Volcker's priors

The Economist features (and only mildly disagrees with) my piece with Arvind Subramanian on financial globalization this week.  Did I mention that I find them quite agreeable these days...

Coincidentally, I made a presentation on the same topic at a breakfast meeting today at the Council on Foreign Relations in New York, organized by my old teacher Peter Kenen.  Paul Volcker was there, and he said he had come to reinforce his priors that all this money sloshing around international capital markets had not done a whole lot of good.  He seemed pretty well satisfied...

On a more dissonant note, I found a surprising amount of hostility to Argentina around the CFR breakfast table. This is after all a country that is growing faster than any decent-sized country in Latin America, and doing so for good Asian reasons (high saving, high investment, competitive currency, external and fiscal surpluses). Oh, of course they still have outstanding debt they are not repaying and they are getting very little FDI.  So they do look like pretty bad business from a Wall Street perspective.

More on Argentina after my trip there next week...

Comments

[Nathan Smith]

I wonder if the benefits of "cheap exports" will continue to hold. Yes, East Asia succeeded that way. But since then, attempts at export-led industrialization have appeared all over the place. As a result-- as a result of the phenomenon generally and of China in particular-- the terms of trade for tradable manufactures have deteriorated. It sometimes happens in markets that following yesterday's winning strategy is a way to lose.

[Nathan Smith]

Oh, and it *is* generally considered basic ethics to honor one's debts, is it not?

[Minivet]

I understand there was something similar at the Malaysian institution of currency controls during the Asian financial crisis: "they spurned us, but the policy will ruin them, and that'll scare everyone into always obeying the orthodoxy of financial liberalization!" With a rather inappropriate amount of glee.

That plan didn't work out so well. Down the memory hole.

[Joao Farinha]

I guess than, in responce to Nathan Smith above, "honor" is just another word in macroeconomics. Another way of putting it is, who's honor? I continue bumping into this evidence that, 70 years after Keynes, some still can't conceive the economy of a country differently than the economy of a household.

If I don't pay back my personal debts, I may go to jail, or I may never get a loan again, in which case, I really have to change my ratio of expense/income for a long time.

At a country level... mmm... they (Argentina) are growing no?

[Nathan Smith]

re: "If I don't pay back my personal debts, I may go to jail, or I may never get a loan again, in which case, I really have to change my ratio of expense/income for a long time. At a country level... mmm... they (Argentina) are growing no?"

But I was raising an *ethical* point. The ethical principle is "you should honor your debts, even if you can get away with not honoring them."

I can imagine there might be some complex reason why a country isn't subject to the same ethical obligations as a private person. But it seems at least plausible that a country does have an ethical obligation to pay its debts, and that one which does not do so puts itself in the wrong and merits some hostility.

[Holger Siebrecht]

Re: Nathan's point, I don't think it's _that_ obscure of an ethical argument why one might not want to repay. Much of the debt was taken on under the military regime and then under Menem where corruption was (as it still is) rampant. That means that agents in a previous period took on debt for illegitimate reasons that the agents in the current period should be on the hook for. You can agree with that but you can also not agree with that.

I'm a little stunned that nobody is mentioning inflation. Given Argentina's horrible track record of inflation and its current misreporting, with official inflation around 14% annually but real inflation quite possibly more around 45% annually and no real option of how to check it on the table, this is what worries me most, I have to say as it has the potential to slow growth subtantially.

[Minivet]

Nathan: I see no moral obligation to pay debts if it's literally impossible, or would severely pauper you long-term (and Argentina's inflation drove debts into that realm). Bankruptcy was designed to deal with that problem.

Lending as a practice incorporates the risk of default; that's what interest and credit ratings are for. So it feels silly to declare default somehow outside the ethical boundaries - besides general obligations to deal ethically (not cover up risks, etc.), of course.

