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Will the Next Pandemic Be a Financial One?

Will the Next Pandemic Be a Financial One?
 Jeremy Adelman
Director of the Global History Lab at Princeton University
 Pablo Pryluka
PhD candidate at Princeton University

As the Coronavirus grinds through the world economy, a new threat is emerging: a wave of defaults in the global south. For the past decade, countries as dispersed as Argentina, Turkey, and Zambia have racked up enormous debts. Emerging markets owe $71 trillion to their creditors. Around one tenth is due in the next six months. Time is running out.

This is why G7 finance ministers and central bankers just approved conditional emergency debt relief for low-income countries. The sum is still unclear. And it awaits approval by the G20. The package is a step in the right direction to confront a coming calamity.

Still, basic questions lie ahead. How will the global south pay if, as the IMF predicts, there is a 10 percent contraction in the world economy? Where will the funds come from if, as the WTO predicts, global trade slumps by 30 per cent? 

This is a near-perfect storm. What was manageable at the end of 2019, is no longer. Because creditors in rich countries face a wave of defaults from businesses back home, they have little leeway. International agencies are hobbled. The US government has made a virtue out of refusing to cooperate. The global south faces a triple crisis: plummeting export earnings, a dramatic public health crisis, and looming payments to creditors.

In past financial crises, markets relied on a mix of brokerage and leadership from three quarters. First, international financial agencies like the IMF and clubs of bankers took the long view. Willing and able to restructure loans, they bridged short-term assistance to get ailing economies through tough times and kept lenders and borrowers at the bargaining table. But current lenders are of a different stripe. No longer the clubby bankers of old, they represent a dizzying array of lenders with fiduciary obligations to their clients, from New York hedge funds to Middle East sovereign wealth funds. They are hard to coordinate and cede to aggressive coalitions of fund managers who want to force debtors to their knees to maximize short-term payments over long-term restructuring.

The global south faces a triple crisis: plummeting export earnings, a dramatic public health crisis, and looming payments to creditors.

Second, in the past, authorities in Washington, especially at the Federal Reserve and the Treasury Department, backstopped international agencies. In the 1980s, the US Treasury helped convert Latin American arrears to commercial banks into collateralized bonds. It was the Treasury that helped Mexico during its meltdown in 1994. Back in 2009, the IMF approved an emergency $250 billion for Special Drawing Rights for poor, cash-strapped, economies. But now, the Trump administration’s affection for sauve-qui-peut policies have blocked IMF Managing Director Kristalina Georgieva’s effort to come up with a rescue plan. 

Treasury Secretary Stephen Mnuchin declared that SDR’s would allow poor countries to "print" new money. It has a puny Catastrophe Containment and Relief Trust with a meager $500 million for debt-service relief. On April 13th alone, 25 countries lined up with cups in hand. Within a week, half the world’s countries – over a hundred – had joined the queue. The Fund was compelled to cancel repayments worth $214 million for the poorest countries for the next six months. This skirts the much larger sums owed to private lenders.

Third, policy makers in debtor countries managed their national crises with the hope that recovery would come soon. Without their cooperation, some would say compliance, global finance would have collapsed. This often came at a brutal price. But as the current crisis drags out, and as creditors refuse to bend, debtor countries will be pushed to the brink of default. Throw in the fiscal demands of a spreading virus, and policymakers will face the agonizing choice over whether to equip local hospitals or pay their foreign lenders.

In this looming crisis, Argentina is particularly vulnerable. Its debt is worth almost 90 per cent of its national economy. Argentina threatens to start a cascade in the same way that Thailand set off the Asian meltdown of 1997 – but in more ominous circumstances. Over the last decade, Argentina struggled with slow growth, rising public debt, and inflation. To help the flailing government of Mauricio Macri to reduce fiscal deficit by replacing it with foreign credit and to stop $50 billion in capital flight, the IMF extended a historic loan in 2018. But instead of righting the books, Macri used the money to reach the 2019 elections without a major economic crisis. His successor, Alberto Fernandez, inherited a mess and is embroiled in a feud over $66 billion in debt. 

How Argentina copes with its creditors and how creditors behave will either create a template for others or lead to a cascade of defaults. As Covid-19 moved in, Martín Guzmán, an Ivy League-educated Finance Minister with IMF backing and an expert in debt restructuring, suggested a delay in payments and a discount on interest. Creditors, led by three different bondholder groups, dug in their heels. Two weeks ago, Argentina defaulted on a $500 million payment. Now, the IMF is urging the government in Buenos Aires to make concessions for fear that an Argentine standoff turns into a global disaster. 

For the Argentine government, what is worse? Give in to creditors and worsen a staggering social crisis? The country’s poverty rate topped one third at the end of 2019. Among children under 14 years old, that percentage is over 52 per cent. And this is before Covid-19! Or default and face capital flight and boycotts of creditors for years? 

Two weeks ago, Argentina defaulted on a $500 million payment.

Either way, Argentina is in for dramatic pain. But just as Covid-19 spilled out of Hubei province in China, Argentina’s malaise will spread. In a tightly-coupled global system, it threatens its bigger neighbor, Brazil. Brazil is in a complete mess, compounding a long economic crisis with a dramatic political and public health disaster. Not far behind Argentina in the default queue is Zambia, then Lebanon. Each one has a neighbor in distress. So, while Zambia’s debts are not large – $11 billion – if Zambia goes under, it will whiplash South Africa. A Lebanese default threatens a struggling Turkey. And so on.

How to escape this vortex? Two agonizing scenarios are possible. The first is less ruinous for the world but forces debtors to pay a high price to prevent a global collapse: cobble together short-term rescue operations and wait for the world economy to recover quickly and enough to restore the oxygen flow to the lungs of world trade. But given the weakness of international organizations, the mayhem in Washington, and the aggressive stance of lenders, the high price of relief is being set by financiers. The other scenario is that we run out of time and watch the economic shock of Covid-19 throw the global financial structure into a crisis unseen since 1929. Either way, the clock is ticking. 



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