A year ago, Argentina was the darling of global investors. So much so that, when it issued a pioneering 100-year bond with a yield of just 7.9 per cent, investors gobbled it up, ignoring the fact that the country has defaulted eight times in the past 200 years.
Whoops! This week President Mauricio Macri asked the IMF for help, after the peso tumbled to record lows. And that century bond? After rising to 105 per cent of its face value late last year, it is now trading nearer to 85 per cent.
This is deeply painful for the Macri government — and for long-suffering Argentine voters who hoped that “gradualist” reforms could deliver an exit from years of economic turmoil, indebtedness and decline. But there is a silver lining too, at least for the wider world: Argentina’s turmoil could offer a timely wake-up call about the bigger challenges in 2018.
After all, financial history shows that when rapid currency swings are combined with a turn in the credit cycle, this can flush out leveraged entities — and deliver Argentina-style surprises.
Some elements of this dangerous combination are now starting to materialise. In the past three weeks the dollar has strengthened, on a trade-weighted basis, by 5 per cent. Meanwhile, global credit conditions are finally tightening a little after six interest rate rises from the US Federal Reserve in three years. This does not necessarily mean that the Argentine debacle will spark a full-blown emerging markets crisis right now. Although countries such as Turkey seem vulnerable, overall financial conditions remain loose by historical standards.
However, the momentum in global markets is shifting. Or to put it another way (and as I noted last year), when future historians look back at Argentina’s 100-year bond, it will probably look like the bond market’s equivalent of the pets.com initial public offering during the 2000 tech boom — namely a sign of a bubble that, at best, is starting to deflate slowly, or, at worst, doomed to pop.
This has at least three implications. First, investors urgently need to stress test their portfolios for a world of currency swings and higher rates. Second, borrowers must become more resilient. After all, as Jay Powell, the Fed chair, observed this week: “Some investors and institutions may not be well positioned for a rise in interest rates.”
Third, policymakers need to prepare too. In recent years, the IMF has urged governments to use the gift of cheap money to make much needed structural reforms, and improve public finances. But, as the fund lamented last month, most governments have ignored that call, and public sector debt has surged. The fact that Argentina has a fiscal deficit of 9 per cent (when central bank borrowings are added in) is symbolic.
This means governments should accelerate structural reforms. Policymakers must also re-examine the wider global financial safety net. This has four overlapping elements: many countries have precautionary foreign exchange reserves; many also have bilateral swap agreements between central banks (to supply funds in a crisis); regional financial assistance programmes have emerged; and the IMF’s lending programmes.
This combination is robust enough to cope with limited shocks. The turmoil in Argentina, for example, will probably be contained if the IMF agrees to its request for a standby credit agreement. But if the turmoil spreads, the safety nets will undergo a far more searching test.
Interaction between the RFAs and the IMF, for example, is wobbly. Nobody really knows what would happen if a country ever failed to repay a swap line. It is also unclear how much firepower the IMF will have in the future.
The fund is due to conduct a quota review next year, and IMF officials are keen for member countries to increase their support, by many tens of billions of dollars. But it is unclear whether the US administration of Donald Trump will agree to support any increase. It is even less clear what might happen if it does not.
This is why the Argentine episode is timely. One hopes that Mr Macri will cut a deal with the IMF in the coming days, which will calm the markets, enable the government to save face and accelerate domestic reforms. But we should also hope that complacency does not return. After all, the best way to prevent a really big shock is to have regular, small jolts. All eyes, then, on that ill-starred 100-year bond.