Krugman: Bond market worries

Michael Pollak mpollak at panix.com
Tue Nov 21 21:36:14 PST 2000


THE NEW YORK TIMES

November 22, 2000

RECKONINGS

The Shadow Of Debt

By PAUL KRUGMAN

I f Argentina were a first-world country, its debt wouldn't be a

problem. Both its budget deficit and its national debt are about

the same fraction of G.D.P. as those of the U.S. eight years ago,

and compared with Japan the country is a paragon of fiscal

prudence. But global bond markets aren't equal-opportunity lenders,

and third-world countries don't get the benefit of the doubt. In a

recent debt refinancing Argentina had to pay an interest rate of 16

percent 10 percentage points more than the U.S. Treasury pays.

Some of this premium reflects the country's unique problems. Not

long ago Argentina's "currency board" monetary system, which fixes

the value of the peso permanently at one dollar, was lauded as a

model for other countries. Now that monetary system has become a

trap; tied rigidly to a strong dollar while neighboring Brazil has

devalued and the euro has slumped, Argentine producers find

themselves priced out of world markets. The country has gone into a

slow but dangerous tailspin. A depressed economy has led to budget

deficits; the need to reassure skittish investors has forced the

government to cut spending and raise taxes, further depressing the

economy; and rising unemployment has led to growing social unrest,

making investors even more nervous.

For now, a deal with the International Monetary Fund has staved off

the imminent risk of default. There is considerable irony here: the

loudest praise for Argentina's currency board came from the Wall

Street Journal / Forbes / Cato Institute crowd, who saw it as the

next best thing to a revived gold standard. Those are the same

people who have been howling for the abolition of the I.M.F. and

other international financial institutions. The irony gets deeper

when you notice that Malaysia, which was supposed to have been cast

into the outer darkness after it imposed controls on foreign

investors two years ago, has had no trouble selling its bonds on

world markets.

In any case, the situation is far from resolved. While the I.M.F.

loan buys time, it is not at all clear how time will improve the

situation.

Still, if this were a story only about Argentina, it would be an

object lesson but not an omen. What makes the story ominous is that

Argentina isn't the only debtor finding that markets are demanding

much higher interest rates. In fact, around the world bond

investors have been fleeing from anything that looks even vaguely

risky. Interest rates on the debt of emerging-market nations like

Argentina have risen by 1.5 percentage points just since September.

And interest rates on high-yield corporate debt what we used to

call junk bonds are at their highest levels in nearly a decade.

These soaring interest rates on risky debt are, in effect, a

prophecy of future troubles for the world economy. All the official

forecasts for the next couple of years are cheerful; budgeters and

international organizations are increasing, not reducing, their

estimates of future growth. But bond investors seem to think it

likely that many overextended borrowers, countries and corporations

alike, will not have enough revenue to meet their obligations.

As the financial crises of the 1990's taught us, such pessimistic

prophecies can be self-fulfilling. A scenario for the next world

financial crisis is already obvious: a default by a big debtor

maybe a country, maybe a big corporation (say an overambitious

telecom company) creates a bond market panic. And the unwillingness

of investors to buy risky bonds forces countries into drastic

austerity programs, forces companies to cancel investment plans and

leads to a slump that validates investors' fears.

Of course, it doesn't have to happen. We could be lucky; or we

could act quickly to limit the damage when financial disruptions

appear. A couple of weeks ago it seemed that an Argentine default

might trigger a crisis; for the time being, at least, the I.M.F.'s

loan package has averted that danger.

What worries me is this: The bond market is warning us of

turbulence ahead. That would be O.K. if the world's largest economy

were being run by experienced, open-minded officials like the ones

who got us through the last crisis. But who will actually be in

charge? If it turns out to be knee-jerk conservatives who are

opposed to any government intervention in markets, you'll be amazed

at how badly things can go wrong.

Copyright 2000 The New York Times Company



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