A third way for Argentina: reprofiling

With its debt neither sustainable nor unsustainable, Argentina meets the test for maturity extensions

Carlos Abadi

Argentina's forward player Lionel Messi controlling a ball during a match in the Russia 2018 World Cup
The path to a deal will be fraught with danger; both sides must put their best players forward © AFP/Getty Images

Despite allegations to the contrary, “reprofiling” is not an Argentine euphemism for debt restructuring. It is a distinct liability management exercise that is optimal, from a welfare standpoint, for certain well-defined sovereign debt crises. In our (preliminary) opinion, Argentina’s situation meets the required criteria for a reprofiling that would defer its maturities for a relatively short period, while not reducing either the face value of its obligations to private creditors or their contractual coupons.

In fact, the IMF incorporated reprofiling to its access policy in 2014, in response to criticism it suffered after its alleged procrastination in requiring private sector involvement (PSI) during Greece’s debt crisis. Until then, there existed only a binary choice for any member seeking exceptional access: they either qualified (as a result of the Fund’s debt sustainability analysis (DSA)) as able to repay “with high probability”, or they didn’t. In the former case they were considered for exceptional access of a “catalyst” nature, and only subject to meaningful PSI in the latter.

However, the 2014 rethink brought the Fund to realise that DSA is not an exact science, especially in that it relies on policy commitments from the debtor to be implemented in the future. Consequently, the IMF allowed a third way for exceptional access: the reprofiling. In the Fund’s view, the reprofiling remedy (which is a form of PSI because, unless the exit yield is less than or equal to the contractual coupon, any maturity extension entails an NPV reduction) is appropriate for sovereign debtors lying in the grey area of their debt being neither sustainable nor unsustainable, in each case under the “with high probability” standard.

While we have not yet concluded our DSA (we expect to do so in the next week or so), we expect that it will place Argentina in that grey zone, at least in the Fund’s mind (if nothing else, because policy undertakings would be made by a new, unfamiliar, administration). Additionally, the Fund subjects exceptional access to the window allowing for a reprofiling to two constraints:

1) The member must have already lost market access — clearly fulfilled in Argentina’s case; and

2) There must be considerable uncertainty regarding the member’s debt sustainability (and, accordingly, doubt about whether market access can be regained) — our intuition is that our analysis will reflect this.

Thus, assuming that Argentina qualifies for a reprofiling, the negotiating variable will be the number of deferral years. I would argue that the extension period should be such that no maturity of the reprofiled bonds should fall due before the later of i) Argentina regaining market access, and ii) the IMF having been repaid in full.

Obviously, should Argentina regain market access, there is no reason for the maturity of the reprofiled bonds to occur much later. The maturity extensions need not be identical for each bond as Argentina i) will be in a position to start repaying shortly after the market opens up, subject to the ceiling set by market appetite, and ii) an identical across-the-board extension could be perceived as unfair by holders of short maturities, since their NPV impairment would be proportionally larger than for those holding long maturities.

We attempted to simplify things here because our goal is to show that there is a path to an orderly restructuring in the form of a reprofiling. But that path is narrow and fraught with danger. As we have argued before, both sides will need to play their A-teams to achieve this value-maximising result. This is because, while any reprofiling transaction will trigger credit default swaps and put Argentina in selective default until closing, it is my expectation that if no deal is reached by the first half of 2020, Argentina will enter a moratorium and its cost-benefit analysis may change.

In particular, Argentina will need to:

1) Be persuaded with convincing econometric evidence that the utility (in terms of future growth) of a market-friendly deal consistent with its economic fundamentals outweighs the sugar high of a strategic default resulting in a reduction in principal and/or interest, and short-term relief from current expenditures;

2) Understand that the NPV reduction resulting from the reprofiling can be communicated internally as a victory, under almost any scenario;

3) Internalise that the economic benefits derived from formulating and implementing a credible path to meaningful primary surpluses will translate into political gains before the end of the next presidential term. Once more, the Argentine side will not take dogmatic generalities about the virtues of fiscal discipline and market reputation at face value; to get the point across, the alternative macro paths will need to be modelled with a robustness nearing the dispositive (an exercise we will start working on immediately following the DSA’s completion); and

4) Realise that a reprofiling deal provides Argentina with the best of both worlds: optionality. Should the government, whether because of externalities, social pressures or mere vagaries, decide that it is not in a position to fulfil its fiscal undertakings, the option to default will remain.

Creditors, on the other hand, will have to struggle with the following internal and external challenges to ensure a satisfactory resolution:

1) Maintaining the cohesion of the creditor group so that precious time is not lost in internal bickering or the formation of competing representative bodies, creating delay and confusion.
Several divisive issues will have to be addressed, including the issue of equity between holders of short and long maturities mentioned above;

2) Negotiating with a party that holds an ace in its sleeve: the ability to strategically default. It is axiomatic that, however costly default may be for a sovereign issuer, it will never be as costly as the same conduct for a domestic corporate debtor. Argentina’s creditors will have to be professional in substantiating with compelling models and data the utility to Argentina (and related agency benefits) of a reprofiling deal consistent with the timing of Argentina’s expected return to market access;