[Nathan Smith]

The "odious debt" argument is a very interesting one. If it became a generally established principle that democratic successors are not responsible for debts incurred by autocratic regimes, that would, as far as I understand, largely destroy the creditworthiness of autocracies. Which I would applaud! But one might retort that development lending can sometimes help countries, and that it's not always feasible or desirable to wait for the country to become a democracy before you offer it. If you think that, and it seems to me at least tenable, a default on odious debt would set a troubling precedent. And Argentina may be ruining things for lots of other non-democratic poor countries that could benefit from development lending.

If the principle of odious debt is what's at stake, it would be more useful if a country made an explicit repudiation of odious debt NOT as a result of a financial crisis. A totalitarian regime falls, and the new democratic government says, "Our economy is doing fine, but we're not paying a dime of this debt on principle, because nobody should have been giving money to our oppressors."

In short, I can see both sides.

[Gabriel]

Holger,

I am not much of a fan of ethical arguments on economics but there is simply nothing supporting the idea that Argentina's debt was somehow illegitimate.

[Sebastian]

Gabriel and Nathan:
Well... Argentina's development in the 90s is a complicated story, but at least in the eyes of most Kirchneristas the debt was accumulated because Arg. was following the advice of the IFIs (imho thay may be pushing it a bit) but I think what's certainly a fair point is that a big chunk of it was added because of the IMFs horrible crisis "management" that prolonged and intensified the 2001/2002 crisis and inflated the debt burden Arg. was left with.

As for the "ethical" point -
if you are a government and you have a million dollar that you can either give to Citibank (who lent it to you predecessor govt) or to feed hungry children, which is the ethical thing to do? I can tell you what the Kirchners' voters here will respond...

I agree with Holger that inflation is a huge concern, both economically and politically (cf. the recent protest of farmers and the urban middle/upper class). I'm also concerned if the recent increas in export taxes on agro goods isn't pushing it too far.
That said, I continue to be impressed by the overall performance of the Kirchners' economic policy.
One thing they seem to have been very good at is getting capable people into the bureaucracies - I've heard very positive things about technocratic competence in the ministries of economia and trabajo - I think that really does explain some of the success (anyone else read Peter Evans' "embedded autonomy"?)

[Gabriel]

Sebastian,

Kirchner is looking to borrow $4 billion to build a high speed train, a completely useless project in Argentina right now. Will future administrations declare that immoral and illegitimate? Or what about the close to $10 billion he paid back to the IMF but then funded with new debt at higher interest rates.

Kirchner's policies appear to be based on simple luck. If the commodity price boom that is fueling fiscal numbers and the economy had started in 1998 instead of 2003 Menem would probably still be in power.

[Joao Farinha]

Gentlemen, I simply can't think of this as an issue of ethics... WHO in Argentina borrowed in the 90s? WHO in Argentina defaulted? WHO in Argentina should now pay that debt? Are these 'WHOs' the same entity?

Those WHO lent, had to price the risk of default, and those WHO borrowed, had to think of the consequences of defaulting. Everyone seems to have had their math correct but the Argentineans... as it seems, the consequences were not that dire... they don't seem to have any trouble now in financing their growth.

International financial markets either have short memory, or they had plenty of success milking the cow before it went bad...

[Gabriel]

Joao,

People forget that a lot of the people who lent to the Argentine government had no choice. I am referring both to banks and to the local 401ks (AFJP) that were forced by law to buy government paper. Among the biggest losers from Argentina's default were Argentines themselves.

[Gabriel]

Another point Dani. It's not clear how much Argentina is really growing. The made-up inflation numbers have raised concerns about all the official statistics in that country. I don't doubt they are growing but it may well be less than the official numbers suggest.

[Nathan Smith]

"if you are a government and you have a million dollar that you can either give to Citibank (who lent it to you predecessor govt) or to feed hungry children, which is the ethical thing to do? I can tell you what the Kirchners' voters here will respond..."

