tag:theconversation.com,2011:/africa/topics/sovereign-default-11264/articlesSovereign default – The Conversation2022-04-18T12:28:58Ztag:theconversation.com,2011:article/1811392022-04-18T12:28:58Z2022-04-18T12:28:58ZRussia faces first foreign default since 1918 – here’s how it could complicate Putin’s ability to wage war in Ukraine<figure><img src="https://images.theconversation.com/files/458329/original/file-20220415-16-jlry37.jpg?ixlib=rb-1.1.0&rect=143%2C0%2C5847%2C3664&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Replacing ships like the Moskva will be pricey. The flagship of Russia’s Black Sea Fleet recently sank after suffering damage.</span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/RussiaUkraine/96ef4c8b56c24796a61a124270f573b9/photo?Query=moskva&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=643&currentItemNo=1">Russian Defense Ministry Press Service via AP</a></span></figcaption></figure><p><em>Russia may be on the cusp of <a href="https://www.npr.org/2022/04/12/1092077016/russia-historic-debt-default-sanctions-invasion-ukraine">its first default on its foreign debt</a> since the Bolsheviks ousted Czar Nicholas II a century ago.</em></p>
<p><em>On April 14, 2022, Moody’s Investors Service warned the country’s decision to make payments on dollar-issued debt in rubles <a href="https://www.nytimes.com/2022/04/14/business/russia-default-moodys.html">would constitute a default</a> because it violates the terms of the contract. A 30-day grace period allows Russia until May 4 to convert the payments to dollars to avoid default.</em></p>
<p><em>A default is one of the clearest signals that the sanctions imposed by the U.S. and other countries are having their intended effect on the Russian economy. But will it have any impact on Russia’s ability to wage war in Ukraine?</em> </p>
<p><em>We asked <a href="https://scholar.google.com/citations?user=bSApaj4AAAAJ&hl=en&oi=ao">Michael Allen</a> and <a href="https://scholar.google.com/citations?user=uLty40oAAAAJ&hl=en&oi=ao">Matthew DiGiuseppe</a>, both experts on political economy and conflict, to explain the consequences of default and what it would mean for Russian President Vladimir Putin’s war.</em></p>
<h2>Why did Russia default on its debt?</h2>
<p>The Russian government has a total of <a href="https://www.nytimes.com/2022/03/15/business/russia-debt-bonds-default.html">US$40 billion worth of debt</a> in dollars and euros, half of which is owned by foreign investors. Russia had an <a href="https://www.npr.org/2022/04/12/1092077016/russia-historic-debt-default-sanctions-invasion-ukraine">April 4 deadline to pay</a> about $650 million in interest and principle to the holders of two bonds issued in dollars.</p>
<p>Russia has plenty of cash – <a href="https://asia.nikkei.com/Politics/Ukraine-war/G-7-resists-going-after-1bn-a-day-Russian-energy-revenue">it collects the equivalent of over $1 billion a day</a> from its oil and gas deliveries alone – but has limited access to dollars because of sanctions imposed by the U.S. The Biden administration had been allowing Russia to use some of the foreign reserves <a href="https://www.nytimes.com/2022/02/28/us/politics/us-sanctions-russia-central-bank.html">it had previously frozen</a> to make debt payments. The U.S. changed course on April 5, when <a href="https://www.reuters.com/business/us-cracks-down-russian-debt-payments-latest-sovereign-payments-halted-2022-04-05/">it blocked Russia from using dollar reserves</a> held at American banks to make the debt payments. </p>
<p>That gave Russia little choice but to try to make the payments in rubles, whose value <a href="https://www.xe.com/currencycharts/?from=USD&to=RUB">has been very volatile</a> since the invasion. If Russia doesn’t switch the payments to dollars by May 4, the government will be in default on its foreign obligations for the <a href="https://doi.org/10.1111/j.1540-6563.1986.tb02008.x">first time since 1918</a>, when the Bolshevik revolutionaries took over Russia and refused to pay the country’s international creditors. Russia also defaulted in 1998 but only on its domestic debt. </p>
<figure class="align-center ">
<img alt="A black and white photo shows groups of men in dark coats carrying caskets on their shoulders in a snowy scene. Someone in distance holds a flag" src="https://images.theconversation.com/files/458272/original/file-20220414-20-8atcc4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/458272/original/file-20220414-20-8atcc4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=431&fit=crop&dpr=1 600w, https://images.theconversation.com/files/458272/original/file-20220414-20-8atcc4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=431&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/458272/original/file-20220414-20-8atcc4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=431&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/458272/original/file-20220414-20-8atcc4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=542&fit=crop&dpr=1 754w, https://images.theconversation.com/files/458272/original/file-20220414-20-8atcc4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=542&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/458272/original/file-20220414-20-8atcc4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=542&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">The last time Russia defaulted on foreign debt was during the Russian Revolution.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/RussiaRevolution/480b20fec8a84465a3b4bb50a3810310/photo?Query=bolsheviks&mediaType=photo&sortBy=arrivaldatetime:asc&dateRange=Anytime&totalCount=747&currentItemNo=1">AP Photo</a></span>
</figcaption>
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<h2>What are the consequences of default?</h2>
<p>When a country defaults on a foreign loan, international investors typically become unwilling or unable to lend more money to it. Or they demand much higher interest rates. </p>
<p>Whether because of higher interest costs or an inability to borrow, this forces a country to cut spending. Less government spending <a href="https://doi.org/10.1016/j.jimonfin.2020.102257">reduces economic activity</a>, <a href="http://dx.doi.org/10.2139/ssrn.3785746">increases unemployment</a> and <a href="https://www.doi.org/10.1057/imfsp.2009.21">slows growth</a>. While some of these effects, like weaker economic growth, are often short-lived, other consequences can haunt a country for years. Trade with other countries <a href="https://www.doi.org/10.1057/imfsp.2009.21">remains below normal for an average of 15 years</a> after a default, while full exclusion from capital markets typically lasts just over eight years. </p>
<p>For example, when Argentina defaulted in 2001, the <a href="https://www.doi.org/10.1007/s11079-015-9350-3">peso plunged</a>, the <a href="https://www.doi.org/10.1080/13600810600705098">economy shrank and inflation soared</a>. <a href="https://www.nytimes.com/2001/12/20/world/reeling-from-riots-argentina-declares-a-state-of-siege.html">Riots over food broke out</a> all over the country, leading to the <a href="https://www.nytimes.com/2001/12/21/world/argentine-leader-his-nation-frayed-abruptly-resigns.html">president’s resignation</a>. Although Argentina’s <a href="https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=AR">economy had recovered by 2007</a>, the country <a href="https://www.nytimes.com/2016/04/25/business/dealbook/how-argentina-settled-a-billion-dollar-debt-dispute-with-hedge-funds.html">remained unable to borrow</a> from foreign investors, which led to default again in 2014. </p>