3) Using collective action clauses (CACs) as both a sword and a shield. Creditors will need to:

a. Strive to represent or speak for blocking minorities of substantially all sizeable outstanding issues subject to reprofiling; and

b. Be mindful of the implications (both internal and external) and the effect on potential deal-killing holdouts of the strategic differences between the post-2005 dual-limb vote CACs and the significantly more debtor-friendly more recent single-limb vote issues. To continue with the same example, creditors should be aware that single-limb issues are relatively new, that their “uniformly applicable” condition has not been tested in the courts, and that a uniform extension that causes some bondholders to suffer a greater relative NPV impairment than others may be challenged in court and that such litigation may frustrate the desired resolution;

4) Information asymmetry is another advantage a debtor holds over its creditors, amplified in the case of a sovereign issuer such as Argentina with financial data that are opaque for some periods and outright unreliable for others. Creditors will have to derive or gather reliable data (such as the true quantum of the debt owed to other public sector entities) from private sources in order to rebut potentially abusive demands for further NPV concessions (we are also in the process of plugging those fuzzy data holes).

Finally, no reprofiling (or even restructuring) can happen without an IMF agreement. Much has happened at the IMF in the past five years, including its change of leadership and the 2014-2015 revised exceptional access framework on which a reprofiling deal hinges. But it still has a rigorous credit process, which relies on getting as collateral a credible fiscal programme and trusting that the sovereign’s policy commitments can be implemented.

Given Argentina’s economic and social condition and even though the incoming administration is an unknown, the IMF will probably have to accept that Argentina will be unable to deliver more than a primary balance for the next 12 to 18 months and that such relative fiscal laxity is a necessary condition for the subsequent delivery of sustained primary surpluses.

Argentina’s burden of proof is not as exacting as it could be if it were seeking exceptional access of the catalyst variety. The kind of support Argentina should aim for does not require proof that its debt is sustainable.

Indeed, exceptional access for a standby facility supportive of a reprofiling requires only rejecting the null hypothesis that Argentina’s debt is unsustainable under the “with high probability” standard. To borrow an analogy from law, Argentina’s strategy (with the creditors acting at its amici) should be to introduce reasonable doubt to a hypothetical IMF finding of unsustainability “with high probability”; in other words, to avoid a Type I error.

My opinion has not changed: an orderly debt restructuring is possible, even likely, but if, and only if, both Argentina and its creditors put their respective Messis on the field.

Carlos Abadi is managing director of DecisionBoundaries, LLC, a New York-based international financial advisory firm.

On Viewing Rembrandt’s ‘Aristotle Contemplating the Bust of Homer’

By:George Friedman



Last weekend I was in New York City, with a rare moment for indulgence.

I chose to visit an old love, one who taught me about my life and what it would cost me.

That love was a painting by Rembrandt, the centerpiece of an exhibition of Dutch masters at the Metropolitan Museum of Art.

It is called by several names, but for me, its name will always be “Aristotle Contemplating the Bust of Homer.”

It is a painting about philosophy, politics and beauty, and the longing for what no one can have: all three.

Aristotle is at the center, dominating the painting.

He is dressed lavishly in cloth of extraordinary luxury, with an ambiguous hat, barely visible, atop his head.

But the true center of the painting is a magnificent gold chain that encircles his body.

It is sensuous in its beauty, but the beauty can’t hide its strength.

What it surrounds it controls, and it surrounds Aristotle.

The reason he is wearing the chain is at first a mystery; he is, after all, a philosopher, a scholar who studied under Plato.

Such men neither have the means nor the appetite for such ornaments.

Then, if you look very carefully at the painting, you see a small medallion attached to the chain, and on the medallion is an image of Alexander the Great, the man who conquered the known world to the foot of the Himalayas and planted himself in eternity, with cities named after him scattered through his empires.

He used these cities as the foundation of his empire, linking them together in trade and weapons.

And in his short life, the Greek from the foothills of the Balkans reshaped the world.

The mystery begins to resolve itself with that medallion, for Aristotle was Alexander’s teacher and teachers bear at least some or sometimes all of what their students become.

Aristotle clearly was proud of his student; otherwise, why would he be clothed in silks and gold and bear the picture of his student so near to his heart?

His bearing is proud in the painting; a man who taught Alexander how to be great must be great as well.

Aristotle’s teaching was not of the art of war but rather of philosophy.

Philosophy teaches about the moral obligations that men bear.

It teaches them about justice, and it teaches them when justice requires kindness and when it requires cruelty.

Philosophy teaches about the city, the polis – or our modern-day nations – and teaches how they are constructed, how they should be ruled, and how they should avoid defeat and slavery.

In the end, philosophy teaches about a place, justice and injustice, and teaches the warrior who must choose the place, and choose what is just.

To me, Aristotle bears himself as a well-decorated soldier.

His hand on his hip, his posture straight, he appears to us as Alexander might, a warrior who has risked much, from his life to his soul, and has emerged with both intact.

When Napoleon visited the great German writer Goethe, Bonaparte is said to have exclaimed, “You are a man.”

He expected to meet another feeble scholar, one who I suppose infested the Bourbon court, uttering platitudes.

That a great writer, and truly a philosopher as well, should turn out to be both a thinker and a man in full astounded Napoleon, perhaps the greatest warrior since Alexander, does not surprise me.

There is a connection in my mind between the scholar and weakness, a willingness to imagine justice but not to fight and die for it.

But Rembrandt understood Aristotle, the philosopher.

