Who Lost Argentina, Again?

With a presidential election approaching next month, Argentina is once again on the cusp of a crisis that could end in depression and default, owing to mistakes made by everyone involved. Should President Mauricio Macri secure another term, he must waste no time in reversing the country's economic deterioration.

Mohamed A. El-Erian

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CERNOBBIO – Investors and economic observers have begun to ask the same question that I posed in an article published 18 years ago: “Who lost Argentina?” In late 2001, the country was in the grips of an intensifying blame game, and would soon default on its debt obligations, fall into a deep recession, and suffer a lasting blow to its international credibility. This time around, many of the same contenders for the roles of victim and accuser are back, but others have joined them. Intentionally or not, all are reprising an avoidable tragedy.

After a poor primary-election outcome, Argentinian President Mauricio Macri finds himself running for another term under economic and financial conditions that he promised would never return. The country has imposed capital controls and announced a reprofiling of its debt payments. Its sovereign debt has been downgraded deeper into junk territory by Moody’s, and to selective default by Standard & Poor’s. A deep recession is underway, inflation is very high, and an increase in poverty is sure to follow.

It has not even been four years since Macri took office and began pursuing a reform agenda that was widely praised by the international community. But since then, the country has run into trouble and become the recipient of record-breaking support from the International Monetary Fund.

Argentina has fallen back into crisis for the simple reason that not enough has changed since the last debacle. As such, the country’s economic and financial foundations have remained vulnerable to both internal and external shocks.

Although they have been committed to an ambitious reform program, Argentina’s economic and financial authorities have also made several avoidable mistakes. Fiscal discipline and structural reforms have been unevenly applied, and the central bank has squandered its credibility at key moments.

More to the point, Argentinian authorities succumbed to the same temptation that tripped up their predecessors. In an effort to compensate for slower-than-expected improvements in domestic capacity, they permitted excessive foreign-currency debt, aggravating what economists call the “original sin”: a significant currency mismatch between assets and liabilities, as well as between revenues and debt servicing.

Worse, this debt was underwritten not just by experienced emerging-market investors, but also by “tourist investors” seeking returns above what was available in their home markets. The latter tend to lack sufficient knowledge of the asset class into which they are venturing, and thus are notorious for contributing to price overshoots – both on the way up and the way down.

Undeterred by Argentina’s history of chronic volatility and episodic illiquidity – including eight prior defaults – creditors gobbled up as much debt as the country and its companies would issue, including an oversubscribed 100-year bond that raised $2.75 billion at an interest rate of just 7.9%. In doing so, they drove the yields of Argentine debt well below what economic, financial, and liquidity conditions warranted, which encouraged Argentine entities to issue even more bonds despite the weakening fundamentals.

The search for higher yields has been encouraged by unusually loose monetary policies – ultra-low (and, in the case of the European Central Bank, negative) policy rates and quantitative easing – in advanced economies. Systemically important central banks (the Bank of Japan, the US Federal Reserve, and the ECB) thus have become the latest players in the old Argentine blame game.

Moreover, influenced by years of strong central-bank support for asset markets, investors have been conditioned to expect ample and predictable liquidity – a consistent “common global factor” – to compensate for all sorts of individual credit weaknesses. And this phenomenon has been accentuated by the proliferation of passive investing, with the majority of indices heavily favoring outstanding market values (hence, the more debt an emerging market issues, like Argentina, the higher its weight in many indices becomes).

Then there is the IMF, which readily stepped in once again to assist Argentina when domestic-policy slippages made investors nervous in 2018. So far, Argentina has received $44 billion under the IMF’s largest-ever funding arrangement. Yet, since day one, the IMF’s program has been criticized for its assumptions about Argentina’s growth prospects and its path to longer-term financial viability. As it happens, the same issues plagued the IMF’s previous efforts to Argentina, including in the particularly messy lead-up to the 2001 default.

As in Agatha Christie’s Murder on the Orient Express, almost everyone involved has had a hand in Argentina’s ongoing economic and financial debacle, and all are victims themselves, having suffered reputational harm and, in some cases, financial losses. Yet those costs pale in comparison to what the Argentine people will face if their government does not move quickly – in cooperation with private creditors and the IMF – to reverse the economic and financial deterioration.