<p>What does this mean for Russia? The country was already <a href="https://www.reuters.com/business/russia-debt-investors-limbo-default-risk-increases-2022-04-07/">locked out of international borrowing markets</a> because of sanctions. A government official recently said Russia <a href="https://www.bloomberg.com/news/articles/2022-04-10/russia-to-halt-bond-issuance-for-rest-of-2022-siluanov-says?sref=Hjm5biAW">would also avoid borrowing domestically</a>, because a default would lead to “cosmic” interest rates.</p>
<p>But its <a href="https://www.businessinsider.com/russia-sell-oil-friendly-countries-any-price-range-ukraine-war-2022-4">significant revenue</a> from sometimes-discounted sales of oil and gas may help offset the need for borrowing in the short term, especially if it can continue to find willing buyers like India and China. On April 14, 2022, Putin acknowledged sanctions <a href="https://www.nytimes.com/live/2022/04/14/world/ukraine-russia-war-news#putin-admits-sanctions-have-hurt-russias-oil-and-gas-sector">were disrupting exports</a> and raising costs.</p>
<h2>Does Russia care if it defaults?</h2>
<p>The Russian government has been trying hard to avoid default.</p>
<p>Until April 5, it was using its precious dollars to stay current on its bond payments. And before its invasion it had built up a <a href="https://www.economist.com/graphic-detail/2022/03/02/russias-attempt-to-sanction-proof-its-economy-has-been-in-vain">significant reserve of foreign currency</a>, in large part to allow it to continue to pay back debt borrowed in dollars and euros even amid sanctions. Russia has even threatened to <a href="https://www.ft.com/content/56df1dc0-6cf3-41f8-a644-d44be5085ee8#post-9a4c235d-5382-40f9-8314-e0c19152ac92">take legal action</a> if sanctions force it into default.</p>
<p>As odd as it may sound, Russia is likely worried about its reputation – at least among bond investors.</p>
<p>A default by a sovereign borrower <a href="https://press.princeton.edu/books/paperback/9780691134697/reputation-and-international-cooperation">establishes a bad reputation</a> that can take years to rehabilitate, as Argentina’s experience shows.</p>
<p>And the long-term impact could be worse for Russia. The reason Russia is in this bind is because it chose to invade Ukraine, <a href="https://www.usnews.com/news/world-report/articles/2021-12-07/u-s-threatens-extreme-sanctions-if-russia-invades-ukraine">despite repeated warnings</a> that doing so <a href="https://www.reuters.com/world/europe/us-uk-ready-punish-putin-associates-if-russia-invades-ukraine-2022-01-31/">would result in severe</a> economic and financial sanctions.</p>
<p>So creditors might wonder if Russia will always prioritize its foreign policy interests over the interests of creditors and raise borrowing costs permanently. If so, they may find it difficult to borrow for years to come. </p>
<p>Another risk is that a default may enable creditors to seize Russia’s overseas assets as a form of repayment. International sanctions have already <a href="https://www.cnn.com/interactive/business/russian-oligarchs-yachts-real-estate-seizures/index.html">enabled countries to seize or freeze Russian assets</a>, which could be used to pay off outstanding debts.</p>
<p>One count suggests that <a href="https://voxeu.org/article/how-creditor-lawsuits-are-reshaping-sovereign-debt-markets">50% of creditors in recent sovereign debt cases</a> have attempted to <a href="https://www.reuters.com/business/finance/clock-ticks-down-towards-russian-default-2022-04-08/">seize assets as an alternative to payment</a>. </p>
<h2>What does this mean for Russia’s war in Ukraine?</h2>
<p>As long as there has been debt, governments have waged wars with other people’s money. In fact, debt has become so vital as a source of power that countries rarely fight without it.</p>
<p>Around 88% of wars from 1823 through 2003 have been at least partly financed with <a href="https://www.cornellpress.cornell.edu/book/9781501702495/how-states-pay-for-wars/#bookTabs=1">funds borrowed from banks and other investors</a>. This reality even bleeds into fantasy worlds, like “Game of Thrones,” in which financing from the Iron Bank of Braavos <a href="https://qz.com/1064757/game-of-thrones-season-7-with-the-iron-bank-a-debt-crisis-is-always-looming/">is vital to financing the wars of Westeros</a>. </p>
<p>Our own research has shown that countries that have defaulted on their debts or have poor credit ratings find it <a href="https://www.doi.org/10.1177/0022343315587970">difficult to build military capacity</a> and, consequently, are more reluctant to <a href="https://doi.org/10.1111/fpa.12044">take up arms</a> against other nations. Related work has found that countries with lower borrowing costs <a href="https://doi.org/10.1177/0022002713478567">tend to win wars</a> – though this effect is stronger for democracies. </p>
<p>One reason is that borrowing allows countries to overcome the guns-versus-butter trade-off: More money spent on the military means less for its citizens’ welfare, which can hurt a government’s ability to stay in power. Foreign loans can help overcome this problem, but losing access to credit forces a government to choose. </p>
<p>In the short term, however, a default is not likely to alter the outcome of Russia’s war – or force Putin to make any unpopular trade-offs – especially if <a href="https://www.bbc.com/news/world-europe-60938544">Russia is able to achieve</a> its <a href="https://www.aljazeera.com/news/2022/4/11/russia-repositioning-in-ukraines-eastern-donbas-region-us">new and more limited military objectives</a> in the eastern Donbas region quickly. </p>
<p>This will change the longer the war goes on. The war was expected to last only a few days, but a <a href="https://www.cnbc.com/2022/03/04/russias-invasion-of-ukraine-is-baffling-military-analysts.html">stronger-than-expected Ukrainian defense</a> has pushed the conflict into its eighth week. Early estimates found that a prolonged war <a href="https://www.consultancy.eu/news/7433/research-ukraine-war-costs-russian-military-20-billion-per-day">could end up costing Russia</a> over $20 billion a day, including both direct and indirect expenses, like loss of economic output.</p>
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<p>If Ukraine becomes a <a href="https://www.theatlantic.com/international/archive/2022/03/how-long-will-ukraine-russia-war-last/627036/">lengthy war of attrition</a>, <a href="https://www.politico.com/news/2022/03/20/ukraine-war-of-attrition-00018752">as some analysts expect</a>, then Russia’s inability to borrow money will weaken its ability to sustain, supply and reinforce its position in Ukraine – especially if <a href="https://www.businessinsider.com/russia-sell-oil-friendly-countries-any-price-range-ukraine-war-2022-4">oil prices fall</a> or the <a href="https://www.nytimes.com/live/2022/04/14/world/ukraine-russia-war-news/europe-starts-drafting-a-ban-on-russian-oil-imports">European Union boycotts</a> or reduces its dependence on Russian fuel. </p>
<p><a href="https://doi.org/10.2968/060002010">Roman statesman Cicero wrote</a>: “Nervos belli, infinitam pecuniam,” which loosely translates as “Successful war-waging capacity requires unlimited cash.”</p>