The chain is the chain of office.

It is the chain an important adviser to a ruler might wear.

And in the end, philosophy becomes an adviser to the ruler.

A man who devotes himself to questions of justice and war and to truly understanding their necessity and the paradox that exists in them, is inevitably advising the ruler, whether the ruler understands it or not.

He shapes the time in which he lives, waging a war against the superficial and self-serving, and usually losing.

Aristotle had won.

He had honed an instrument of justice and war unlike many the world has seen, and Alexander understood – according to Rembrandt, at least – that he had been honed.

You can see the pride with which he wears the gold chain. But you can also see sadness.

To Aristotle’s right, clouded in the darkness Rembrandt had mastered, is the bust of Homer, the blind poet of the heroic age of Greece, without malice on the part of anyone, shunted off into the murk.

Aristotle’s hand rests on Homer’s head, gently and almost tenderly. His eyes do not face straight ahead like a soldier’s, or suspiciously in all directions as a politician’s would.

Aristotle’s hand rests on the bust like a lover’s, but the eyes aren’t focused. They see Homer, but they see something else, something that is not there but that rivets Aristotle’s attention.

He has one hand on his chain, another on Homer, and his eyes contain a deep sadness.

Forget that the chain is gold, forget that it is a reward for his greatness.

It is still a chain that binds him to Alexander, a bond forged because he was a philosopher who taught a conqueror how to conquer.

That is a triumph – the highest triumph philosophy can achieve – but is it enough to satisfy the soul of philosophy?

Homer was a poet, and poets hear and sing songs.

He knew that hearing the songs of the sirens was worth dying for.

He wrote of the battle for Troy as if dying were a small price to pay for having been there.

The poet’s song is the song of beauty and despair and makes no attempt to justify either.

This makes poetry the enemy of philosophy.

Philosophy must explain everything.

Its need, its compulsion, is to leave nothing as the philosopher found it but to examine it, twisting and turning it until he owns its soul.

Poetry celebrates the simple reality of being.

It does not weigh the good and the evil but gives thanks to the gods that both are there.

The philosopher is proud of what he knows and is proud of the mark he left on history.

The poet is a sensualist.

He wants to teach feeling by revealing it in language turned to song.

With this, the poet teaches what true joy and true sorrow feel like.

The philosopher lives by rigor, suppressing feelings in the name of truth and necessity.

The poet lives sensually, in the mind, soul and body, and contents himself with celebrating what is, whether victory or defeat.

In a way, the poet is an anarchist, subject to his tropes only when he chooses, in love with what he sees and with whoever listens.

The lover may be twisted and depraved, but that simply makes his lover worthier of the song.

Aristotle is caught between the power of the state, the rigor of philosophy and the voluptuousness of the poet.

Aristotle chose to be the adversary of the poet, and he achieved everything any reasonable man could dream of.

But the price he paid for both was the rigorous management of all his feelings, a constant analysis of why the world is as it is and why rulers rule as they do.

Homer never cared about either.

He accepted the world as it was, and he wanted to capture treachery, bravery, banality and the enchanted.

He never explained why the siren’s song was so seductive.

He was simply content to speak of women who generate urges that would cause men to knowingly go to their death.

Aristotle would have dissected it.

Homer might well have died simply to die hearing that song.

The tension is between experiencing life, understanding life and dominating life.

Aristotle ultimately chose the last two.

Homer chose the first.

Rembrandt portrays Aristotle, perhaps at the moment he realized what he won and what he lost, longing for the life of the poet.

There is a sense given to all of us who are human, when the tension between being somewhere and cherishing it for what it is, competes with the mind wandering off to other things.

Homer was the siren, asking us to stop thinking and give ourselves over to his song.

And Aristotle was the philosopher and adviser to the great who realized he had never done that, and that it was now too late to do more than imagine that purity.

Rembrandt had to have understood this agony, or he couldn’t have painted the picture.

Philosophy, statecraft and poetry are far from the only moments, but they are at the extreme.

The painting is a monument to our lives, of the price we pay for Eden, where we learned of good and evil, and from which Cain could learn to kill Abel.

It would seem to be the tragedy of the human condition, that the search for justice and power destroys the pleasure of being human.

I myself have rarely found escape from the conundrum, but I have found a path.

She who lives hidden in plain sight.

China Needs Economic Stimulus

China’s GDP growth has been slowing steadily since the first quarter of 2010, and the prospect of slower growth has gained widespread acceptance, both within and outside China. But the downward trend is riskier than many observers seem to realize.

Yu Yongding

yu51_VCGVCG via Getty Images_chinastockmarket

BEIJING – China’s GDP growth may still be strong by global standards, but the annualized rate of 6% in the third quarter of 2019 is the lowest the country has recorded since 1992. In fact, China’s GDP growth has been slowing steadily since the first quarter of 2010, when it exceeded 12%, year on year.

This downward trend is riskier than many observers seem to realice.

In recent years, the prospect of slower Chinese growth has gained widespread acceptance, both within and outside China. A shrinking working-age population means that 8% growth is no longer essential for full employment, it is argued, so introducing more fiscal or monetary stimulus isn’t worth the risk.

Instead, China’s policymakers should focus on improving the quality of growth through supply-side structural reforms – an objective that, most economists in China argue, may in fact be easier to achieve in a lower-growth environment.

