by John Rubino
About a year ago, Argentina – which has inflated away and/or defaulted on its currency every few decades for the past century – issued 100-year government bonds. And the issue was oversubscribed, with yield-crazed developed-world institutions throwing money at the prospect of a lifetime of 7% coupon payments.
A media account of the deal at the time:
Argentina sees strong demand for surprise 100-year bond
(CNBC) – Argentina sold $2.75 billion of a hotly demanded 100-year bond in U.S. dollars on Monday, just over a year after emerging from its latest default, according to the government.
The South American country received $9.75 billion in orders for the bond, as investors eyed a yield of 7.9 percent in an otherwise low yielding fixed income market where pension funds need to lock in long-term returns.
Thanks to a stronger-than-expected peso currency, the government has increased its overall 2017 foreign currency bond issuance target to $12.75 billion from its previous plan of issuing $10 billion in international bonds, Finance Minister Luis Caputo told reporters in Buenos Aires.
Argentina is going to the international capital markets to help finance a fiscal deficit of 4.2 percent of gross domestic product this year. Caputo said Argentina has $2.6 billion in bonds left to be issued this year. The new paper could be denominated in euros, yen or Swiss francs.
The new bond had a coupon of 7.125 percent, the finance ministry said in a statement that hailed success of the sale as evidence that Argentina had regained “credibility and confidence.”
That similar transactions between US and European “investors” and Latin American countries have happened with regularity and have nearly always blown up in the investors’ faces once again didn’t matter.
And once again it’s blown up. This time with more than the usual shock and awe.
Now the question is, who’s stuck with those 100-year bonds that are plunging in value and will – possibly soon – default? The above article noted that pension funds were especially interested.
The implication? Owning 7% bonds has allowed an unknown number of pension funds to pretend that they’re capable of earning the 7.5% annual return that their political bosses demand. And now the possible default on those bonds has stripped those same pension funds of even the pretense of meeting their obligations. The already real pension crisis just got more real.
As for the hedge funds that bought these bonds with leverage – we’re about to see even more reports of formerly solid funds underperforming, closing down and returning what’s left of their clients’ capital.
This is how a crisis at the periphery spreads to the core.
Here’s an excerpt of an excellent overview of the emerging market situation:
Behold The Sudden Stop. Risk of Emerging Markets Collapse
(Daniel Lacalle) – The recent collapse of the Argentine Peso and other emerging currencies is more than a warning sign.
It could be the arrival of a “sudden stop”. As I explain in Escape from the Central Bank Trap (BEP, 2017), a sudden stop happens when the extraordinary and excessive flow of cheap US dollars into emerging markets suddenly reverses and funds return to the U.S. looking for safer assets. The central bank “carry trade” of low interest rates and abundant liquidity was used to buy “growth” and “inflation-linked” assets in emerging markets. As the evidence of a global slowdown adds to the rising rates in the U.S. and the Fed’s QT (quantitative tightening), emerging markets lose the tsunami of inflows and face massive outflows, because the bubble period was not used to strengthen those countries’ economies, but to perpetuate their imbalances.
The Argentine Peso, at the close of this article, lost 17% annualized is one of the most devalued currencies in 2018. More than the Lira of Turkey or the Ruble of Russia.
What explains this drop?
For some time now, many of us have warned of the mistake of massively increasing money supply and using high liquidity to avoid much-needed structural reforms. In Argentina, the government of Cristina Fernández de Kirchner left a monetary hole close to 20% of GDP and massive inflation after years of trying to cover structural imbalances with increases in the money supply greater than 30-35% per year.
Unfortunately, as in other emerging markets, the urgent reforms were abandoned, and an alternative formula was tried. Issue great quantities of debt and continue financing a growing public spending with central bank money printing expecting economic growth and cheap debt would offset the growing fiscal and monetary hole.
This wrongly-called “soft adjustment” was justified because of the enormous liquidity in international markets and appetite for emerging markets’ debt driven by consensus estimates of a continued weakening of the US dollar. Many Latin American and emerging market economies fell into the trap. Now, when it stops, and the US dollar recovers some of its weakness, it is devastating.