The pleasures of default

DANIEL.DAVIES at flemings.com DANIEL.DAVIES at flemings.com
Wed Jan 12 01:37:23 PST 2000


By now, I hope it's pretty clear that I don't really know enough about Africa to be talking about this at all. Indulge me as I shoot off my mouth once more.


>In other words, no going it alone if you're heading a weak
>state, mr president. You'd need, instead, to invoke very rigorous
>international solidarity amongst people of conscience who can put
>pressure on governments and multilaterals. That's underway (with
>Jubilee 2000), of course, though not without healthy debates over
>strategy/tactics.

Not necessarily, and once more my point fell victim to my inability to express myself clearly. I think it is possible to go it alone to a very significant extent. Expanding my remark about "the political economy of default" in the poor, weak country case, I think it's possible to treat bilateral creditors as if they were the private sector (ie, to default on them). The IMF and the World Bank are a bit more tricky to default on, and I'd think twice about how desperate I really was before trying to mess with them. On the other hand, the "Never Shalt Thou Default on the IMF" sacred cow might be ready for slaughter too -- Congo is in arrears since 1991 which will (a.s.) never be paid, even if it ever recovers.

In general, while supporting Jubilee 2000, I think that developing nations ought to be following the policy of default, then negotiate. The age of the gunboat is over (I still argue that gunboats in support of debt collection were very rare in the first place), and it is possible to quarantine trade finance from other debt. Conscience is one thing, but the first step must surely be to stop paying.


>> Because I'm printing money
>> domestically, I need to run a large current a/c deficit (even if the
cocoa
>> price rebounds, my reflationary policies will tend to create an external
>> deficit.


>Unless you really clamp down on luxury imports and base your
>reflation on a self-reliant economic restructuring that first and
>foremost meets basic needs, which generally doesn't require a lot of
>hard currency, right?

Well, I suppose so, but the Kerala option doesn't really appeal to me in my role as a populist general. I don't see a global shortage of hard money at the moment, so I don't think that this degree of austerity is necessary unless one wants to impose it for other reasons. Self-reliance is pretty painful, and autarchy isn't really an option for a country like Cote d'Ivoire whose natural resources are largely geared to export goods.


>On this point, my sense is that we really need, at the end of the
>day, export credit agencies in the North that will give a lefty South
>leader like you a break, and of course that would occur ONLY because
>the better surgical lefty NGO types have begun to keep an eye on
>EximBank or KfW so that when all the other bankers decide to do a
>creditors' cartel, popular pressure would keep supply lines open.

My sense is that a creditor's cartel would be incredibly different to organise in the modern financial market, and (as hinted above) that trade finance can be quarantined from other kinds of debt. Most trade finance these days is provided by suppliers themselves, which helps, and national export credit agencies are becoming less and less important. Although I have a worry that I don't really know enough about Africa to say that definitively.


>Again, such a "reform" process is in fact in motion, and it's got a
>bit of potential (far more so than "reforming" the IMF/Bank/WTO), but
>I fear that the good surgeons involved in this work (from EDF,
>ActionFinanz and Berne Declaration amongst other groups) haven't
>thought this far down the road -- i.e., about why trade finance can
>be a matter of life and death for a defaulting country. Does that
>make sense, Daniel?

Absolutely so. When I was working on this full time, one of the proposals we tried to establish was that bona fide trade finance had to be considered *absolutely* sacrosanct -- senior even to IMF loans. It helps in this case to have entities other than the government running most of the economy -- it helps the quarantine, and allows the government default to save foreign exchange for trade.

I've actually published the following "hierarchy of default" in a research note on Russia, going from safest to softest, from the creditors' point of view:

Figure 10 Hierarchy of risk

Guaranteed by OECD state agencies Other trade finance Brady Bonds Other external sovereign bonds (Eurobonds) Collateralised credit (eg against oil receipts) Sovereign bank loans Interbank credits Large (international) corporations Sovereign domestic debt Domestic retail business Domestic corporate business


>> I cling to the belief that as
>> long as I don't print too much of it, I can still have as much control
as I
>> need over the domestic money supply even with open capital markets.


>That's not very realistic in Africa, is it now? Because now you are
>relying more and more on financial system intermediation. That's a
>problem, when we're seeing rapid financial shallowing all over the
>continent. There's just too much stuff going on outside the formal
>banking system for you to control anything terribly well. Better
>retain that printing press.