This approach is misguided. While structural adjustment is crucial, slower economic growth is not a prerequisite for success; on the contrary, it would impede reform. Moreover, given that the complexity of China’s labor market impedes data collection, it is likely that China’s employment situation is not as strong as many believe.

In this context, the Chinese government’s top priority should be to arrest the decline in GDP growth – not least to prevent a kind of snowball effect that will make restoring growth far more difficult later. After nearly a decade of continuous deceleration, with no end in sight, investors and consumers are becoming increasingly reluctant to spend.

Serious financial vulnerabilities will only deepen their concerns; ceteris paribus, declining growth will worsen all indicators of financial stability.

Fortunately, China has the policy space to pursue stimulus. To be sure, as a share of GDP, China’s broad money supply (M2) is among the world’s highest. The country’s fiscal position may not be as strong as official figures suggest, and its corporate debt-to-GDP ratio is also among the highest in the world.

But a closer look suggests that the associated risks are overblown.

The primary risk associated with monetary expansion is, of course, inflation. But Milton Friedman’s assertion in 1956 that “inflation is always and everywhere a monetary phenomenon” has been thoroughly debunked in recent years. Countries with high M2-to-GDP ratios have often maintained low inflation, and countries with low M2-to-GDP ratios have sometimes struggled with high inflation.

China is no exception. Although M2 has grown faster than nominal GDP consistently over the last decade, China’s core consumer price index has hovered around 2%, and its producer price index has often fallen into negative territory. This can be explained partly by Chinese households’ financial habits: they save a lot, boosting M2, but mostly in savings accounts, which aren’t inflationary. For China, deflation is now a more serious concern than inflation.

On the fiscal front, the figures are doubly deceiving. Officially, China has had an average deficit-to-GDP ratio of less than 2% over the last decade, and a government debt-to-GDP ratio of about 40%. Yet, in the first ten months of this year alone, local governments have issued CN¥2.53 trillion ($359 billion) in special-purpose bonds, intended to support public-interest projects.

Such bonds are not recorded as deficit financing, because it is assumed that the projects they fund will generate enough income to cover all debt obligations. If they were, China’s deficit and debt ratios would rise significantly.

Yet, even if these indicators were recalculated to account for all of the government’s contingent liabilities, China’s fiscal position would remain significantly stronger than those of most developed economies. More important, China’s government boasts net assets worth some $17 trillion in 2016, according to the Chinese Academy of Social Sciences – a powerful buffer against fiscal shocks.

The bigger risks arise from China’s corporate debt, which surpassed 160% of GDP in 2017. But even here, there is little reason to panic, because China’s corporate debts – largely the result of underdeveloped share markets – are financed mostly by domestic savings. (Despite having increased in recent years, China’s foreign debt remains relatively low.)

Moreover, the growth of China’s corporate debt-to-GDP ratio has slowed in recent years. The best way to bolster this trend is not to refuse to roll over corporate debts – potentially causing liquidity shortages that drive companies needlessly into bankruptcy – but rather to give firms the chance to grow out of debt. That requires a faster-growing economy.

China has the policy space to implement a powerful economic stimulus package. While the side effects and limits of such a package should be fully recognized, the risks of a continued slowdown – not only for China, but also for a global economy primed for recession – dictate that the government should use it.

Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006.

Geopolitical Determinism

By: George Friedman

Having written a great deal on space and enchantment, it is time to come down to earth. I want to return to the central thesis of geopolitics as I practice it: the idea of geopolitical determinism.

I differ from other people who write on geopolitics in two senses. While I regard geography as a fundamental determinant in human behavior, I don’t regard it as being the sole determinant.

For me, Greek philosophy is pivotal in defining what it means to be human. I am not sure that Plato or Aristotle could have written in any place but Greece, or at any time other than they did. But regardless of that question, we are all, in the global civilization that has emerged, shaped to some extent by them as by the highest moments of all civilization. But this could not have come about without the European imposition of a global system on the world, so we are back to geopolitics.

My point here is that geopolitics is far more complex and subtle than simply the physical reality of the globe, but also that the subtlety of the world constantly circles back to that physical reality.

More controversial is that I’m a determinist. I do not believe that we are shaped merely by mountains and deserts, but it is evident to me that each of us is shaped by both place and the forces emanating from place. In the simplest example, the life of an Indian born in the slums of Mumbai is profoundly different from the life of an American born in a wealthy Dallas suburb like Highland Park. Both are constrained.

The Indian is not likely to become a partner at a private equity fund. The Highland Parker is not likely to become a petty thief. The former must resort to his or other related modes of living, and everything he knows, including the culture of his slum, leads him there. Similarly, the Highland Parker is going to live a very different life. (Of course, since thievery is part of the human condition, he may become a thief – but at a far more exalted level.)

The existence of Mumbai’s slums is shaped by the land, the climate, the surplus of people and the minimal existence of resources. All of this places constraints on the life of someone born there. The existence of Highland Park is shaped by the vastness and relative underpopulation of Texas, the generous flow of oil, and the investments made in Texas infrastructure and higher education as a result of that oil.

Put those conditions and wealth in Mumbai rather than Texas, and while the two people might not change places, they would each likely have different lives. The very wealthy like to say that you are what you make yourself. Even that isn’t true, since you are surrounded not only by wealth but cultural expectations that grow from it.