Whoever prevails at next month’s presidential election, Argentina’s government must reject the notion that its only choice is between accepting and refusing all demands from the IMF and external creditors. Like Brazil under then-President Luis Inácio Lula da Silva in 2002, Argentina needs to embark on a third path, by developing a homegrown adjustment and reform program that places greater emphasis on protecting the most vulnerable segments of society. With sufficient buy-in from domestic constituencies, such a program would provide an incentive-aligned path for Argentina to pursue its recovery in cooperation with creditors and the IMF.

Given the downturn in the global economy and the rising risk of global financial volatility, there is no time to waste. Everyone with a stake in Argentina has a role to play in preventing a repeat of the depression and disorderly default of the early 2000s. Managing a domestic-led recovery will not be easy, but it is achievable – and far better than the alternatives.

Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He is President Elect of Queens’ College (Cambridge University), senior adviser at Gramercy, and Part-time Practice Professor at the Wharton School at the University of Pennsylvania. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers four years running. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.

Global bond bull run has reached historic levels

There are precedents for today’s markets, if you reach back far enough

Robin Wigglesworth

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The global bull run that started in 1985 is now one of the most intense in the debt market’s 700-year history, comparable with a deleveraging and economic growth spurt that followed the Napoleonic wars.

Despite longstanding predictions of the end of the bond bull market that started after former Federal Reserve chair Paul Volcker quashed inflation in the 1980s, government debt has kept rallying this year, taking the average annual fall in yields to 17.4 basis points (0.174 percentage points) over the past 34 years.

That puts it on the cusp of surpassing the 1873-1909 bull run in length, and makes it the strongest decline in long-term interest rates since 1817-1854, when bond yields declined by 22 bps a year, according to research by Paul Schmelzing, a visiting scholar at the Bank of England.

The only other stronger periods of declines since Italian city-states first began issuing bonds in the 12th century were under the reign of Louis XIV, Venice’s 14th and 15th century heyday and during the stability that followed the Peace of Cateau-Cambrésis in 1559. That ended the European power struggle between Habsburg Spain and France over control of Italy.

Although more than $15tn of bonds now trade with negative yields, the fact that the world has seen comparable, if rare, falls in bond yields, and the long-term nature of the decline since the 12th century, casts doubts over suggestions that the global economy is experiencing something unprecedented, according to Mr Schmelzing.

“The ‘secular stagnation’ theory is highly questionable against this evidence: the fall in real rates has in fact been continuous for centuries, and recent years merely witnessed a trend-return,” he said.

The data on global, inflation-adjusted bond yields have been collected by Mr Schmelzing for his upcoming PhD thesis at Harvard. The data were first published by the Bank of England in January 2017 and updated for the Financial Times to include the bond market’s rally since then.

US regulator reforms ETF rules

SEC aims to stimulate innovation and competition

Chris Flood

Jay Clayton, chairman of the U.S. Securities and Exchange Commission (SEC), speaks during a House Financial Services Committee hearing in Washington, D.C., U.S., on Tuesday, Sept. 24, 2019. Clayton said this month his agency and other regulators are keeping taps on emerging risks in the fast-growing corporate debt market, highlighting assets that could he susceptible to liquidity shocks. Photographer: Andrew Harrer/Bloomberg
© Bloomberg

The Securities and Exchange Commission, the US financial regulator, has simplified the rules covering exchange traded funds with reforms that are expected to encourage more new participants to enter the fast-growing ETF industry.

The rule change is intended to encourage greater competition and innovation, leading to more choice for investors. It will also allow new ETFs to be launched more quickly as the SEC has swept away the existing cumbersome process where asset managers had to apply for so-called exemptive relief from existing US mutual fund rules for each ETF that they wished to launch.

“As the ETF industry continues to grow in size and importance, particularly to Main Street investors, it is important to have a consistent, transparent, and efficient regulatory framework that eliminates regulatory hurdles while maintaining appropriate investor protections,” said Jay Clayton, chairman of the SEC.

The regulator has issued more than 300 exemptive orders since 1992 allowing ETFs to operate. Since then, more than 2,000 ETFs have been launched in the US with combined assets of more than $3.3tn.

The Investment Company Institute, the trade body representing US asset managers, welcomed the change as “an important step” in the evolution of the ETF industry.