<p>And that means borrowed money. Wars usually end quickly without it.</p><img src="https://counter.theconversation.com/content/181139/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michael A. Allen has received funding from the Department of Defense's Minerva Initiative, the US Army Research Laboratory, and the US Army Research Office.</span></em></p><p class="fine-print"><em><span>Matthew DiGiuseppe receives funding from the European Research Council. </span></em></p>Russia is on the verge of defaulting on its foreign debt, which not only could have severe economic consequences but could also complicate Putin’s ability to wage a prolonged war in Ukraine.Michael A. Allen, Associate Professor of Political Science, Boise State UniversityMatthew DiGiuseppe, Assistant Professor of International Relations, Leiden UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1793232022-03-16T20:55:20Z2022-03-16T20:55:20ZDebt repayment in roubles, a possible economic counterattack for Russia?<figure><img src="https://images.theconversation.com/files/452172/original/file-20220315-27-15gf38s.jpg?ixlib=rb-1.1.0&rect=0%2C8%2C1920%2C1069&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">At the heart of the economic war: the parity of the rouble.</span> <span class="attribution"><span class="source">Ulianapinto/Pixabay</span>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>The Russian response to Western sanctions took a rather original form on Monday 7 March: to draw up a <a href="https://www.euractiv.com/section/global-europe/news/russia-adopts-list-of-enemy-countries-to-which-it-will-pay-its-debts-in-rubles/">list of “hostile” countries</a> and to authorise Russian individuals and companies to repay their debts in roubles, despite the fact that the credit was contracted in another currency.</p>
<p>On this list, we find the countries of not only the European Union, the United States, the United Kingdom, Japan, but also Canada, Switzerland, Monaco and Korea.</p>
<p>The decision of the Kremlin seems in fact quite shrewd and aims to indirectly gain the support of foreign banks.</p>
<h2>Double punishment?</h2>
<p>Most of the <a href="https://www.reuters.com/markets/europe/how-financial-western-sanctions-might-target-russia-2022-01-19/">economic sanctions taken against Russia</a> are intended to financially isolate the country. The logic is simple: money is the backbone of the war. Without money, it seems extremely complicated for Russia to be able to continue its action in a sustained manner.</p>
<p>This strategy of undermining the Russian economy is partly working. On February 24, the day of the invasion, the euro/rouble parity rate was 95 (i.e., 1 euro was equivalent to 95 roubles). On Monday March 7, it had risen to 148.38. This means that a Russian who wanted to buy a product for 300 euros in France had to pay 28,423 rubles on February 24, and 44,366 rubles on March 7.</p>
<p><iframe id="7TeJ8" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/7TeJ8/1/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>The ability of Russians to trade at the international level is therefore greatly reduced. When we know that the Russians imported nearly <a href="https://www.tresor.economie.gouv.fr/Pays/RU/commerce-exterieur">240 billion dollars</a> in 2020 (about 197 billion euros), the bill will increase significantly.</p>
<p>One might think that this devaluation of the rouble would reduce Russia’s export costs to foreign countries, favouring Russian producers on the international scene. However, to counter this potential positive effect, most European countries have decided to <a href="https://www.washingtonpost.com/world/2022/03/02/boycotts-russia-invasion-ukraine/">boycott Russian exports</a>. For example, they refuse to issue export licenses for certain goods. As a result, the penalty is twofold: imports are decreasing, and exports are being blocked.</p>
<p>What are the traditional solutions to this currency depreciation for Russia? The exchange rate regime of the rouble against other currencies is a so-called floating regime, i.e. it is fixed by the laws of supply and demand on the market. To strengthen the rouble, it would be necessary to increase the demand for it, and thus to increase the number of international financial transactions in rouble… which is deliberately prevented by the sanctions that have been imposed.</p>
<p>What card is left in the hands of the Kremlin? The answer given is imaginative, to say the least: to allow the payment of Russian credits abroad in roubles.</p>
<h2>International banks in a bind</h2>
<p>In addition to the international trade players, people who have credits with foreign institutions are directly affected by the international sanctions. Let’s say you are Russian, you have borrowed 100,000 euros from a French bank, and you pay back 500 euros every month. As of February 24, this amounted to 47,530 roubles, while the same amount is 74,190 roubles as of March 7. The credit is becoming more and more complicated to repay.</p>
<p>So there is a risk of a massive increase in defaults, causing difficulties for foreign banks. This is precisely the leverage that Moscow intends to use. By allowing Russian debtors to pay for their foreign loans not in local currency but in roubles, the country’s authorities are delegating the maintenance and management of their currency from Russia’s central bank to foreign banks.</p>
<p>Let’s take our example from another point of view: you are a French bank, you hold in your assets 100,000 euros of debt issued by Russian clients, with a monthly repayment of 500 euros per month. As shown above, the repayment value of this loan between February 24 and March 7 is not the same amount in roubles, respectively 47,530 roubles and 74,190 roubles. </p>
<p>In itself, this may not seem problematic for the French bank, since in both cases it recovers the equivalent in value, namely 500 euros. However, the problem is not the value, but the currency. Once owning this amount, the bank has two options. It can decide to keep this money in rouble, but with the significant risk at the moment that it will devaluate again, and therefore that the reimbursements will not be worth 500 euros anymore. Alternatively, it can decide to go to the financial markets to exchange these roubles for euros.</p>
<p>But if everyone tries to convert their roubles at once, this will lead to an even sharper fall in the value of this currency and thus a direct devaluation of the value of the repayment. In both cases, the French bank risks a significant loss of value on its repayments.</p>
<p>The French bank therefore has every interest in ensuring that the rouble/euro parity does not lose more value than it already has. Thus, by taking this decision, Russia has ensured that international banks will seek to indirectly support the Russian economy, in order to avoid seeing their credit devalued.</p>
