The Debt Jubilee Is Going Global
The coming worldwide debt crisis will render to rubble the very foundations of the global economy. It’s not a question of if… It’s a question of when.
In the U.S., we can see exactly what’s happening by looking at the balance sheet of the Federal Reserve. The U.S. central bank has pumped upward of $3 trillion into the economy over the past few months alone. Its total assets now exceed $7 trillion.
And it’s our children (and grandchildren) who will be paying it all off.
That is, if it’s ever paid off.
Today, policies, politicians, and political expediency are aligning for debt forgiveness and moratorium on an unprecedented scale.
Whether it’s consumer debt, student debt, mortgage debt, municipality and state debt… a “debt jubilee” is a redistribution of money from those who have invested and saved – to those who can’t pay what they owe.
But this is only one piece of the “debt mosaic” that stretches far beyond the U.S. borders. The rest of the world has also been drinking from the “debt punchbowl,” too…
And next, American taxpayers might be footing the bill for debt jubilees in other countries… for places and people you may never have even heard of… for debt that’s never entered your mind. Like money owed by the government of Argentina – which, last month, defaulted for the ninth time in the past century – or any number of other developing economies around the world.
According to the Institute of International Finance, a finance industry association, total global debt – money borrowed by companies, households, and governments – has risen by $87 trillion since the start of the 2008 to 2009 global economic crisis… to around $258 trillion as of the end of March.
That means global debt stands at 331% of total economic output.
That’s up nearly 50 percentage points since the last big economic crisis. And since forecasts of how much economic output is going to fall in 2020 are all over the map, in reality, this percentage is probably larger.
One of the ironies of a potential debt jubilee in emerging markets is that even now, some of the world’s most rickety economies are still piling up on debt, due in part to the Fed pumping liquidity into the global economy. From April 1 through mid-July, emerging-market governments raised an incredible $90 billion by selling bonds to global investors.
And in a lot of ways, the debt situation for the U.S., the eurozone, and Japan is an anthill compared to the Mount Everest-sized challenge facing countries that don’t enjoy the luxury of being a reserve currency.
The Fed can easily create new money, whether to bail out small businesses hit by the coronavirus, pay holders of U.S. Treasurys, or to buy “junk bond” exchange-traded funds (“ETFs”).
But if developing economies from Ecuador to Zimbabwe start printing their local currencies to buy ventilators, pay bus drivers, or meet a bond payment… they’ll spark massive inflation. That will cause far more damage to their economies than the destruction they’re trying to head off.
Total debt from emerging markets has more than doubled since 2010 to $73 trillion today. The biggest emerging markets include China, India, and Russia. The grand total includes around $3.2 trillion owed by the dozens of “frontier markets,” which are economies that haven’t reached “emerging” status yet.
In recent years, as yields on bonds in developed countries have collapsed to zero and into negative-return territory, investors have tripped over each other to lend to markets where they can earn interest of around 9% (Zambia’s 2015 international bond issuance) or 7% (Tajikistan’s in 2017).
Before the coronavirus-inspired crash in global asset prices earlier this year, bonds issued by Mexico and Brazil yielded around 6.5%. When the global economy is growing, those look like good bets.
But the risk-reward setup has all changed now.
Lying on Their Deathbed
With the global economy lurching into depression, many developing economies have been hit the hardest. Those most dependent on trade are seeing demand evaporate… and countries that sell a lot of commodities (oil, in particular) are hurting the most.
Poverty, a weak health care infrastructure, and the physical impossibility of social distancing are prime breeding grounds for the spread of the coronavirus – from Nigeria to Brazil to Russia to India. Five of the six countries globally that have the most coronavirus cases are in the emerging world (the U.S. is the exception).
The International Monetary Fund (“IMF”) projects that Brazil’s economy will shrink by more than 9% this year. That would be Brazil’s worst recession in history. The Russian currency, the ruble, is down 15% since the start of the year. South Africa is in such dire straits that it’s borrowing money from the IMF for the first time since the end of apartheid in 1994. India’s prime minister has warned that the coronavirus could set back the country’s socioeconomic progress by “decades.” Economic growth in 2020 in emerging markets as a whole is forecast to shrink for the first time in 60 years.