Paul Schott Stevens, the chief executive of ICI, said the reforms would “greatly benefit ETFs and their investors by lowering barriers to entry, fostering more innovation, and facilitating greater competition in the marketplace”.

Deborah Fuhr, co-founder of ETFGI, a London-based consultancy, said the reforms would create a more level playing field between ETFs and mutual funds.

“Applying for exemptive relief to launch a new ETF was often a lengthy process that could take several months. These reforms should reduce the cost of bringing new products to the market and improving choice for investors as we are seeing many innovations with new indices, custom baskets and ESG strategies that can all be embedded in an ETF wrapper,” said Ms Fuhr.

Gold price could smash records at $2,000, says Citi

Precious metal has rallied after big purchases from central banks, including China’s

Henry Sanderson

The price of gold could hit a record high of $2,000 an ounce within the next two years as US economic growth fades and the Federal Reserve cuts interest rates, according to analysts at Citigroup.

The New York-based bank said in a Monday research note that the precious metal could top levels last seen eight years ago, when gold surged to $1,900 an ounce, as uncertainty over the 2020 presidential election combines with a sputtering domestic economy.

Investors around the world have been drawn to gold at a time of negative bond yields, which have increased the appeal of yieldless assets such as gold. Around $15.3tn of bonds are trading at levels that guarantee buyers a loss, if the bonds are held to maturity. The gold price has risen by 17 per cent this year to trade at $1,495 a troy ounce, putting the precious metal on track for its best year since 2010.

Citi said a combination of lower rates, growing risks of a global downturn, and strong demand among central banks could push prices higher still. Central banks are buying more gold this year than any year in the past nine, according to the World Gold Council.

“We expect spot gold prices to trade stronger for longer . . . posting new cyclical highs at some point in the next year or two,” strategists including Aakash Doshi said in Citi’s note.

Big foreign-exchange holders such as China, which has $3.1tn in reserves, have been keen to diversify their portfolios to limit exposure to the US dollar. China’s central bank has bought $4.8bn worth of gold over the past nine months.

“It does seem that gold’s status within the portfolio has been reignited,” said Suki Cooper, an analyst at Standard Chartered in New York.

The People’s Bank of China increased its holdings of gold to 62.45m ounces in August, from 59.24m in November, according to a weekend notice on its website. That takes the bank’s total gold holdings to around $94bn at current prices.

Last year, central banks bought the most gold in 50 years, led by Russia, whose holdings of gold are now worth around $100bn.

Alistair Hewitt, a director at the World Gold Council, said that central banks across emerging markets are attracted by the liquidity of the gold market and its lack of default risk. Countries such as Russia have also adopted a clear policy of “de-dollarisation,” he said.

China is the world’s biggest producer and consumer of gold, but the precious metal makes up just 2.7 per cent of its official reserves, which are worth more than $3tn.

“Their FX reserves are so large [diversification is] going to take decades and decades,” said Bernard Dahdah, a commodities analyst at Natixis.

The precise composition of China’s foreign exchange reserves is a state secret, but officials have previously said that the currency mix is broadly in line with the composition of global reserves as indicated by IMF data collected from member countries. US dollar assets comprised 64 per cent of allocated reserves by the end of 2016, according to the latest data.

Baghdad Donald

By: Peter Schiff

For Donald Trump, it seems that these are the best of times except that they are the worst of times. How else to explain his contradictory demand that the Federal Reserve cut interest rates by 100 basis points despite his repeated claims that our current economy is “the best in the history of the United States?” That kind of “break glass in case of emergency” monetary policy is something that even the eldest among us have only seen once or twice. And those times have certainly been desperate.

As has been showcased in recent days, Trump can flip-flop faster than anyone in Washington. He wants capital gains indexing on Monday, only to abandon the idea on Tuesday. At breakfast, he wants expanded background checks for firearms, but drops the idea by lunch. But in his call to slash interest rates in a “great” economy, the president flip-flops in the same sentence.

While I don’t believe that the Fed, or anything other than market forces, should have the power to set interest rates, accepted economics dictate that interest rates should generally be higher when the economy is strong and lower when it is weak. This is the result of the reliable law of supply and demand. In this case, the supply of savings and the demand for loans.

