Yield-desperate investors stop before nothing. What have central banks wrought?
Junk-rated, deficit-plagued, inflation-whacked Argentina just sold $2.75 billion of 100-year dollar-denominated bonds. This was the first time ever that a junk-rated country was able to sell 100-year bonds denominated in a foreign currency, or any currency.
Argentina sports a “B” credit rating from Standard & Poor’s. Five notches below investment grade. Deep junk.
And 100 years is a very, very long time for Argentina and its regularly beaten-up creditors: Just over the past 65 years, it has defaulted six times – in 1951, 1956, 1982, 1989, 2001, and its “selective default” in 2014. Its default in 2001 on $80 billion of dollar-denominated debt was the largest sovereign default at the time.
And yet, yield-desperate investors don’t seem to care. According to The Wall Street Journal, demand for the private-placement offering was such that Argentina could sell those “century” bonds at a yield of 7.9%, down from the initial price talk of 8.25%.
They’re priced at about one percentage point higher in yield than Argentina’s 30-year bonds. So yes, in that respect, they’re a good deal.
Argentina will certainly default on them. These bonds are denominated in US dollars. Argentina does not control the dollar; so it cannot inflate or devalue away the dollar bonds, as it can with local-currency bonds. And it cannot print the money to service the bonds as it can with local-currency bonds. Years and decades down the road, Argentina has to earn enough devalued pesos to service its dollar debt. This is precisely what it couldn’t do so many times in the past.
Weeks after it exited its last default, it started borrowing in dollars again. In April 2016, it sold $16.5 billion of foreign currency bonds, the largest-ever sovereign-bond issuance by a developing country at the time (Saudi Arabia later beat that record). So its pile of foreign currency bonds is starting to grow. There is no doubt that Argentina will default again on its foreign currency debts over the next hundred years, and probably several times. The hope is that it won’t do so over the next few years.
For now, given its defaults in the past and the haircuts it imposed on creditors, and having been locked out of the global credit markets for a decade-and-a-half, its foreign currency debts are relatively low. And what investors care about today is today’s yield.
At institutional investors, such as insurance companies and beleaguered pension funds that must earn an average return of 7% a year for all times or go bust, the people who made the decision to buy these things have one hope: Collect the fat yield for a while, personally pocket the bonuses over the period, and then change firms or retire and let someone else deal with the fallout. After all, they’re just managing other people’s money.
Other countries have recently issued 100-year foreign currency bonds, including Mexico – and Ireland, if you count the euro as a currency the issuing country does not control. They all wanted to lock in the super-low interest rates and take advantage of investor desperation. But all of them have investment-grade credit ratings.
Argentina’s Finance Secretary Luis Caputo claimed that the bond sale had been possible because the country had regained credibility in global credit markets. In reality, the bond sale had been possible because central-bank interest-rate repression and asset-price inflation has driven global investors into a state of desperation.
Whatever the future holds for Argentina’s foreign currency bonds, their yields look temptingly juicy today. Its foreign currency sovereign debt has risen 8.3% in value so far in 2017, according to the Wall Street Journal. Yield-chasing global investors, blinded by eight years of central-bank interest-rate repression have the hots for this type of yield, no matter what the risks.
You can’t blame Argentina for those dollar bonds. It’s simply doing what investors encourage it to do.
But no investor should buy foreign currency bonds from Argentina, unless they come with huge yields. Foreign currency bonds regularly lead to debt crises all over the world, not just in Argentina, thus triggering international bondholder bailouts by the IMF and other organizations that then try to impose “austerity” on the country. Instead, Argentina needs to stop monetizing its deficits and get inflation under control, thus building credibility for its own currency – which would take many years, given the shenanigans of the past decades – so that it can rely on issuing peso bonds at a low cost. It controls the peso, and it will never default on peso-denominated bonds.
It does sell peso bonds. But investors exact their pound of flesh in return for exposure to Argentina’s toxic currency. Earlier this year, for example, it issued five-year bonds denominated in pesos at a yield of around 18%. Inflation, at 24% in May on a 12-month basis, will likely eat up the yield, and plus some. So there’s not a lot of appetite among investors for taking this sort of beating on a regular basis.
But that central-bank-imposed low-interest rate environment may not last much longer, at least not in the US. Oh my, how things have changed since late last year. Read… The Fed is on a Mission, Doesn’t Worry about Markets: New York Fed’s Dudley
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The dollar to Argentinian peso has been surprisingly stable the last year. A far cry from the days when they weren’t letting it float. I visited for the 2nd time just as they removed the float and blue dollars disappeared. It was an amazingly cheap time, but I noticed a ton more graffiti from the last time I had visited 5 years before. My Colombian BIL lives there because he can mooch off the government much better than in Colombia.
They will default again before 100 years is up, without a doubt. Most likely several times within the next century. I doubt investors will even make enough in interest to recoup their principal.