An individual might escape his fate, but the statistical likelihood of divergence is limited. The sheaf of practical policies might expand or contract, but life is lived within that sheaf.

The place in which you are born makes it possible to escape. As I write this, I am in Dubai and am surrounded by an Indian underclass made up of people who clean hotel rooms and drive visitors to and from the airport. If anyone from Highland Park is here, then he is likely the recipient of these Indians’ services, as I am.

I don’t know where they come from, but if it’s not from the slums, then it’s likely near them.

The point is that even when you change your place in the world, you change it within the constraints of who you are.

Andre Malraux, the French writer (and forgive me if I repeat myself, but I value this very much), said that men leave their countries in very national ways. The American expatriate who has learned perfect Bulgarian is still an American expatriate living in Bulgaria. You can recognize an American student on their junior year abroad, with Columbia University emblazoned on their souls.

I was born in Hungary, and when I go back to Hungary, I shock my wife with how quickly I become Hungarian even though I left as an infant. Hungarians, on the other hand, know by whatever sense that I am American, and therefore that I should be sold a fake diamond.

The degree to which our lives and our souls are shaped by where we were born and where we live is astonishing. I lived in a neighborhood in the Bronx and went on to get a doctorate. The Puerto Ricans with whom I lived and fought for the most part had no conception of the value of a doctorate and no desire to have one. I lacked their understanding of the street but they had other needs, which I couldn’t fathom.

It’s not obvious which was more important. But my parents were shaped by the first half of the 20th century, by World War II and by the Holocaust. The Puerto Ricans were shaped by their families’ backgrounds, often impoverished, on a tropical island. Their imaginations and appetites were different from the moment of birth, and so I went one way and they another, and I could imagine no other path – with important exceptions on all sides. But we were both fleeing lives that we couldn’t bear, and fled them in very different ways.

The idea that place does not create constraints and imperatives that few can overcome is, I think, naive. This is the foundation of determinism, and we have no trouble imagining this in the markets. In economics, the assumption is that you predict the appetite for or revulsion of good or bad stocks.

I get endless emails from advisers who promise to make me wealthy (side note – if someone can amass vast wealth, why is he hustling me for few bucks?). The assumption is that markets have a degree of predictability. This is true even of market disruption. Amazon founder Jeff Bezos understood what the internet would do, and he aligned himself with what was inevitable.

Our lives are filled with forecasts. When you step off the sidewalk with a “walk” light, you are forecasting that the car approaching will stop. When you choose your profession, you are forecasting that it will serve your needs. When you marry your spouse, you do so based on expectations of happiness. That these may not occur does not change the fact that forecasting is inextricably bound up with human existence.

The argument I am making is twofold. First, that it is impossible to avoid forecasting but that the greater the risk and reward, the more your forecast must be refined. Second, since the behavior of nation-states can give you the greatest reward or risk, forecasting the behavior of nations is indispensable, and refining the forecast into a reliable guide is indispensable.

It seems impossible. But for the most part, the oncoming car stops at the light. Your reading of the situation is correct. In the same way, I will argue that forecasting how nations will behave is possible, if you begin with an understanding of how the forces of that nation define how individuals will behave.

Geographic determinism can be a form of superficial vulgarity. But if it is part of a general understanding of the manner in which humans see the world and their own souls, then predicting the movement of 330 million people becomes possible. In predicting what the United States will do, you must begin with the fact that Americans are human, that they differ from other humans based on where they are, and that like all humans, they experience imperatives and constraints the same way. Doing this allows you to predict the direction a nation will take both internally and toward other nations.

This is the foundation of Geopolitical Futures and what I am doing. It is imperfect, but all things are. It is not simplistic modeling based on geography. It is an attempt to consider how the geography of Greece forged the Greeks, how the Greeks created an extraordinary moment in human thought, and how they gave way to Rome.

You can predict, on the whole and with exceptions, the trajectory of someone’s life by where he was born and to whom he was born. You can describe what he will believe, who he will love, and who he will hate. And taking them together, you can see them crack under pressure, or stand astride their enemies. It may not be perfect, but life is far from random.

I will go from Dubai to Calgary to New York and Istanbul. I am sure there is a common thread that makes this necessary, and traces back to the Magyar tribes east of the Carpathians. I will find it.  

Decline of motor industry drives global economic slowdown

Car production shrank for first time in decade, accounting for a quarter of GDP fall

Delphine Strauss in London

A worker operates on the car production line of the newly opened automobile assembly plant of the German automobile maker and Mercedes Benz outside Moscow, on April 3, 2019. (Photo by Pavel Golovkin / POOL / AFP) (Photo credit should read PAVEL GOLOVKIN/AFP via Getty Images)
© AFP via Getty Images

As the global economy faces its sharpest slowdown since the financial crisis, one industry is both culprit and victim.

The motor industry affects the health of the global economy far more than its share of total output would suggest: carmakers have long supply chains to source parts; they are also big consumers of raw materials and chemicals, textiles and electronics; and their fortunes affect millions of service sector jobs in sales, repairs and maintenance.

Last year the sector shrank for the first time since the global crisis. The IMF believes this fall in output accounted for more than a quarter of the slowdown in the global economy between 2017 and 2018.