And for every big headline emerging market that’s stumbling, there are a dozen small countries – from Zimbabwe to Peru to Cambodia – that are facing even darker prospects. They’re smaller and have fewer resources to fall back on. If a 175-pound man loses 20 or 30 pounds, he looks skinny and gaunt. If a 90-pound man loses 20 or 30 pounds, he’s on his deathbed.
In response to the dark prospects for poor countries, the G-20 – a group of mostly developed economies – agreed to suspend repayments for government-to-government loans to as many as 76 poor countries for the rest of the year.
The G-20 was thinking of both the risks of a default – as well as the human suffering in poor countries. According to the Financial Times:
The debt postponement was “a plan to tackle the health and economic crises triggered by the coronavirus pandemic and prevent an emerging-markets debt crunch.”
The idea is that the G-20 and other government-supported bodies want poor countries to boost their own economies and save lives with the money that they would otherwise be paying them in bond payments.
So to help poor countries, governments are pressuring investors in the debt of the world’s small and emerging-market countries to join them in allowing poor countries to push back payments and start to talk about restructuring debt.
Restructuring sovereign debt is usually a long and messy process. And it usually involves swapping old bonds for new ones that carry a lower interest rate or longer repayment periods.
In the end, investors take a “haircut” – that is, they get back less money than they were originally promised.
That’s precisely why individual investors need to pay attention. The debt jubilee octopus has wrapped its tentacles around us already.
(And this is only a small way… Stansberry Research founder Porter Stansberry recently released a startling presentation that explains how the debt jubilee can hurt you – and how to protect yourself and your family – and your assets.)
Is Your 401(k) at Risk?
The big private investors in emerging and frontier market debt are recognizable names. They include BlackRock (which manages the biggest emerging-market bond ETF), Vanguard, VanEck, Invesco, Fidelity, and other asset managers.
The debt of emerging-market governments is sprinkled in with a lot of high-yield bond funds. Nearly two dozen emerging-market bond ETFs are traded on the New York Stock Exchange. The largest is BlackRock’s iShares JPMorgan USD Emerging Markets Bond Fund (EMB), with a market capitalization of around $14 billion.
Without realizing it, a lot of small investors in the U.S. hold the debt of emerging-market governments and companies in their retirement accounts and other funds or ETFs.
In the past, these sorts of big asset managers haven’t raised much fuss when countries want them to take a haircut. They’ve typically simply taken the hit – or rather, the people owning their funds have taken the hit – and moved on.
But this time, according to the Financial Times, the asset managers say they’ll play hardball. Although the need for financial relief is stark in many cases, there are indications that some investment groups may break with the custom of reluctantly accepting financially painful compromises to achieve a restructuring and instead fight for a better deal.
Some restructuring is inevitable, especially for countries in particularly dire financial straits – like Lebanon and Zambia, which were part of an early wave of emerging economies looking to make a deal with creditors. So far, of the 76 countries (based on level of economic development) eligible for a special G-20 debt service suspension program, around 41 countries have applied – for a total of $8.8 billion in requested postponement.
According to the Financial Times in mid-July, the head of the World Bank, David Malpass, pushed the G-20 to “open the door to consultations about the debt overhang itself and effective ways to reduce the net present value of both official bilateral and commercial debt for the poorest countries.” And that would very likely lead to pushing for something similar by private creditors. (Who’s that?… that’s you.)
The worst-case scenario for this process?
Argentina in Free Fall
As recently as June 2017, investors had enough faith in Argentina’s turnaround that they bought $2.75 billion of a 100-year bond.
It was faith… or maybe they were blinded by greed and the 7.9% yield on the bond. Either way, they simply ignored the country’s history of default. (The IMF went one better, extending $57 billion in loans to Argentina just a year later.)
Now, Argentina is in free fall.
A nationwide lockdown has decimated the Argentine economy, which is forecast to contract by about 12% this year. But what’s different for Argentina is that the economy was already in dire shape, after shrinking 2.5% last year – and posting inflation of 48%.