I think the operative phrase here is "as much control as I need". My plan would be to follow a (generous) money supply rule, or even, God help me, a Taylor rule, and hope to hit just the right degree of reflation. Which is a hell of a gamble, but I'm in a risky situation anyway. Financial shallowing in Africa is, unless I'm mistaken, a result of monetary contraction in 1998, and reversible. I'd tend to want to use the banks as my printing press.


>> I'm
>> not hoping for a miracle; I just want to be able to run a looser
monetary
>> policy than would otherwise be possible. I might experiment with
>> Chinese-style controls on capital *inflows*.


>Into what, the mickey-mouse stock exchange?

The Cote d'Ivoire stock exchange would be the BVRM (the stock exchange for Francophone Africa), and it's not so mickey mouse that Flemings don't trade on it. A lot of money was invested on these sort of infrastructure-of-capitalism projects in 1997/8. Although you're right to say that runaway capital inflows aren't likely to be a problem for Africa any time soon.


>No one is going to buy
>your bonds, right?

I disagree. People will buy my bonds if they're properly marketed. By this stage in the original sequence of steps, the situation would be:

*I had reached an agreement with my creditors

*I had an IMF program in place and was certified by them as being "in compliance"

*My economic prospects looked much better than they did before the default (due to reflation)

*I've got Goldmans and BNP pumping them to high heaven.

In this situation, my intution is that the bonds would sell if priced correctly. Which means "expensive" in the first issue, with the price falling on subsequent ones. I'd try to mitigate the pricing by adding cocoa and coffee warrants, similar to the oil warrants on the Mexican Brady bonds. According to http://www.bradynet.com (which is a very good source of information, btw, particularly its message boards), Cote d'Ivoire was on the point of launching a Brady at the start of 1998.


>And if they fear your propensity to default then
>they'll probably fear your propensity to restrict capital gains
>and profit repatriation.

But the balance of greed vs. fear can work in my favour if correctly managed. So long as developed world interest rates are low, and there's no crisis going on *right now*, fund managers will be looking for yield and largely ignoring the risks.


>> By the time I got around to lifting capital controls, I would
>> have expected to have nationalised (or quasi-nationalised) most of the
>> local banks,


>Now we're talking. That's fine, but have you factored in London or
>Parisian head offices of your banks, and also local power relations
>in the event the banks are domestically owned?

Banque National de Paris is the main foreign bank, and they're unlikely to seriously hurt me while I'm they're client on the investment banking side. The other foreign banks will not suffer from insolvency, but I wouldn't expect them to stick around. In terms of local power relations, you have a point, but the Mexican and Russian examples seem to suggest that the power of a bank-owner pretty much disappears at the point of insolvency. Given that the default and associated monetary chaos would probably have left the locally owned banks at the mercy of my central bank, I don't envisage many problems in nationalising the insolvent banks, and in more or less directing the rest. Since I'm not asking them to do anything fundamentally against the grain (all they have to do is lend the money I'm printing), I think they should fall into line. If they sppear to be moving their assets overseas, I'll reintroduce capital controls (because it would be a sign that the economy wasn't ready for them to be lifted).


> What, aside from a
>military coup, have you done to change those balance of forces? With
>all due respect, president, I think you have forgotten to mobilise
>the masses along the way.

Nonsense, the masses love me.:-)

I think the default itself will have largely kicked over the existing local elites, and as long as I can resist the temptation to become corrupt myself, I should be able to push through my financial programme. As long as it works. If it doesn't there will be another coup. But renegotiating the debts will help push the odds my way.


>> The most important defaults between Brazil '87 and Ecuador would have
had
>> to have been Poland/Hungary/Czech Republic in 1994/5 (I count these as
>> defaults because this was when the debts were finally written down under
>> their Brady deals) and Russia in 1998 (first and only example of the IMF
>> effectively writing off money)


>True? I thought that the new money from the IMF went to pay the
>interest on their old loans first and foremost?

Yes, but this practice is extremely rare for the IMF, and not many people believe that they won't end up writing off at least part of the loan. A commercial bank which carried out the same sort of deal would have to make a provision, but IMF accounting is "special"


>Anyhow, the May 1999 "Lusaka Declaration" of African social movements
>(a better term than civil society we'd agree) committed that if the
>African debt isn't written off by 31/12/00, then there will be a
>massive continental uprising that will result in a debtors' cartel.

Makes a lot of sense. Will it happen, do you think?

cheers

dd

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