The sector may also be responsible for up to a third of the slowdown in global trade growth between 2017 and 2018, the fund said last month, after factoring in the spillover effects on trade in car parts and other intermediate goods.

“The car sector has been weighing heavily on manufacturing activity and growth,” Gian Maria Milesi-Ferretti, deputy director of the IMF’s research department, said last month.

The IMF’s forecast of a modest pick-up in global trade in 2020 hinges on a recovery in the sector. But its analysis also underscored the potential for further damage if the sector becomes the next casualty of the escalating trade spat between the US and EU; the White House is due to decide by November 13 whether to impose a 25 per cent tariff on auto imports.

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Some motor industry executives already blame US trade policy for much of the sector’s misfortune, in particular for a sharp downturn in the Chinese market that had driven global sales growth.

“This trade war is really influencing the mood of the customers, and it has the chance to really disrupt the world economy,” Herbert Diess, Volkswagen’s chief executive, said at the Frankfurt motor show in September, adding: “Because of the trade war, the car market [in China] is basically in a recession . . . That’s scary for us.”

But while carmakers are suffering like other manufacturers from the broader uncertainty over trade policy, they have not yet become a direct target of US trade policy.
Instead, the IMF said the industry downturn was mainly due to policy changes in China — including the withdrawal of tax breaks encouraging car ownership and a clampdown on peer-to-peer lending — and the disruption caused by the rollout of new emissions tests in Europe.

The IMF noted that in many countries, consumers were holding off on purchases because standards were changing rapidly, while the options for car-sharing were evolving.

Meanwhile Indian car sales have slumped because of problems in the shadow banking sector that provides around half of new car finance; while recession in Turkey and Brexit-related uncertainty in the UK have held back sales in other big markets.

Overall, car sales fell by about 3 per cent in 2018 and car production by around 2.4 per cent, after correcting for differences in the average price of cars between countries, the IMF said.

Research published by Fitch Ratings earlier this year argued that this global fall in car sales could have reduced world gross domestic product by as much as 0.2 per cent — significantly more than the IMF estimates — after taking account of spillovers to other industries and the effects of lower wages and profits on household and business spending.

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“This is where the global slowdown has been concentrated,” said Brian Coulton, chief economist at Fitch Ratings. “It has been the lead sector, not just broader collateral damage [of the trade war] . . . There is no doubt this is a key driver of the global manufacturing cycle.”

Matters will worsen if the car industry does fall victim to tit-for-tat tariffs. With supply chains criss-crossing borders, and just-in-time manufacturing processes, the industry is especially vulnerable to new trade barriers.

Wilbur Ross, US commerce secretary, hinted in an interview with the Financial Times last month that Washington was inclined to pursue talks with the EU, rather than imposing tariffs on auto imports when a six-month reprieve runs out in the middle of this month.

Yet the threat of tariffs remains live. Analysis published earlier this year by the Peterson Institute for International Economics found that if the US were to act on the threat, imposing a 25 per cent tariff on auto imports from all countries, US auto production would fall by 1.5 per cent, with the sector shedding almost 2 per cent of its workforce and 195,000 workers becoming unemployed nationally as a result of the macroeconomic shock.

If other countries retaliated, US production would fall 3 per cent, with 624,000 US jobs lost and 5 per cent of the sector’s workforce displaced.

“If they do this, we are all losers,” Oliver Zipse, BMW’s chief executive, told a conference last month, adding that tariffs would threaten jobs and production at its factory in South Carolina.

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So far, the US is the only big market where car sales have remained relatively resilient.

Much of the downturn elsewhere appears to be cyclical: the decline followed several years of surging sales, and it came just as many carmakers were being forced to make large investments to develop electric vehicles that will be lossmaking in the near term at least.

But pervasive uncertainty over trade — and the resulting worries over global growth — do not help.

As Holger Schmieding, an economist at Berenberg, pointed out, this kind of uncertainty tends to scare consumers off big ticket purchases: “If you are uncertain . . . you don’t have to buy the car.”

What Really Happened in Bolivia?

Events in the country remain exceptionally fluid following the ouster of President Evo Morales, who has been given political asylum in Mexico. Nonetheless, three preliminary conclusions can already be drawn.

Jorge G. Castañeda


MEXICO CITY – Events in Bolivia remain exceptionally fluid following the ouster of President Evo Morales. There may or may not be free and fair elections within 90 days. Morales, who has been given political asylum in Mexico, may run again for president or seek to return to power by other means.

The Latin American left may recover from the fall of an icon, or continue to lose ground.

Morales’s policies, good and bad, will be overturned by a rightward swing in Bolivia, not unlike the recent anti-incumbency backlash elsewhere in Latin America, or they will outlast him.

Nonetheless, three preliminary conclusions can already be drawn. The first involves the regional implications of Morales’s downfall, regardless of the details of its consummation. After Latin America’s so-called pink tide – roughly from 2000 to 2015 – many of the left’s emblematic leaders were voted out of power, or resorted to various authoritarian stratagems in order to remain in control. Once the commodity boom ended, and when corruption scandals erupted in several countries, many leftist leaders or parties were unceremoniously evicted.

This occurred in Brazil, of course, as well as in Argentina, El Salvador, and Chile. In Venezuela, Nicaragua, and Bolivia itself, the left hung on to power through increasingly repressive and anti-democratic procedures. With the exception of Mexico, where Andrés Manuel López Obrador won the presidential election in 2018, the left has been on the wane across the region.