When I visited Argentina’s capital, Buenos Aires, last September, the mood was dark. Today, it’s apocalyptic.
My friend Tomas, an economist and private investor in Buenos Aires, told me recently over the phone, “We’ve had MMT here in Argentina for the past 70 years.”
He was referring to “Modern Monetary Theory,” which argues that governments can pay for huge spending by simply issuing more currency without needing to worry about deficits. However, as Tomas explained, there’s a big difference in Argentina…
“Here it’s not modern, and there’s nothing monetary about it. It’s just the central bank printing money, giving it to the Treasury, and the Treasury never has to give it back. It’s the only way to survive.”
Over the past six months, the printing presses have been running overtime in Argentina.
In a desperate attempt to pay the bills, the government has increased the total monetary base – that’s the total amount of currency in circulation or in the commercial bank deposits held by the central bank – by more than one-third in recent months. It doesn’t help…
Most of those wet-ink pesos are quickly converted into dollars. That’s been reflected in the 20% drop in the Argentine peso against the U.S. dollar since the beginning of the year. And in reality, the drop is a lot worse.
Inflation has been relatively contained in recent months because people haven’t been buying much while in lockdown. And price controls on some consumer items have helped keep inflation under control for the time being. The country’s government recently came to terms with creditors to stave off another default, but that’s like putting a Band-Aid on a patient who’s suffering a heart attack, broken leg, and concussion all at once.
Inflation is still forecast to hit around 40% for the year. And that estimate is going to rise sharply in coming months.
“Hyperinflation is on its way,” Tomas told me.
In Argentina, inflation hit close to 5,000% in 1989. When Argentines talk about high inflation, they’re not kidding.
What’s Next for You?
Argentina won’t be the first debt jubilee that you help fund… particularly if you hold emerging-market bonds somewhere in your portfolio. And it probably won’t be the last.
In the meantime, the stronger emerging markets will continue to pull away from the rest. (Strangely, South Korea and Taiwan – highly developed economies – are still considered emerging markets.)
And China is in a different universe from the countries of the developing world that are going hat in hand to the IMF.
But today, investors should be sure to look under the hood of their emerging-market bond funds to see what’s really inside. We suggest you make this a regular practice with every investment you have… whether it’s stocks, pension funds, or ETFs.
ETFs, in particular, sometimes either don’t reflect what their titles suggest or may include assets that you’re not aware of – such as emerging-market debt.
Finally, don’t get me wrong, all of this matters a lot now… as currencies in places like Argentina and Brazil drop in value relative to the U.S. dollar and as poor countries struggle.
But if and when the debt jubilee starts in earnest and that entire $258 trillion global debt tab comes due, then emerging markets might be the least of our problems.
Now here are some of the stories we’re reading…
Claims well exceed the worst week in the 2007-2009 recession, and while new Covid-19 cases have been slowing, thousands are still reported daily.
‘Don’t be fooled by stock market highs’
“We’ve had a magnificent V-shaped recovery in the stock market, but the stock market’s not a great reflection of the broader economy anymore,” Jim Cramer said.
The odds of catching Covid-19 on an airplane are slimmer than you think, scientists say
One explanation for the apparently low risk level is that the air in modern aircraft cabins is replaced with new fresh air every two to three minutes, and most planes are fitted with air filters designed to trap 99.99% of particles.
The Rich Recover From the COVID-19 Recession While Main Street Suffers
Rich people own financial assets – stocks, bonds, and commercial real estate, for example. They get richer not just from fat paychecks, but also when those assets go up in value. And over the last three decades, the Federal Reserve has made it its business to make sure those assets keep going up in value.
How agonizing surgery paved the way for anesthetics
From first cut to severed limb dropping into a box of bloodied sawdust, 1840s surgeon Robert Liston could remove a leg in 25 seconds… The speed of the procedure had its advantages. With no pain-relief available, it shortened the almost unimaginably horrific trauma of surgery.
And let us know what you’re reading at [email protected].
Chaos Chronicles Editor, American Consequences
With P.J. O’Rourke and the Editorial Staff
August 21, 2020