If this point of view is accepted then no one should *lend* a dime to any country that has any poverty in it. Since the loans would be, in effect, donations, they should just be called grants from the start. If that's what you think, fine; just be clear on the implications of your position.

"Gentlemen, I simply can't think of this as an issue of ethics... WHO in Argentina borrowed in the 90s? WHO in Argentina defaulted? WHO in Argentina should now pay that debt? Are these 'WHOs' the same entity? Those WHO lent, had to price the risk of default, and those WHO borrowed, had to think of the consequences of defaulting."

Presumably the risk of defaulting is higher if defaulting is regarded as ethically neutral. Certainly the repayment of debts is not traditionally regarded as ethically optional. Indeed, the word "ought" is etymologically related to the word "owe" in most languages. In Russian, "dolzhen" (should) and "dolg" (debt). And the Spanish "deber" is recognizeably related to the word "debt."

The debt of any collective or corporate entity is a complex matter. Perhaps the very idea of sovereign debt doesn't make ethical sense and deserves to be retired? But then, hardly any economist would deny that it is in the public interest for the government, at least occasionally, to borrow.

[Gabriel]

Nathan,

What's interesting is that while Argentina (and many other Latam nations) will default relatively easily there are countries in the same region (Caribbean) like Jamaica, which much, much greater debt loads but who consider that paying their debt is a matter of national pride. There is a cultural thing there as well.

[William]

Nathan: to come back to your initial post, "Oh, and it *is* generally considered basic ethics to honor one's debts, is it not?" --

Doesn't the US have a huge outstanding public debt?
Last time I checked, it was approaching $9.5 trillion...

[Nathan Smith]

Yup. And the US is not defaulting on it. So what's your point?

[William]

My point is that the US is not "honoring" its debt either. Although it may not be defaulting on its debt, it is steadily and continuously increasing it.

[Sebastian]

@Gabriel:
but if I'm not mistaken the AFJPs weren't defaulted, they were just cut in three because of the devaluation.

I think the point about "cultural" factors is total bogus - Germany defaulted on its debts (though other types of debts) in the 1920s and 1930s, Malaysa didn't literally default, but restricted capital movements, etc.
My suspicion is that Jamaica simply wouldn't be able to pull a default of without getting crashed and burned (and we shouldn't forget that Argentina was terribly burned before the default...).

@Nathan:
No - debt default is an extremely risky business, because it does affect your ability to take on futur credits at reasonable interest rates, so it's not clear, that it's always in the best interest to default. But if the amount of debt you have - large parts of it due to circumstances that you perceive as unjust - is so high that the interest payments make reasonable social policy in a crisis stricken country impossible, that's a different matter.
My (cautious) admiration for Kirchners' policy has partly to do with the fact that he was able to negotiate a partial default of the debt without much of the negative consequences one might have expected.

And since you want to insist on the analogy between private and national debt - most countries do have private bankruptcy laws that allow for a fresh start and the Argentine crisis of 01/02 would certainly qualify as a bankruptcy.

[Barkley Rosser]

Nathan,

Sure, in general it is honorable to pay one's debts. However, in the case of bankruptcies arising from extraordinary circumstances, especially if those circumstances are partly the fault of those from whom one has borrowed, things can get muddy.

Now, I was in Buenos Aires in 1999 for the IEA meetings of that year (were you there, Dani?). I gave a talk that was disrupted by a woman who was denouncing the US (and holding me personally responsible) for the fact that the Argentine economy had gone into a deep recession. Of course, I was not personally responsible, I don't think, but I understood why she was shouting and screaming at me. (BTW, my talk had nothing to do with these issues.)

Argentina was following a policy specifically suggested strongy by the IMF with the backing of the US Treasury and the large US banks to whom Argentina owed most of its money in US dollar debt. This included fixing its exchange rate in a one-to-one ratio with the US dollar with a currency board attached. Now, we all know that this was designed to end the hyperinflations of Argentina, and by sometime before 1999 that had happened.