<p>Some might argue that another possibility for these foreign banks would be to simply refuse payment in roubles. However, this is extremely complicated from a legal point of view because the question arises as to which authority is competent to judge this case and whether the other party to the contract will recognise the legal decision issued, which is not a given. From an economic point of view, this also means increasing the probability of never being repaid should the conflict escalate…</p><img src="https://counter.theconversation.com/content/179323/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Les auteurs ne travaillent pas, ne conseillent pas, ne possèdent pas de parts, ne reçoivent pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'ont déclaré aucune autre affiliation que leur organisme de recherche.</span></em></p>The idea: to use the credit channel by making foreign banks bear the consequences of the devaluation of the Russian currency.Jérémie Bertrand, Professeur de finance, IÉSEG School of ManagementAurore Burietz, Professeur de Finance, LEM-CNRS 9221, IÉSEG School of ManagementLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/317042014-09-16T05:23:19Z2014-09-16T05:23:19ZHow Argentina’s government has drawn new energy from the vulture fund crisis<p>Sovereign debt, crises and default have been regular features of the Argentine economy for years – but the latest debt crisis, involving the government and the so-called “vulture funds”, has thrown up new questions about the state’s capacity versus the ethics of capitalism. </p>
<p>Vulture funds are private creditors who deliberately took up cut-price Argentine bonds after the 2002 collapse, then refused to renegotiate their terms in 2005 and 2010 when the country entered a process of debt restructuring – all with the aim of eventually litigating against default and reaping exorbitant profits. </p>
<p>Accordingly, these creditors had been demanding the full value of the debt on which they had originally speculated. At the end of July this year, in the latest twist in its fiscal saga, Argentina was <a href="http://www.bloomberg.com/news/2014-07-30/argentina-defaults-according-to-s-p-as-debt-meetings-continue.html">declared to be in default</a> for the second time in 12 years. </p>
<p>Defaults are always economically damaging and politically destabilising, particularly in a context of inflation and growing political and social malaise. But the irony this year is that, unlike December 2001, today’s markets seem relatively untroubled by the event – and that rather than putting the government on the ropes, the current financial crisis is apparently shoring up the dominance of the Kirchnerist project.</p>
<h2>The bad old days</h2>
<p>The background to all this is Argentina’s financial crisis of 2001-2002, precipitated by what was then the biggest <a href="http://www.efinancialnews.com/story/2011-07-25/history-of-debt-defaults-argentina-2001?ea9c8a2de0ee111045601ab04d673622">sovereign debt default</a> in history. </p>
<p>Argentina was at a critical juncture; its public debt as a percentage of GDP reached 166%, the nation was facing abrupt pauperisation, road blocks, and factory takeovers; its leaders were struggling to preserve social cohesion. Two months after Argentina defaulted, the value of the peso dropped by more than a third. </p>
<p>Cross-class demands for more inclusive and responsive democracy screamed “¡Que se vayan todos!” (“Out with all of them”), expressing the enormous gap that had opened up between government and society. </p>
<p>As the country’s whole political economic order collapsed, presidents came and went in quick succession – until a temporary parliament-led government under the Peronist former leader of Congress, <a href="http://www.economist.com/topics/eduardo-duhalde">Eduardo Duhalde</a>, assumed some degree of institutional command. That administration eventually gave way to the elected government of Nestor Kirchner in May 2003.</p>
<h2>Fixing it up</h2>
<p>The challenges facing the new government were huge. A judicious devaluation of the peso in January 2002, however, led to a considerable expansion of exports, especially agro/industrial ones, greatly boosting state revenues. Systematic renegotiations of the terms of privatised companies and nationalisations followed suit. Negotiations also began with creditors of 152 different bonds series, issued under several jurisdictions. </p>
<p>In 2005 and 2010, a deal brought the country’s default to a successful close, with 93% of creditors accepting new bonds worth 30 cents on the dollar. The remaining 7% of “hold-out” creditors rejected the offer, demanding payment in full. The government also sought independence from the IMF, cancelling off the debt and creating an image of a sovereign state, with greater room for manoeuvre than was possible in the previous decades.</p>
<p>A more confident and better-resourced government was often accompanied by controversial forms of social and political incorporation. Like Menem in the 1990s, the administrations of Nestor Kirchner, followed by Cristina Fernandez de Kirchner, concentrated heavily on reinforcing executive authority, took timely yet bold initiatives and advanced controversial forms of government interventionism. </p>
<p>This strategy paid off by doing something to alleviate widespread poverty, inequality and exclusion. But whatever the social gains, the cost has been economic stress, distributional pressures and badly weakened political institutions.</p>
<h2>Betting the farm</h2>
<p>The political strength of the government has been tested to the extreme by two main forces: farmers and vulture funds. </p>
<p>In 2008, during a state decision to increase agro-export taxes to reflect fluctuating <a href="http://www.nytimes.com/2008/10/22/business/worldbusiness/22iht-pension.4.17173710.html?_r=0">commodity prices</a>, landowners and farm-based groups organised lock-outs, road blocks and the destruction of crops bound for market, until the export tax was settled.</p>
<p>To this day, conservative and reactionary rural factions play a massive and direct role in shaping policy, even while supporting the political opposition. In a flailing economy that has failed to diversify its industrial base and is highly dependent on the primary sector, this is not a minor concern.</p>
<p>Argentina is now stuck with recession, high inflation and, over the past year, the pressure of an unstable peso and the <a href="http://www.slate.com/articles/news_and_politics/roads/2014/02/argentina_s_black_market_for_hard_cash_buenos_aires_deliverymen_will_bring.html">black market for dollars</a>. All this, combined with the gloomy global environment, leaves the country increasingly dependent on foreign capital to maintain growth, employment and price stability.</p>
<h2>Under pressure</h2>
<p>Factions outside the government have increasingly joined forces in the renewed legal battle being waged on behalf of the vulture funds – and litigation from hold-out creditors, which has persisted for more than a decade, now carries the weight of the <a href="http://www.washingtonpost.com/blogs/worldviews/wp/2014/06/26/three-things-to-know-about-the-supreme-courts-ruling-on-argentine-debt-and-why-it-matters-to-argentina-and-the-world/">US Supreme Court</a>, which in July upheld a decision ruling that Argentina is legally obliged to repay its American hold-out creditors in full. </p>
<p>This took a Kafkaesque turn when the Argentine government deposited the bondholders’ payment into US-based financial intermediaries, only to be <a href="http://www.theguardian.com/business/2014/aug/07/argentina-default-griesafault-more-accurate">blocked by US district judge, Thomas Griesa</a>, alleging that payments could not be processed at all unless settled directly with the vulture funds. As a result, Argentina defaulted.</p>