President Mauricio Macri’s defeat last month by the Peronist candidate Alberto Fernández in Argentina restored hope to the left’s supporters throughout the region. Similarly, the massive, though often violent, demonstrations in Chile since October, frequently seen as anti-neoliberal protests and as a clamor for a “different path,” gave reason for leftists to believe that the pendulum had swung back.

In this context, Morales’s political demise clearly counts as a defeat. He had lasted longer than any of the region’s other leftist leaders. His indigenous roots in one of the region’s poorest countries, together with his charismatic – or grandstanding – anti-imperialism and flamboyance, made him a rock star in much of the world.

The fact that the economy grew impressively, and that his opponents were often racist, also helped. This is now over, despite his best efforts, aided by his Mexican hosts and their Cuban and Venezuelan allies, to maintain his social-media presence in Bolivia and the international press.

Morales and his backers have sought to portray his fall from power as a classic military coup d’état, analogous to those that overthrew Guatemalan President Juan Jacobo Árbenz in 1954 or Salvador Allende in Chile in 1973. In each case, the military steps in, with American support or acquiescence, captures the presidential palace and most of the president’s aides, shuts down the legislature, represses left-wing activists or leaders, and remains in power for years to come.

Having been overthrown, the democratically elected president who wished to continue to govern with a democratic mandate either commits suicide or goes into exile.

None of this is what occurred in Bolivia in October and November. Morales violated the constitution by running for a fourth term. The two Organization of American States Electoral Observation Missions that he himself had invited, and whose terms he had accepted, then refused to certify the outcome. The Bolivian military arrested no one.

True, Morales resigned when the military told him to, and after he had agreed to protesters’ demands for a new vote. But the existing constitutional provisions were subsequently followed.

The Constitutional Court, which allowed Morales to run, deemed the presidential succession legal; timely elections have been promised; and the military have not taken power. Indeed, the high command under Morales, who “suggested” he resign, has been replaced.

The broader, more abstract question is this: If electoral mechanisms no longer suffice to replace a president who is bent on remaining in power, when does an attempt to remove him or her through other means become legitimate? Would a coup to overthrow Venezuelan President Nicolás Maduro, Nicaraguan President Daniel Ortega, or Raúl Castro in Cuba be acceptable?

What about dictators like Chile’s Augusto Pinochet and Argentina’s Jorge Videla in the 1970s and 1980s? Why is it acceptable when millions in the streets demand their leaders’ resignation, but not when the military join them verbally, and without the use of force?

When dictators assume power through electoral means, and then hold onto it through other methods, eliciting demands for their departure by students, unions, women, and indigenous peoples – like in Ecuador, just weeks ago – matters are no longer as clear-cut as they seemed decades ago.

Morales’s fall was brought about by a complex combination of factors, only one of which was the military’s call for him to step aside. Transforming him into a modern-day Allende who survived because he fled may be good propaganda for the radical left in Mexico, New York, and Bolivia, but it does not correspond to realities on the ground.

This leads us to the third conclusion. If the new Bolivian government sticks to the timetable foreseen by the constitution and schedules elections within 90 days, this will foreclose the discussion about coups and non-coups.

If Morales’s party, the Movimiento al Socialismo, fields a candidate other than Morales, it will lend full legitimacy to the process. Morales will almost certainly not be allowed to run, both for having attempted to steal the previous vote, and in view of the existing prohibition on running for a fourth term.

If the center-right opposition wins, it will undoubtedly attempt to overturn many of Morales’s policies and decisions. It is worth noting, however, that Carlos Mesa, who would have contested the run-off vote against Morales if the latter had not proclaimed himself the winner in the first round, is no extreme right-winger.

In fact, he was Morales’s representative at The Hague in Bolivia’s suit against Chile before the International Court of Justice. But that is what elections and rotation in power are for: to change course when the electorate so decides.

Morales will continue seeking to use his Mexican asylum and official sympathy for his cause to return to power. He may even succeed. But that would not address the country’s underlying dilemma. During 200 years of independence, Bolivians, like so many others in Latin America, have failed to transfer power peacefully and democratically over a sustained period of time.

Mandates to govern were interrupted by coups, revolutions, insurrections, or accidents – or leaders remained in power indefinitely. Having Morales pass from the scene for good, while transferring power peacefully and democratically from one president to another for the foreseeable future, would be a major accomplishment.

Jorge G. Castañeda, former Foreign Minister of Mexico, is Professor of Politics and Latin American and Caribbean Studies at New York University.

Gold Will Break Its All-Time High in 2020

By E.B. Tucker, editor, Strategic Investor

I sat down for half a dozen media interviews earlier this year where I called for $1,500 per ounce of gold in 2019.

In several cases, the hosts nagged me about my prediction, asking if I would stick with it. I did. In August, it hit my target.

Now, the price has retreated a bit since, but gold’s still flirting with $1,500 per ounce, as I write.

Here’s why I’m writing you today: I believe $1,500 is only the beginning for gold.

I expect gold to take out its previous high of $1,900. That’s a 27% gain from here. And I expect that to happen in 2020.

In fact, as I told Kitco News recently, from there I see it hitting $2,200 – about a 47% rise from its current price of $1,492 per ounce.

