SYNOPSIS: Emerging nation Bond markets give hints of trouble ahead for the world.
If 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.
Originally published in The New York Times, 11.22.00