% discount rate, as if they deserve a risk-free return of 10% or more, when the US Treasury rate is just over 1%.
The financial press follows these conditions, indicating, out of a sense of duty, that Argentina imposes a significant reduction on creditors, while it does not. Indeed, Argentina is reducing the interest rate that runs the risk of default, to an interest rate that will not cause this.
Global financial markets often panic when one country, let alone many, begins to slip. There are likely to be 30-40 countries in severe financial distress now. All of these countries need to refinance their debt this year and next.
In such cases, collective rationality in financial markets requires guidance from the International Monetary Fund and the leadership of a number of key creditors. Otherwise, this will lead to a creditors race to extract the assets (a form of the principle of the prisoner’s dilemma). Each creditor says to the other: “You refinance the debt while I receive the payment, thank you.”
When the banks panicked in 1907, it was J. Perpont Morgan and his bank that led the financial system away from the brink. In 2020, the leader must be BlackRock, which was managing $ 6.5 trillion in assets at the end of the first quarter of the fiscal year, and it is one of Argentina’s major creditors.
Black Rock can direct the bondholders to refinance Argentina’s debt at a safe rate of interest, and to do the same with other sovereign borrowers, who are suffering from the epidemic.
It’s your turn, Larry Fink, to help prevent a global financial disaster.
* Professor of Sustainable Development, Professor of Health Policy and Administration at Columbia University, Director of the Colombia Center for Sustainable Development and Director of the United Nations Sustainable Development Network.