<p>Legally, Judge Griesa’s sentence is widely believed to be impracticable: agreement with vultures means last-to-come-in creditors get the best deal, which would send Argentina into an economic tailspin based on an contorted interpretation of the legal principle of <a href="http://www.lse.ac.uk/fmg/events/financialRegulation/LFR14L_Buchheit-(How-to-Negotiate-the-Pari-Passu-Representation-Clause).pdf">pari passu</a> (equal treatment of creditors). </p>
<p>So, full payment: politically unlikely and economically impossible. The government will need to weigh Argentine laws and citizens versus US laws and investors – a fiendish balancing act for a government that has invested all its political capital in opposing the vultures at all costs.</p>
<h2>Paradox</h2>
<p>The case against the vulture funds has had a huge impact on the economic agenda not just in Argentina, but also internationally: in early September, the United Nations General Assembly <a href="http://lainfo.es/en/2014/09/07/argentine-foreign-minister-lead-un-debate-on-sovereign-debt/">began work</a> to establish a new international convention regulating the restructuring of sovereign debt.</p>
<p>Meanwhile, the political fallout of the crisis at home has paradoxically been largely to the benefit of term-limited president Cristina Kirchner, reasserting her centrality in politics just as she was losing her clout in the run-up to the 2015 elections. </p>
<p>The struggle against the hold-out creditors is being played out electorally through social mobilisation. This is just what happened in the 2008 conflict with the farmers; Cristina Kirchner’s strategy was to appeal to the urban working class. She pointed out farmers’ relative prosperity and stoked fears that popular social programmes would have to be eliminated if they got their way – even publicly calling them “greedy” and “coup-plotters”. </p>
<p>The Kirchner administration is now once again back on its old mettle, appealing to citizens with the slogan “Patria o Buitres” (“homeland or vultures”), a binary definition that suits her barnstorming rhetoric and mocks casino capitalism and those who support it. Her political opposition is back on the defensive – and her government perhaps reinvigorated – even as she grapples with the thorniest crisis of her tenure.</p><img src="https://counter.theconversation.com/content/31704/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pia Riggirozzi receives funding from ESRC-DfID grant Poverty Reduction and Regional Integration: SADC and Unasur Health Policies (PRARI) </span></em></p>Sovereign debt, crises and default have been regular features of the Argentine economy for years – but the latest debt crisis, involving the government and the so-called “vulture funds”, has thrown up…Pia Riggirozzi, Senior Lecturer in Global Politics, University of SouthamptonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/302242014-08-07T05:19:46Z2014-08-07T05:19:46ZArgentina will survive default but indebted nations in Africa will not be so lucky<p>The Argentine government recently defaulted on its external debt. The country’s debt issues had been <a href="http://theconversation.com/for-argentina-debt-default-is-a-solution-not-a-problem-30010">building up for some time</a> and then, just over ten years ago the country’s newly-elected president, Néstor Kirchner, rejected responsibility for the external debts his predecessors had recklessly accumulated.</p>
<p>Specifically, Argentina’s neoliberal regimes of the 1990s had tried to sustain the peso one-to-one with the dollar. To paraphrase <a href="http://www.quotesandsayings.com/quotes/oscar-wilde/">Oscar Wilde’s comment on fox hunting</a>, this was a case of the unspeakable in pursuit of the unsustainable. Quite sensibly, Kirchner felt no obligation for his government to honour this foolishly acquired debt, which had brought no benefit to the vast majority of Argentines.</p>
<p>Instead of completely cancelling the US$80 billion debt, the new Argentine government negotiated with creditors over the amount they would repay. Far from some transgression of basic values, such renegotiations of debt occur quite commonly among creditors and debtors, both public and private (when corporations declare bankruptcy, for instance). After several years <a href="http://www.jubileeusa.org/truth-about-debt/vulturefunds/argentina.html">agreement was reached with creditors</a> holding over 90% of the debt to accept 30% repayment (to employ the current cliché, the creditors accepted a “<a href="http://www.investopedia.com/terms/h/haircut.asp">hair cut</a>”).</p>
<p>As these discussions proceeded, some hedge funds saw the possibility to make a fast buck (to use an old fashioned cliché) by purchasing Argentine debt with the intent to hold out for full payment. Foremost among these “vulture” debt speculators was MNL Capital that had bought its US$1.3 billion (face value) of bonds for far less than that amount, and far less than the 30% reached in the agreement. How much less we do not know because MNL Capital has not been notably forthcoming with such information (<a href="http://www.nmlcapital.com/">its website</a> is a blank page with a small logo and nothing more).</p>
<p>To achieve their speculative end, the directors at MNL Capital “went to court” in New York state, where some of the Argentine bonds were sold (establishing jurisdiction for the case, NML Capital vs. Argentina). To the surprise of many if not most, the judge ruled in favor of MNL Capital, and the US Supreme Court declined to review the case (de facto endorsing the lower court decision).</p>
<h2>Cash in hand</h2>
<p>What makes this lender-borrower dispute rather unique is that the cash to meet the pending debt obligation (less than US$600m) <a href="http://www.nasdaq.com/article/bank-of-new-york-mellon-still-has-argentina-payment-money-20140731-01160">sits in the Bank of New York Mellon</a> ready for collection by the holders of the 90% of the debt that was renegotiated. The funds remain frozen in the Mellon bank because the judge in the case ruled that the Argentine government could pay no creditor without also paying the “holdouts” – the speculators in MNL Capital; ergo, we have default by the formal definition.</p>
<p>This is the first case I have ever encountered in which the borrower has made the necessary debt service payment, but the lender is prohibited from collecting it. Even the International Monetary Fund, always in favour of full payments of sovereign debts, described itself as “<a href="http://www.imf.org/external/np/tr/2014/tr060514.htm">deeply concerned about the broad systemic implications</a>” of NML Capital v Argentina, with a stronger criticism of the court decision <a href="http://www.cepal.org/cgi-bin/getProd.asp?xml=/prensa/noticias/comunicados/3/53183/P53183.xml&xsl=/prensa/tpl-i/p6f.xsl&base=/prensa/tpl-i/top-bottom.xsl">made by Alicia Bárcena</a>, head of the United Nations Economic Commission for Latin America and the Caribbean (<a href="http://www.cepal.org/cgi-bin/getProd.asp?xml=/prensa/noticias/comunicados/3/53183/P53183.xml&xsl=/prensa/tpl-i/p6f.xsl&base=/prensa/tpl-i/top-bottom.xsl">CEPAL</a> in Spanish).</p>
<p>The IMF’s concern is hardly surprising because if the New York court decision becomes generally accepted legal practice, many countries face financial disaster now or in the future. This disaster does not immediately threaten or even focus on Argentina. The danger lies in the longer term implications for sovereign debt management.</p>