In a weak economy, uncertainty causes people and businesses to spend and invest less while they save more. This gives banks more money to lend at a time when the demand for credit falls, generally pushing rates down (the price of money). The good news is that these low rates tend to stimulate borrowing, which may help the economy recover. Free markets work well that way. In contrast, when times are good, the exuberance causes people and businesses to spend and invest more, and save less. This gives banks less to lend at a time when demand for credit is high. This pushes up interest rates, which encourages more savings to finance additional investment to sustain the expansion.

But as Trump is looking for all the help he can get, logic and economic common sense have been unceremoniously abandoned. He wants it all, and he doesn’t want to explain why.

Economic weakness is to President Trump what American tanks were to Baghdad Bob in 2003: A dangerous presence that is never, ever, to be acknowledged, even when its barrel is pointed straight at you. I believe the President knows the economy is weakening, he just can’t admit it. And so, his only choice is to lie, audaciously, loudly, and unapologetically. The tactic has never hurt him in the past, and he’s banking on it not hurting him now.

The really tricky part is to argue that, despite a historically strong economy, rates should be cut quickly and drastically. His preferred argument seems to be that since other countries have zero or negative rates, our higher rates puts our “strong” economy at an unnecessary disadvantage. He argues that if they are doing it, so should we. In essence, he suggests we succumb to monetary peer pressure…all the cool central banks are doing it!

Fed Chairman Powell is caught in the crosshairs of Trump’s contradictions. Although Fed Chairs are well known for their skills of obfuscation, few mortals can attempt a rhetorical gambit as bold as the President’s. His task will become increasingly difficult in light of fresh signs that the economy is weakening. (Maggie Fitzgerald, CNBC, 9/2/19) Powell may now be regretting that he took the job in the first place.

Coming back from the Labor Day Weekend, markets were greeted with the news that the Institute for Supply Management’s (ISM) manufacturing index fell to 49.1% in August from 51.2% in July. (A reading below 50 indicates a contraction in manufacturing). This is the first time the index has slipped below 50 since Trump was elected, and is the weakest reading in 10 years. The decline also represents the biggest year over year decline in the index (it was at 60.8 in August 2018) since April 2009! In addition, the August Manufacturing PMI, while still above 50, fell to 50.3, its lowest level in 10 years.

More clouds gathered with today’s release of the August jobs report, which shows the private sector added just 96,000 jobs in the month. This tepid figure means that we are experiencing the slowest average year to date private sector job creation since 2010. But more importantly, just 3,000 of those jobs came from manufacturing. The report also revised down the 16,000 previously reported July manufacturing job creation to just 4,000. The numbers confirm the suspicion that manufacturing is sputtering.

But the real economic concern started this early in the summer when the yield curve for two-year and ten-year Treasuries inverted for the first time since the Great Recession. Over the decades, these inversions, in which investors get a lower yield on a 10-year bond than they do on a two-year bond, have tended to be one of the most reliable signs of recession.

Then, in August, the Bureau of Labor Statistics (BLS) significantly downgraded its previously released employment statistics for the prior year through March 2019. While this happens every year (when the BLS matches up prior projections with actual employer reports), this year’s downgrade, which saw 501,000 fewer jobs than previously expected, was the biggest in a decade and on a scale not seen since the Great Recession. (Jeffry Bartash, Market Watch,8/24/19) The report does not say that a half a million people just lost their jobs, it simply reveals that those jobs never existed in the first place. This puts the average monthly job creation of 2018 at 185,000, hardly the blockbuster numbers that the Administration has been touting.

And the hits keep coming…

Data released last week showed that U.S. GDP growth slowed to a 2.0% annualized rate in the second quarter of this year. While the quarter did see the strongest growth in consumer spending in 4-1/2 years, the positive effects were more than offset by weaker than expected exports and a smaller inventory build. While 2.0% growth would not normally be something to panic about, it does represent a sharp deceleration from the 3.1% rate in the first quarter, and brings the first half growth in at a mediocre 2.6%. This is a far cry from the 3%-4% growth Trump and Republicans claimed the tax cuts would produce. Instead all we got was Obama-era type growth, but with much larger deficits.

According to a study by the Congressional Research Service, the President’s tax cuts and trade policies have done little to revitalize the business climate, but have stimulated more debt creation so that the Federal government and consumers can keep spending money they don’t have. But this type of debt-fueled, consumption-led GDP growth is unsustainable. Trump has merely enlarged the big, fat, ugly bubble he inherited from Obama.