Today, I’ll share why… and how you can start taking advantage…

A Major Gold Rally Is Underway

All of the serious money I’ve made investing came through positioning for a big move and sitting tight. Trading is tough. In and out all the time can work over a short period. But the big gains come from sitting tight and letting the bull market run.

After hitting an all-time high in 2011, the price of gold fell 45% to a low of $1,052 in late 2015.

While the Obama administration and the Federal Reserve experimented with radical money policies, gold stayed stuck. Notice in the chart above it didn’t do much after hitting its 2015 low.

What’s bad for gold is unbearable for gold miners. They commit to projects assuming they’ll sell produced gold for $1,500. Then it falls to less than $1,100. That means the project is bankrupt before it pours the first gold ounce.

That period is over.

I can give you a list of anecdotal evidence as proof. Several large mining firms combined this year in order to survive. These were not bidding war takeovers. CEOs got over their egos and merged to avoid losing their companies entirely.

Political dysfunction and ballooning deficits also set the stage for gold today. The three largest central banks in the developed world recently declared they’ll do anything to stimulate their economies. That’s central bank lingo for “create more money.”

But we need more than strong anecdotes to risk money on the gold sector.

From our view, that’s why the chart of gold is so important. It’s how I determined $1,500 was an important target for gold this year. If it hit that target, which it did, I felt it was a green light to invest more aggressively for higher prices.

The gold chart below goes back to 2014. Notice that after gold hit its low in late 2015 (circled in red), each rally that followed registered a higher low. The pullbacks of 2016 and 2018 (also circled in red) each hit low points higher than the last. To us, this meant it was a matter of time before gold exploded higher.

Breaking $1,500 was the first test. Now, I expect it to correct, which is market speak for rest and get ready for the next leg higher.

That next move for gold will catch mainstream asset managers off guard. As I said above, I expect it to eventually take out its 2011 high. That’s why the current pullback in gold is the perfect time to position for what may come next.

If you haven’t already, the first step is buying some physical gold. If you’re new to gold, start with common 1-ounce coins like the ones offered here by Gainesville Coins.

(I asked Gainesville Coins to create this page as a starting point for Casey Daily Dispatch subscribers who are new to physical gold. We do not receive any compensation from Gainesville Coins for bringing you this offer.)

After owning physical gold, you should consider speculating on select mining stocks, which can provide leverage to a rising gold price.

Let me explain…

Gold Mining Stocks… and the Power of Leverage

The word “leverage” usually means borrowing. That’s not the case at all in the gold market.

If you aren’t familiar with the concept of leverage in gold stocks, here’s a quick example of how powerful it can be…

Say the price of gold rises from $1,300 to $1,400. That’s roughly an 8% gain. If you own physical gold, you’re up 8%.

Now, say a mining company owns a million ounces of gold in the ground, and gold is trading at $1,300. The value of the gold in the ground isn’t simply $1.3 billion (1 million ounces x $1,300 per ounce). Instead, the gold in the ground is worth much less than that, because it will cost a lot of money to extract.

Say it costs the company $1,250 per ounce, all-in, to mine the gold. At a gold price of $1,300, the company has a potential profit of $50 on each ounce of gold.

However, if the price of gold rises only 8% to $1,400, the company’s profits per ounce increase by 200% ($1,400 – $1,250 = $150 profit per ounce). This small move in gold can cause the stock price to increase 40%, 50%, or more.

This is why a small increase in the price of gold can cause a gold stock to soar many times that amount.

It’s happened before…

Gold producers boomed during three separate cycles when gold surged: 1979-1980, the mid-1990s, and 2001-2006.

First up, the king of all gold bull markets: 1979-1980…

Gold more than tripled during this period. But gold stocks more than quadrupled.

This wasn’t the only time gold stocks ran further than gold itself…

There was another boom in the 1990s. The average gold producer went up more than 200%…
Cambior rose 124%. Kinross Gold returned more than 190%. And Manhattan Gold & Silver skyrocketed over 760%.

All while gold only rose 8%.

Then, another big boom hit from 2001-2006.

Gold returned 158%, while the average gold producer gained over 400%.

Newmont shot up 270%. Gold Fields soared over 500%. And Goldcorp returned over 800%.

As you can see, an increase in the price of gold (even a small one) can lead to huge returns.

Now’s the Time to Take Advantage

You don’t want to be sitting on the sidelines while the motherlode of all gold rallies gains momentum…

Remember, before owning a gold stock, it’s wise to have some physical gold.

Then, you can speculate on higher gold prices by buying gold miners, which gives you the chance to multiply your money in a gold bull market.

You can look into an exchange-traded fund (ETF) like the VanEck Vectors Gold Miners ETF (GDX), which holds a basket of gold stocks.

But the best way to take advantage is by following our advice in my newsletter Strategic Investor. In our core portfolio we have a world-class gold miner that shot up 56% during gold’s move from May to September of this year. This is no penny stock. This multibillion-dollar miner turns a profit and pays a dividend.

The same goes for silver. Our top pick surged 83% over the same period. It too pays a dividend.
In short, now’s the time to strike before gold really takes off.

Just remember, gold stocks are extremely volatile. Like in any industry, the stocks of stronger companies will go up more than those of the weaker ones. As always, never bet more money than you can afford to lose.

It only takes a small stake in the right companies to make a fortune as gold prices rise.