<h2>Willing and able</h2>
<p>But, first, the impact on Argentina: <a href="http://www.theguardian.com/world/2014/jul/31/argentina-defaults-debt-talks-break-down">according to the Guardian</a> “it could add more pain for Argentinians, with the economy already in recession”. It would appear that most bond speculators disagree; Argentine <a href="http://www.ft.com/cms/s/0/c9e3efac-18bc-11e4-a51a-00144feabdc0.html#axzz39PxDopoz">bond prices have risen</a>, not fallen, after the formal default.</p>
<p>The explanation should be obvious. The Argentine government wishes to pay the service on 90% of its debt, but is prevented from doing so by a court order. Any <em>compos mentis</em> speculator (aka “investor”) draws the obvious conclusion – the government is willing and financially able to service its debt.</p>
<p>Of course, the limited impact of the formal debt default does not mean all is well. Depending on your definition of “recession”, Argentina is either <a href="http://www.economist.com/blogs/americasview/2014/06/argentinas-economy">in it or will be soon</a>. But either way, debt is not the major factor. </p>
<p>Inflation, Argentina’s dominant economic problem, has little to do with tension over the external debt (the economy has been <a href="http://en.wikipedia.org/wiki/Economic_history_of_Argentina">prone to inflation, even the hyper version, for decades</a>), and it is no great secret that the Argentine economy rises and falls with the fortunes of its much larger neighbor, Brazil (the former economy about US$500 billion, the latter US$2.3 trillion).</p>
<p><strong>Follow the Leader: Argentina and Brazil</strong></p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=405&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=405&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=405&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=509&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=509&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55884/original/dw43c8qb-1407336099.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=509&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Annualised quarterly growth rates.</span>
<span class="attribution"><a class="source" href="http://stats.oecd.org/index.aspx?queryid=350">OECD</a></span>
</figcaption>
</figure>
<h2>Real losers</h2>
<p>Poor countries, especially those in Africa, are the real losers from this whole fiasco. Unlike Argentina with its relatively diversified economy and skilled labour force, the sub-Saharan countries have few options. Their underdeveloped financial sectors and near-total dependence on primary product exports leave them heavily reliant on foreign borrowing.</p>
<p>As catalogued by <a href="http://blogs.wsj.com/moneybeat/2014/06/25/what-happens-when-the-the-vulture-funds-start-circling/">Daniel Huang in the Wall Street Journal</a> (hardly an anti-business source), three sub-Saharan countries have infamously suffered assaults by hedge funds – Zambia (by Donegal International, not the Irish car rally and head office in the British Virgin Islands, no website), Democratic Republic of the Congo (FG Hemisphere, New York based, which has a <a href="http://fgcap.net/">website</a>), and Republic of the Congo (Kensington International, Cayman Islands, no website). </p>
<p>The British government considered the first two of these so appalling that it over-ruled the court decisions granting the hedge funds their prey, the latter through the intervention of the Privy Council of England (apparently not all royalist relics are dysfunctional). Subsequently Parliament passed <a href="http://www.theguardian.com/business/2009/may/06/vulture-funds">legislation to clip the wings and claws of the vultures</a>.</p>
<p>There is a general principle in the affairs of finance – default by a small borrower is the debtor’s problem and default by a large borrower is the lender’s problem. During the Latin American debt crisis of the 1980s that principle was over-ruled by the US government, which prevented defaults by a variety of political and economic interventions.</p>
<p>The US government now lacks the power to do that again, and the rule is back in force. A global mechanism for sovereign default would make life easier for countries such as Argentina. For the poor countries of the earth it could be the difference between stagnation and development.</p><img src="https://counter.theconversation.com/content/30224/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Weeks does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Argentine government recently defaulted on its external debt. The country’s debt issues had been building up for some time and then, just over ten years ago the country’s newly-elected president, Néstor…John Weeks, Professor Emeritus, SOAS, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/300102014-07-31T23:19:12Z2014-07-31T23:19:12ZFor Argentina, debt default is a solution not a problem<figure><img src="https://images.theconversation.com/files/55457/original/f6r2kkf8-1406829483.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">No need for doom and gloom.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/mauriciomacri/14506939245">Mauricio Macri</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span></figcaption></figure><p>Unless you just returned from holiday in some ultra-remote region lacking newspapers, television or internet access (is there such a place?), you will be aware the government of Argentina has <a href="http://www.bbc.co.uk/news/business-28578179">defaulted on its external debt</a>. </p>
<p>The immediate cause of the default was a New York federal court decision that an agreement reached between the Argentine government and creditors <a href="http://www.jubileeusa.org/truth-about-debt/vulturefunds/argentina.html">holding over 90%</a> of the country’s external debt was illegal.</p>
<p>The principal litigant bringing the case against the government holds less than US$2 billion of the Argentine debt, which by comparison makes a tail wagging a dog seem a credible anatomical interaction. This litigant, NML Capital, never lent a cent to the Argentine government (nor to any other). It acquired its one billion plus of Argentine bonds on the re-sale market, purchasing at far below face value.</p>
<p>Depending on your source of [mis-]information, you will think that this default is 1) the result of a feckless, spend-thrift government failing to accept responsibility for its actions (as argued, for example, <a href="http://www.forbes.com/sites/jamesglassman/2012/07/25/dont-mention-argentina-and-greece-in-the-same-breath/">in Forbes</a>), 2) the harbinger of deep <a href="http://www.cnbc.com/id/101875052">economic trouble for the Argentines</a>; and/or 3) the consequence of the <a href="http://jubileedebt.org.uk/actions/support-argentinas-fight-against-vulture-funds">predatory evil of “vulture” hedge funds</a>.</p>
<p>Taking these three in order, they are 1) false, 2) probably false, and 3) true but not terribly important. The current debt of the Argentine government was accumulated before 2003, much of it under the disastrous presidency of Carlos Menem (forced to resign in 1999) and three short-term successors (<a href="http://en.wikipedia.org/wiki/Fernando_De_la_R%C3%BAa">Fernando de la Rúa</a>, 1999 to end of 2001; <a href="http://en.wikipedia.org/wiki/Adolfo_Rodr%C3%ADguez_Sa%C3%A1">Adolfo Rodríguez Saá</a>, last two weeks of 2001; and <a href="http://en.wikipedia.org/wiki/Eduardo_Duhalde">Eduardo Duhalde</a>, 17 months to May 2003).</p>
