The Dangers of Playing with Credit Markets

Governments have unique power over credit markets.  If a private party, provided that you live in a reasonably well-functioning democracy, the government will make him pay--or at least, set out the terms by which he can avoid doing so.  Saying, like Bartleby the Scrivener, that "I would prefer not to" is usually not considered sufficient.

A government, of course, can default whenever it wants, under any terms it wants.  It is limited only by the prospect of future difficulties in borrowing money.

But in times of duress, politicians--especially in emerging markets--are willing to deal with that comfortably far-off possibility, rather than find the money to pay the creditors now.

One of the big whiffs of my career--and every journalist has one of these eventually--was the time I wrote and filed a piece stating that Argentina was of course not going to default on its debt to the IMF, because that would be so obviously, phenomenally, stupid.  Three hours later, Argentina defaulted on its debt to the IMF, and I stayed up half the night rewriting.

I also wrote that I thought it probably wouldn't actually make good on its threats to squeeze its foreign creditors down to less than thirty cents on the dollar, because that was so clearly going to starve the country of capital as it tried to recover from a financial crisis.  Argentina willfully flouted my impeccable reasoning, and wrote its foreign creditors down to less than thirty cents on the dollar.  I call that spite.

And for a while, it all seemed to be working.  The world had a commodity boom, and Argentina, which grows a lot of commodities, boomed right along with it.  Plus, countries recovering from a financial crisis always grow fast, because the contraction was so brutal.  Between 2003 and 2007, Argentina averaged 9% annual growth, and the country did a very respectable 7% in 2008.   It would take a stricter libertarian than I to deny that shedding that burdensome foreign debt at such attractively low rates probably helped the country grow back towards trend.

Unfortunately, when we sneeze, the developing world catches cold.  Lengthened unemployment and great personal unhappiness here translate into malnutrition and physical suffering in middle-income countries.  The government is running out of money--not in the vaguely doom-ridden sense in which you and I talk about coming Medicare deficits, but in the sense that it is now looting its pension system because that's the only remaining source of ready cash.  All emerging markets are worried because the volume of borrowing in the developed world may absorb all the ready funds, crowding out emerging market borrowing.  But Argentina has no access to the credit markets at all except through state agencies with real assets.  That means that it may very shortly have to run an aggressively contractionary fiscal policy in a contracting economy.  Financial assets are fleeing the country, and the yield on its existing debt has risen to levels that signal a horrifyingly high risk of default.

What Argentina did wasn't different in kind from what other emerging markets have done.  It was different in degree.  It bought short term prosperity at long term risk.  Argentina didn't use the respite to build a more productive economy; it used it to do social spending that kept the Kirchner's in power.  Now its citizens will pay the price.

The other night, I had dinner with someone who said that he wasn't that worried about the Chrysler interventions, because after all, memories in finance are short, especially when a financial crisis is involved.  And he has a point--if he didn't there wouldn't be any emerging debt markets.  But I have two questions.  First, how short?  Argentina's creditors show absolutely no signs of forgiving and forgetting.  Its own citizens won't lend it money directly.  And second, is this really true?  When capital wasn't badly impaired and the disasters were short lived, perhaps investors shrugged it off and went back for more.  But memories of the actions of both banks and private actors surrounding the Great Depression seem to have persisted more than a generation.