South America has been a special part of my life for four decades. I have lived many years in Brasil and Peru. I am married to an incredible lady from Argentina. I want to share South America with you.
Is collective memory loss an endemic occupational hazard of the professional fund management community? The question is worth asking in the light of Argentina’s return to the international capital markets last week with a $16.5bn debt offering at yields ranging from 6.25 per cent for three-year paper to eight per cent at the 30-year mark.
Of course it is good news that the country will now be able to settle its long-running dispute with investors who own debt on which it had defaulted and who fought for full repayment until a deal was reached earlier this year. Yet such is the search for yield in today’s low-interest world that there is a strong possibility default risk is being mispriced — especially in the light of history.
Argentina has been a serial defaulter on its external debt, starting with a default in 1827, 11 years after becoming independent from Spain. London bankers and investors poured money into Argentina and other Latin American countries in a manic search for yield. Britain’s current account surplus created a savings glut that resulted in huge capital exports. Today’s savings glut is more widely spread from Japan and China to Germany, but the historical parallel remains clear.
The investment story behind this early 19th century stampede was that the funds would be used to support nation building in resource-rich, newly independent countries. Then the Bank of England inconveniently raised interest rates and precipitated a market panic. Latin America was as vulnerable to monetary tightening by the global hegemonic power as emerging markets are today when the US rules the global roost. Argentina has since defaulted a further six times on its sovereign debt.
In their book on financial crises, This Time Is Different, Carmen Reinhart and Kenneth Rogoff point out that serial defaulters tend to be victims of a syndrome in which weak institutional structures and a problematic political system make external borrowing a tempting escape from hard decisions about spending and taxing. The price of access to capital denominated in a foreign currency, though, is a mismatch that becomes lethal if investors lose confidence in the debtor country’s economic management. As the currency collapses, the foreign debt burden escalates and the country’s solvency is called into question.
In the 19th century, default was less painful for investors in big creditor countries because of gunboat financial diplomacy. Britain invaded Egypt in 1882 and Istanbul after Turkey’s 1876 default to enforce debt contracts. Even in the 20th century the British pressured Newfoundland, which was hopelessly over-indebted in the 1930s, into abandoning its status as a democratic self-governing dominion and accepting federation with Canada.
Today the gunboat option is unavailable. And it remains difficult for serial defaulters to graduate to a more stable status, not least because capital flows are pro-cyclical and volatile.
Investors are, then, showing remarkable sang-froid in relation to Argentina. Some sovereign debtors have been deprived of access to international capital markets for decades after defaulting. Yet Argentina is back just fourteen years after a $95bn default that was the largest in history at the time. The story that has attracted investors to its latest bond offering on what look remarkably generous terms is that a wretchedly bad government has been replaced by a more investor-friendly one that promises better economic management.
It also helps that emerging markets have been picking up after a long period in the doldrums. At the same time it is hard to summon up optimism in the short term about neighbouring countries such as Venezuela and Brazil, which for emerging market bulls adds gloss to the story on Argentina.
The search for yield is not always irrational. Where insurers have promised guaranteed income returns for pensions, a world of low or negative interest rates forces them down this path. Yet a search for yield almost by definition implies greater insensitivity to risk.
On balance, behaviour in global bond markets perfectly exemplifies the dictum of Hegel, the German philosopher, who said “what experience and history teaches us is that people and governments have never learned anything from history, or acted on principles deduced from it”.
John Plender is a columnist at the FT
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