<p>The massive debt accumulation (see chart below) resulted from the hapless attempt to maintain a one-to-one exchange rate between the national currency and the US dollar via a “<a href="http://www.investopedia.com/terms/c/currency_board.asp">currency board</a>”. This neoliberal bright idea legally links the amount of national currency in domestic circulation with the US dollars held by the central bank (in this case, the Banco Central de la Republica Argentina).</p>
<p>By the rules of this bone-headed currency “regime”, the national money supply must fall when US dollars flow out of the country (for example, if there is a trade deficit or capital flight). Contraction of the money supply invariably means contraction of the real economy. To avoid this, prior to May 2003 the government (under its revolving door of presidents) borrowed US dollars through sales of public bonds, driving the public debt up to almost 200% of national income (measured on the left hand axis of the chart).</p>
<p><strong>Public debt and GDP growth in Argentina, 2000-2013</strong></p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=385&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=385&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=385&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=484&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=484&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55455/original/6ppxbg6v-1406826595.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=484&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="http://data.worldbank.org/data-catalog/world-development-indicators">World Bank</a>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>This debt was not accumulated in pursuit of “populist” expenditures by a fiscally irresponsible government. On the contrary, not a centavo of the debt funded any public service or brought any benefit to people in Argentina. To the extent that the foreign currency acquired by the bond sales stayed in Argentina, it sat idle in the Banco Central. And when this extraordinarily misconceived and mismanaged currency regime inevitably collapsed, it brought the entire economy down with it, a decline of almost 5% in 2001 and 12% in 2002 (read from the right hand axis of the chart), plus runaway inflation that climbed over 100% during these years.</p>
<p>In the wake of this disaster generated by the neoliberal currency regime, Nestor Kirchner won the presidential election of 2003, succeeded by Cristina Fernandez de Kirchner 2007, who was overwhelmingly re-elected in 2011. Becoming president after the end of completely discredited neoliberal governments, Kirchner abandoned the “currency board” system and disowned the debt accumulated in a foolish attempt to sustain it.</p>
<h2>Why governments default</h2>
<p>This Argentine move demonstrates a general principle – most sovereign debt defaults are not the result of mismanagement or wild spending by sitting governments. Two centuries of debt “refunding” shows there to be at least three major motivations for defaulting on sovereign bonds, unrelated to excessive public spending.</p>
<p>First, we find many examples where debts were repudiated because they were accumulated in dubious circumstances under previous governments, and Argentina is an obvious example. A more extreme example is the cancelling at the <a href="http://en.wikipedia.org/wiki/Agreement_on_German_External_Debts">1953 London conference</a> of the external debt of the Federal Republic of Germany (holdover from the Nazi regime).</p>
<p>Second, global economic and political shocks can make it impossible for a government to service its debt (excellent source is the 1973 <a href="http://www.alibris.co.uk/The-Refunding-of-International-Debt-Henry-J-Bittermann/book/5617431">book by Henry Bittermann</a>). Obvious examples are the debt defaults by Latin American governments during the 1930s (due to a sharp fall in primary product prices) and the 1940s (collapse of international trade due to war).</p>
<p>Third, and being played out now in the euro zone, is public sector nationalisation of private debts. As I show in <a href="http://www.anthempress.com/economics-of-the-1-percent">economics of the 1%</a>, during 2009-2010 the Spain government, previously with the lowest debt-to-GDP ratio of major EU countries, refinanced all its failing banks. This created both an unsustainable fiscal deficit (where before it boasted a surplus) and a public debt it could not finance. </p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=413&fit=crop&dpr=1 600w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=413&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=413&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=519&fit=crop&dpr=1 754w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=519&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/55456/original/ghcb7ny5-1406827982.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=519&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Augusto Pinochet with his patron Henry Kissinger.</span>
<span class="attribution"><a class="source" href="http://en.wikipedia.org/wiki/Augusto_Pinochet#mediaviewer/File:Reunión_Pinochet_-_Kissinger.jpg">Chile foreign ministry</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>This particular path to debt disaster was pioneered in the early 1980s by none other <a href="http://countrystudies.us/chile/67.htm">than the Pinochet regime in Chile</a>, under pressure from the US government (in value the largest nationalisation in Chilean history, far larger than anything the <a href="http://www.britannica.com/EBchecked/topic/16237/Salvador-Allende">socialist Salvador Allende</a> had done).</p>
<p>All this leads to an obvious conclusion – default serves as the solution to an otherwise intractable problem, an unsustainable foreign debt. The problem is not default, the problem is the absence of an international mechanism to bring it about in an orderly manner.</p><img src="https://counter.theconversation.com/content/30010/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Weeks does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Unless you just returned from holiday in some ultra-remote region lacking newspapers, television or internet access (is there such a place?), you will be aware the government of Argentina has defaulted…John Weeks, Professor Emeritus, SOAS, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/283812014-06-30T05:03:06Z2014-06-30T05:03:06ZArgentina’s debt trail favours speculators and the super rich<figure><img src="https://images.theconversation.com/files/52307/original/mt7v48gv-1403752941.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The US Supreme Court's decision has received worldwide condemnation.</span> <span class="attribution"><a class="source" href="http://multimedia.aapnewswire.com.au/Search.aspx?search=argentina+protest">David Fernández/AAP</a></span></figcaption></figure><p>Argentina is facing the potential of a new financial crisis after it defied legal attempts to force it to repay US$1.33 billion in debt owed to the so-called “vulture” funds that have pursued the country for more than a decade.</p>