Now in 1998 we had the Russia-LTCM crisis/default, that then triggered Brazil to massively devalue its currency, Argentina's main trading partner and partner in Mercosur. The upshot was the recession in Argentina as its peso had now become wildly overvalued. However, there it was, plugging away, following IMF and US bank advice, with jobs shedding and women showing up at international economics conferences to scream at speakers from the US.

So, then in 2001, the Argentines unpegged their currency, which promptly collapsed to something like 25% of its previous value, plunging large portions of the Argentine middle class into a lifestyle they were most definitely not accustomed to due to the suddenly elevated prices of imported consumer goods they were used to consuming, with people banging pots and pans in the streets and toppling government after government. This devaluation (ah, those glorious floating forex rates!) also made the ability of Argentina to continue paying the interest on its debt to be extremely difficult, with the only government that could get in and survive being one that decided not to do so and to default.

So, Nathan, do you think that the US banks who advised Argentina to get into this situation (and leant it money to do so) did not out of honor have to accept some of the blame and some of the cost for these unfortunate events that transpired? WEre the Argentine people supposed to bear all the costs of this hideously bad advice from abroad?

BTW, I would expect that if the Argentine government wants to borrow money internationally for a useless project, given its bad credit history, that it would face very high interest rates based on a very reasonable risk premium, and that any lender doing so should know what to expect.

[Sebastian]

thanks Barkley, that's a great comment. I suspect that if the useless product in question is a certain high-speed train, credit from French sources might be somewhat easier to secure :-)

[Barkley Rosser]

sebastian,

Thanks (or gracias?). Of course you are right regarding the train funding issue.

I also add a followup on the disruption I experienced in 1999. I actually wanted to say something to the woman, but before I could, impressively armed security guards dragged her off rather forcibly while apologizing to me profusely. After that I wanted to apologize to her, and for more than just the US role in the economic problems Argentina was experiencing at the time (and would experience later).

[wjd123]

Excuse my ignorance about infastructure projects in Argentina, but with oil at a $100.00 a barrel why is a high speed train a "useless product?"

[Sebastian]

I'm not sure it is, the claim is Gabriel's,
but having seen regular trains in Argentina it would seem like a more useful investment to repair and upgrade those (I don't know if you remember, there was a riot in the main -retiro - station in Buenos Aires some time ago, because yet again a commuter train was cancelled because of a technical defect.), instead of investing in a prestige project like a highspeed train - but as I said, I'm not sure.

@Barkeley - no, although I'm right now in Buenos Aires, I'm not Latin American, the name is a German Sebastian (without an accent on the a). I just like & study Argentina.

[Madeleine]

As a student in Buenos Aires last semester, I echo Nathan's first comment doubting the sustainability of Argentina's growth.

The high growth rate reflects policies that worked well immediately following the crisis, but problems now arise:

1. Inflation: Central Bank President Martin Redrado told Euromoney last September that he was "profoundly worried by [the country's] inflation," despite price controls. (Not to mention the INDEC scandal.)

2. "Retenciones" on exports are a key source of income for maintaining the fiscal surplus, but I imagine (as do protesting farmers) that the current level of 60% on some products is unsustainable.

After you've traveled the country, I would be interested to hear your take on price controls and taxes on export profits as tools for growth.

[Student]

By the way, inflation is not Argentina's only problem. Their price controls and subsidies are nothing to envy either.

[wjd123]

Thanks Sebastian,

I guess the underlying theme here is that the high cost of borrowing for Argenitina doesn't allow it to walk and chew gum at the same time.

Too bad, I'm a big fan of the odious lending doctrine: it makes lenders take into consideration the morality of a political economy and not just contractual relationships.

[Student]

Aside from its inflation, one should also note that Argentina's price controls and subsidies are nothing to envy.

[Student]

Sorry for the double post but strangely I can't read my original post (or the new one) on the list of comments. I thought that it had gotten erased.

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