At 7.9% yield it would take a little under 13 years to recoup the principal… without taking into account capital gain taxes, inflation, bank fees etc. And that’s for those lucky enough to buy these bonds at issue without the large premium that will be put on them in maybe six months when they will be in high demand among us NIRP refugees from Europe and Japan.
Argentina going 13 years without at least a “selective default” is a massive bet, one that should pay far more than that miserable 7.9% (before taxes and fees, of course). On a ten years timeframe already one is probably better off betting on the likeness of a default in London or Las Vegas.
You are looking at the question entirely wrong.
The relevant question is which CURRENCY is likely to DEVALUE first….the U.S. Dollar or the Argentine peso.
Seen from this perspective….a bet on these Argentine bonds isn’t nearly as crazy as it first appears…..at least over the next decade.
Argentina’s economy is improving (which means tax receipts increase) while the U.S. economy is rolling over (tax receipts declining).
Argentina’s debt burden is low (because of its recent defaults) and its near-term interest payments are manageable as a result. The U.S. debt burden is relatively high (especially if various off-balance sheet liabilities are considered) and there has been no curb in spending (even in light of falling tax receipts).
More importantly, interest rates in the U.S. are ridiculously suppressed and for a decade the gov’t has been shifted much of the debt away from the long end of the curb to the short end to benefit from these low rates and allow it to continue to overspend without ‘consequences’. Thus, it takes very little in rates to have an huge percentage affect on our annual interest payout.
It’s not that the FEDERAL RESERVE wants to raise rates….it HAS TO. The question in the Feds mind is which part of the economy can it allow to blow up first. The entire insurance and pension industries are already poised to topple due to the extended period of suppressed interest rates. Allowing either to fail is a non-starter given the interconnnectedness of the financials. So my guess is that the part of the economy which will be allowed to fail is GOV’T bonds….starting with muni/local….and working its way up the chain to eventually Federal…..all of which which will weaken the U.S. currency as enough of these bonds start defaulting.
(To be fair…I still don’t see the U.S. defaulting on U.S. federal debt for some years to come….but its coming…and as long as it occurs BEFORE the next Argentine debt crisis….the buyers of these 100-year Argentine bonds will be sitting pretty. )
regarding: “So my guess is that the part of the economy which will be allowed to fail is GOV’T bonds….starting with muni/local….and working its way up the chain to eventually Federal….”
Win win for social machinations. This will allow further demonization of those few left with negotiated pensions, permission to not support them or borrow to build local projects, and general deterioration for wage earners in general.
Hope that infrastucture is built and renewed pronto. :-) LOL
Valuation Guy, you wrote: “Argentina’s economy is improving…”
So here is a chart that shows just how dismal that economy is. Over the past 12 quarters, GDP sank in six of them. The last two quarters were mildly positive. The prior three were sharply negative. This economy is in terrible shape:
And inflation, currently at 24% annually, remains a huge problem. Inflation is what eats up the currency permanently. That’s over 10 times the current US rate of inflation. In 2000, the peso was worth $1. Today it’s worth 6 US cents.
There’s an old saying about Brazil which can be applied to Argentina (and several other South American countries) as well: “Brazil is the country of the future. And will remain so for a very long time”.
Argentina shows little sign of putting some order into her house of cards. Official inflation remains in double digit and even official GDP figures are on a rollercoaster.
I see the grandchildren of the immigrants who left the valleys for Argentina decades ago are coming back, looking for work, or at least better work. Young people don’t leave a country in droves for a very uncertain future if things are improving.
I have no doubt Argentina has great potential, but like Brazil she needs to fix problems going back to the Perons or even further back and which have never been properly addressed.
Until I see some signs of improvements my assessment of Argentina remains negative, as it has been since 2013, when I sold off the last investments I had in Latin American markets.
(can’t reply directly to your response to my original post so I’m, replying to my own post.)
While I agree with you that local currency inflation is a major issue there….I’m looking at annual household income per capita (in U.S. dollars to negate the inflation factor)…see link below:
While GDP declined overall in 2016…it turned positive in 4Q16 and forecasts I have seen put GDP growth at 2.5%-3.5% in 2017.
I don’t think they are outta the wood….the socialist mentality is still ingrained and labor is very powerful….but the years of the Kirchners resulted in the current very pro-business (and reform-minded) admin which looks likely to increase its hold in upcoming elections this year.
Corruption and waste are endemic there…but just a bit of reform could go a long way to improving trade and result in a large increase in international investment after years of under-investment due to business, tax policy, and currency uncertainty.
I suppose in the current environment, it doesn’t matter whether the assets will pay off on their own. You just need to flip them for a higher price. Those bonds could make traders a lot of money as long as they can sell them off.
It’s perfect for a hedge fund really, buy a bunch of this type of debt, mix it with Coco bonds and other “emerging-market” debt, re-package it as a “diversified and therefore safe” high yield government-debt fund, and get passive investors to buy in.