<p>Over the weekend the Argentine government proceeded with a $US539 million payment to creditors that had agreed to restructured debt terms following the country’s 2002 default. </p>
<p>But it has ignored a US Supreme Court order to pay out a group of mainly New York-based “hold out” hedge funds. These had refused the country’s restructured terms and are demanding a payment of $1.33 billion.</p>
<p>US Supreme Court Judge Thomas Griesa described Argentina’s payment to the restructured debt holders as illegal and “explosive”, ordering the Bank of New York Mellon <a href="http://www.bloomberg.com/news/2014-06-27/argentina-bond-fight-judge-says-he-will-nullify-bny-payment-1-.html">to return the money</a> to Argentina. The judge has pleaded with Argentine authorities to negotiate with the hedge funds to avoid a technical default. Argentina argues that paying both classes of creditor would also cause it to default.</p>
<h2>A brief history of debt</h2>
<p>The dramatic events have been brought about by the court’s decision on June 16 to quash an appeal by the Argentine government against an earlier decision forcing it to repay the hedge funds.</p>
<p><a href="https://theconversation.com/argentina-wins-brief-reprieve-from-default-but-the-vulture-funds-are-circling-10989">As I have written before</a>, the dispute dates back to the country’s US$100 billion debt default, the world’s largest. </p>
<p>Vulture funds are private financial institutions that speculate by investing in debt such as high-yield bonds and other financial securities that are close to defaulting. <a href="http://www.afdb.org/en/topics-and-sectors/initiatives-partnerships/african-legal-support-facility/vulture-funds-in-the-sovereign-debt-context/">According to the African Development Bank Group</a>, these financial institutions buy “… distressed debt on the secondary market, where it trades significantly below its face value, and then seek to recover the full amount, often through litigation”. They operate in a legal space that is highly favourable to them, often in the US or European courts.</p>
<p>On February 23 2012, US District <a href="http://en.mercopress.com/2012/11/22/argentina-s-outbursts-backfire-judge-griesa-orders-payment-to-holdout-bond-investors">Judge Griesa ruled that Argentina had infringed</a> upon the notion of “pari passu” or equal treatment provisions for all creditors when it paid bondholders who accepted debt restructure swaps in 2005 and 2010, while refusing to pay vulture funds.</p>
<p>At times, the saga has taken startling turns. In October 2012 the Argentine sailing ship ARA Libertad was detained by the Ghanaian government and prevented from leaving the Port of Tema, due to an injunction by US hedge fund NML Capital. However, the Argentine vessel managed to sail back to Argentina while court proceedings continued in US jurisdictions. </p>
<p>In November 2013, the US Second District Court, the jurisdiction where the original loans were contracted, ruled in favour of the holdout funds. Argentina responded by filing an appeal to the US Supreme Court in February 2014, which was finally rejected on June 16.</p>
<h2>The fallout</h2>
<p>The ramifications of this crisis are staggering. <a href="http://www.jubileeusa.org/whatwedo/debt-related-issues/vulturefunds/argentina.html">According to the USA Jubilee Network</a>, an organisation that calls for debt relief for poor countries:</p>
<blockquote>
<p>The decision will impact debt restructurings, poor country access to credit and propel predatory behaviour. The Court also ruled against Argentina in a related case involving the ability of hold-out creditors to locate the foreign assets of the sovereign nations they are suing. </p>
</blockquote>
<p>The vultures’ legal victory virtually means that they have been given free rein to target poor countries’ funds which are badly needed for financial recovery and economic and social development. The <a href="http://www.jubileeusa.org/whatwedo/debt-related-issues/vulturefunds/argentina.html">Jubilee Network again</a>: </p>
<blockquote>
<p>The orders here give a preference to a minority of holdout creditors like Elliott at the expense of the majority of creditors who agreed to give relief to a sovereign facing economic difficulties … If this type of relief becomes the law, bondholders who restructure their debt - a group that consists of numerous individuals and pension funds - could be deprived of payments on their bonds, thus resulting in economic hardship to many people.</p>
</blockquote>
<h2>International consequences</h2>
<p>The Union of South American Nations (UNASUR) has criticised the effects of the decision on the international financial system. UNASAR warned that the “legalisation” of such behaviour threatens the stability of the system. </p>
<p><a href="http://www.pressenza.com/2014/06/uruguays-president-mujica-says-vulture-funds-argentinas-oil/">Uruguay’s President Mujica expressed his deep concern</a> and suggested the real intentions of the vulture funds “ … are related to the Vaca Muerta oilfields in the Province of Neuquen”.</p>
<p>The court ruling is quite unprecedented given that it went against a decision on a similar claim made in Europe by another vulture fund on Argentine assets. On July 11 2013, <a href="http://www.jubileeusa.org/whatwedo/debt-related-issues/vulturefunds/argentina.html">German courts rejected hedge fund claims</a> on Argentine assets in Germany. </p>
<p>The $1.33 billion Argentina is being forced to pay back to the New York-based hedge funds represents a staggering 1,000% profit margin. Of further concern is the fact that the <a href="http://www.theguardian.com/business/2014/jun/24/argentina-hits-back-vultur-funds-newspaper-advert">vulture funds represented 1.6% of bondholders</a>, hence jeopardising 92.4% of bondholders who voluntarily accepted a restructure.</p>
<p>Meanwhile, the high-level stakes played by Judge Griesa and the Argentine government continue to spring surprises. Argentina’s financial daily <a href="http://www.ambito.com/noticia.asp?id=747216">Ambito Financiero</a> reported that if the Bank of New York Mellon does not make its payments to bondholders according to the instructions directed by Casa Rosada the bank would be in breach of its obligations as a financial representative of the Argentine government. </p>
<p>This would mean that payments to creditors could then be shifted to a new geographical jurisdiction outside the US. This could well be Buenos Aires, as earlier requested by the Argentine government of its bondholders. It is no surprise, therefore, that Judge Griesa asked both Argentina and the vulture funds to negotiate. </p>
<p>The chess game of financial brinkmanship continues with numerous twists and turns. In the meantime, the international financial community and many indebted third world nations await its outcome. </p><img src="https://counter.theconversation.com/content/28381/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexis Sergio Esposto does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Argentina is facing the potential of a new financial crisis after it defied legal attempts to force it to repay US$1.33 billion in debt owed to the so-called “vulture” funds that have pursued the country…Alexis Sergio Esposto, Senior Lecturer, Economics, Swinburne University of TechnologyLicensed as Creative Commons – attribution, no derivatives.