Global Debt Market Roundup

20 April 2014

Sunday


zero dollars

A couple of recent articles in the Financial Times about the global debt market caught my attention. On Wednesday 16 April 2014 the FT ran “Risk seekers seize the day in South America: Investors are being drawn to bond issues in Argentina, Venezuela and Ecuador,” by Benedict Mander. Nation-states with very troubled financial histories (such as the three named) are not only able to sell their debt, but the writer says that Argentina, “has admitted to receiving loan proposals from international investment banks after local media reported that it was negotiating a $1bn loan from Goldman Sachs.”

Mander’s article also mentions the return of the “carry trade,” that is to say, borrowing money where it is really cheap and loaning it out again where money comes dear. During those years when Japan was loaning money at an effective zero rate, the carry trade was big business, as that zero percent money could be re-lent at 5 or 6 percent elsewhere. In my previous post, Rhine Capitalism, I discussed German bankers trying to present themselves as humbled and chastened by the past financial crisis, welcoming regulation as the price of stability. But that’s not the message we’re getting from the Financial Times, where we find a detailed record of the reconstruction of spectacularly risky financial schemes that will, in due course, have their day or reckoning.

On Thursday 17 April 2014 the FT ran “Investors get selective as frontier debt rush slows: Buyers of poor countries’ bonds are becoming more careful about risk vs reward,” by Elaine Moore, which discusses the “exotic debt” of nation-states such as Sri Lanka, Pakistan, Ghana, and Nigeria (also called “frontier markets”). Dollar-denominated bond issues in such unlikely places as sub-Saharan Africa find plenty of takers, though rates vary from country to country. The article states:

“Internal conflicts, political instability and poor credit records are all being factored in, but what economists say is really propelling the increasing differential in yields between borrowers is the knock-on effect of China’s economic evolution.”

It seems that China’s transition from an export-led growth model to a consumer-led growth model based on internal markets is re-configuring the global commodities markets, as producers of raw materials and feedstocks are hit by decreased demand while manufacturers of consumer goods stand to gain. I think that this influence on global markets is greatly overstated, as China’s hunger for materials for its industry will likely decrease gradually over time (a relatively predictable risk), while the kind of financial trainwreck that comes from disregarding political and economic instability can happen very suddenly, and this is a risk that is difficult to factor in because it is almost impossible to predict. So are economists assessing the risk they know, according to what Daniel Kahneman calls a “substitution heuristic” — answering a question that they know, because the question at issue is either too difficult or intractable to calculation? I believe this to be the case.

In Monday’s Financial Times (which is already out in Europe, so I have read it over the internet but haven’t received my copy yet) there is another debt-related article, “Eurozone periphery nurses debt wounds” (by Robin Wigglesworth in London). This article mentions, “the high demand for peripheral eurozone debt in recent months,” which would seem to be a part of the above-mentioned trend of seeking out higher rates of return and accepting higher risks in order to get those higher rates.

These are perfect examples of what I recently wrote about in Why the Future Doesn’t Get Funded, namely, that there is an enormous amount of money looking for a place to be invested, and that nation-states are pretty much the only thing on the planet that can both soak up that kind of investment as well as being sufficiently familiar to investors — the devil they know — that the investors don’t balk when offered high returns even in a risky debt market.

What is the lesson here? Is it simple investor greed that sees 8 percent and can’t resist? In the cases of Venezuela and Argentina, we have nation-states that are not only politically and economically unstable, but these countries have governments that have spectacularly mismanaged their respective economies, along with a history of nationalizing private assets. This mismanagement is now being rewarded by the global financial community, not least because investors are so worried that they might miss an opportunity. But if events go south while your money is invested in Argentina, you may well find yourself expropriated of your wealth and excoriated by a populist regime (those holding out for payment on the last defaulted bonds have been called “vulture funds”). What kind of rationalization hamster runs its endless cycles in the investor’s brain, convincing them that they can get a few years of eight percent on a billion dollars — which is nothing to sneeze at, being 80 million dollars a year — before the situation collapses, like it did for earlier investors?

There are all kinds of visionary projects that could be funded with this money — projects that would advance the prospects for all humanity — and perhaps at a rate of return not less than that offered by “exotic debt,” but the Siren Song of nation-state debt issues paying at 8 percent or better is too great of a temptation to resist. So why do uncreditworthy nation-states get billions while business enterprises and private opportunities go begging? It is an interesting question.

It is a bit facile (even if it is also true) to point out that most nation-states fall into the category of “too big to fail,” and that the international community will bail them out time and time again, no matter the level of corruption or mismanagement. (We hear constant talk about the evils of “austerity,” and about the terrible things that the IMF and the World Bank are doing by lending these poor, long-suffering nation-states more money, but very little about the evils of the profligacy that necessitated the austerity.) This is a bit too facile because even small nation-states, the default of which would not be particularly ruinous, often receive similar treatment. What’s going on here?

There is more at work here than merely shoddy lending practices that are opening up entire classes of investors to risks that they do not understand. This is an artifact of the international nation-state system that prioritizes the impunity of nation-states, whether in regard to human rights, economics, or any other measure you might care to apply. Nation-states are not held to account, and because they are not held to account they have become reckless. For the institutional investor looking for a place to park a few billion dollars, even severely compromised nation-states may appear to be the only game in town. I won’t hold my breath for the day when one of these institutional investors will put their money into some more productive, less reckless investment instrument, but I won’t stop hoping either.

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Frontiermarkets

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Grand Strategy Annex

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