Make no mistake, the growth in debt has been remarkable. In recent weeks, the Congressional Budget Office drastically pulled forward the date by which the U.S. will see sustained deficits greater than $1 trillion annually. (These projections exclude money that will need to be borrowed to finance off-budget spending which can add hundreds of billions annually to official budgets). Heading into the 10th year of an economic expansion, we would expect that deficits should be shrinking, not exploding. This provides more evidence that we may have been riding on top of a financial bubble, not genuine economic growth.

And while government debt may be reliably expected to increase, consumer spending, which constitutes nearly 70% of the U.S. economy, is on shakier ground. Spending is highly influenced by consumer confidence, which has shown signs of slipping. Last week the University of Michigan posted its August Consumer Sentiment Index, which saw a decline of 8.6 points, the largest such monthly decline since December 2012. If the trend continues and consumers pull back on spending, one of the few remaining drivers of GDP growth will fail.

Not surprisingly, given all these tensions, the political antagonism between the President and the Fed has erupted into broad daylight. Everyone has seen the fire from the President with his daily (and even hourly) Twitter rampages accusing Chairman Powell of incompetence or even outright malevolence. But, more recently, the Fed, through proxies, has started to fire back.

In an August 27 Bloomberg News Op-ed, Bill Dudley, the long-serving former President of the Federal Reserve Bank of New York, urged his former colleagues to resist Trump’s efforts to force the Fed’s hand on interest rates. Many surmise that Trump’s increasingly incoherent tariff pronouncements are simply designed to sow the kind of economic chaos that would force the Fed to cut rates below its comfort zone. Dudley confirmed this theory and urged his colleagues to not take the bait. By holding firm on rates, he argued that the Fed could make the President pay politically for the mess he has created.

While I agree that the Fed should not bail out Presidents who make bad fiscal choices, it is also true that Dudley’s position reeks of hypocrisy and a double standard. The Fed has been compensating for bad fiscal policy for generations. In fact, I would argue it has its mission.

Without the Fed’s cooperation in artificially suppressing interest rates and monetizing government debt, the economic consequences of reckless deficit spending would have already manifested in a downturn that probably would have brought down any incumbent then in office. To specifically deny such protection to Trump would further divide the nation politically and open the Fed to partisan attacks that could threaten to make the Fed even more political and irresponsible.

All this adds up to an increasingly ridiculous set of monetary and economic policies that are guiding the world’s dominant economy. Fortunately for the U.S., much of the global focus is understandably fixated on the final stages of the Brexit drama in the U.K. and the possibility of a new Tiananmen Square in Hong Kong. It is sad, but not illogical to assume that both of these issues will be resolved in the relatively near term. However, the problems in Washington will likely not be resolved until a crisis intervenes to force a painful resolution.

Once the world does focus more intently on the Keystone Kops who currently set our policy in Washington, a decline in confidence in the U.S. as the world economic leader may arise. When that confidence ebbs, so too might support for the U.S. dollar. Ironically, a decline in the dollar is precisely the outcome Trump has been hoping for, and the only policy goal he may achieve. (Unfortunately, it might not deliver the beneficial outcome he expects).

Though the dollar has been strong relative to other fiat currencies (the Dollar Index is up more than 1% since the end of May), it has been weak relative to real money, gold and silver. Over that time, gold and silver are currently up 16% and 28% respectively. The precious metals markets may be showing an underlying dollar weakness not yet reflected in foreign exchange markets. But if central banks and investors prefer holding gold and silver to U.S. dollars, particularly as bond yields drift down, the dollar’s days as the world’s reserve currency may be numbered.

A July 10th report by Craig Cohen, FX, Commodities and Rates Strategist, from JPMorgan recently stated. “We believe the dollar could lose its status as the world’s dominant currency (which could see it depreciate over the medium term) due to structural reasons as well as cyclical impediments And this month, Bank of England Gov. Mark Carney claimed that the dollar’s status as a hegemon is putting the global economy under increasing strain and needs to end. (Andy Langenkamp, MSN opinion contributor, 9/1/19)

A dollar in secular decline may be the final piece in the puzzle that shows the insanity of our current fiscal and monetary policy. The U.S. bubble economy rests on the foundation of the dollar’s status as the reserve currency. If that status is lost, the entire house of cards may just come crashing down.