You don’t even have to truanch it out like the mortgage-backed securities of 2008, just ETF it ’cause that’s the big thing nowadays.
Thanks, Wolf. Great article as usual!
It could be worse. When Draghi sees this, he will undoubtedly propose a 100 year bond for general use when member countries issue new debt, and suggest a rate of -1%, or possibly a negative rate of -1.5%
People will buy it.
Both Belgium and Ireland have already issued 100 year bonds in private sales. Belgian sovereigns yield a laughable 2.7%. I don’t remember how much Irish ones yield but it’s surely well under 3%. Austria is presently pitching 70 year bonds. And France, Italy and Spain have all issued 50 year bonds. The reward for lending money to Italy for half a century? All of a massive 2.85%.
Throw in capital gain taxes and assorted fees and duties and it’s not even enough to cover for official inflation, let alone real one.
Who buys this junk? Because that’s what it is: if it yields less than inflation when all is said and done it’s junk, even if it’s issued by Amazon, personally blessed by Ellon Musk and pitched by Goldman-Sachs as the safest investment ever.
Chiefly European banks, who care little about yield on sovereigns and can use these bonds as collaterals to get endless liquidity from Frankfurt, followed by speculators who are only interested in selling them at a profit down the road.
But not at -1% for 100 years. Think about it.
Wait, it’s coming. The last gasp.
” Who buys this junk? ”
My same exact question. With an additional .. Why ?
The fact that Argentina is doing this comes as no surprise [ got family there … know all the inside facts .. heard all the stories ]
What dumbfounds me is who the hell buys hopeless junk investments period … never mind 100 year junk . I mean have these .. err … delusional misfits ( possibly addled by a bit of Dr Tim’s chemistry for ‘ better ‘ living … ) suddenly become convinced they’re going to live for ever ? Or is it a case of the Bots gone BuyCrazy mad in a programing fit of digital lunacy ?
Sigh … and they said we were delusional back in the 60’s . Suffice it to say Kesey , Leary and HST at their worst had nothing over these folks
And damn when this does finally all come to an end is it ever gonna end … ugly .. with no winners in sight .. or as the bard ( Jim Morrison ) put it ;
” No one here gets out alive “
Junk bonds in the EU yield a paltry 2.7%. Now THAT’S insanity!! Even Argentina doesn’t match that.
In sum, western civilization may be at risk. Welcome to the crisis season of The Fourth Turning.
The bondholders know that in our crony capitalist wonderland, taxpayers will be forced to make good any and all financier losses.
No doubt that’s their belief. Anything to stop contagion. It won’t be current taxpayers, though. Just print more money.
Yeah, that’s what the buyers of Peurto Rican bonds were betting on 5 years ago when they were tripping over each other to get in on the action. Ask them how confident they are now that the taxpayer will get the check on that one.
Nice to read here what MMT says, Wolf. The mainstream is not interested in reality, so you channel MMT in understanding that borrowing in a foreign currency is madness, sometimes unavoidable [Boeing wouldn’t likely sell Argentina a 747 for pesos] but always best avoided. And to say the IMF is guilty of asset stripping a debtor country needs a lot more publicity. Be nice to see you up to speed on the rest of the economic basics MMT advocates.
John, MMT is an economic religion. It requires a “leap of faith.” Unless you make that “leap of faith,” big parts of MMT make no sense and you cannot believe in it.
Magical Money Tree. MMT is a theoretical framework which allows unscrupulous financiers to rack up huge fictional losses, sufficient to allow them to hold entire economies hostage until governments cover their losses with tangible assets. Fraud and theft are technically crimes, so MMT was invented to legalise wholesale pillage.
From your link-
“It follows that currency-issuing governments could (and, depending on how you lean politically, should) spend as much as they need to in order to guarantee full employment and other social goods.”
Using that logic the government could simply mail each US taxpayer a 1 million dollar check and we could all live happily ever after.
How’s that working out with the free money given to banks to produce housing bubble #2?
MMT rests on the notion that human ‘needs’ are unlimited (beyond the basics of food and shelter) and that it is impossible to print too much money beause there would always be some ‘need’ to soak up the cash and limit inflation.
People are not that complex!
Its a crazy world. Not too many investors would risk their funds like this, but they’re happy to shovel them to some broker who throws the accumulated funds at everything, hoping enough of his bets will pan out to make a net positive return in the long haul. If they don’t, well no skin off his bum, he will have his fees and be long gone before the day of reckoning.
The “desperate investors” aren’t going to live a hundred years to the bonds’ maturity. They are betting on a shorter-term rise in the price of the bonds.
Same phenomenon as the “investments” in stocks: Betting that stock prices will continue to rise.
These are “desperate GAMBLERS”, not investors.
If the return the Argentines are expecting to get by borrowing this overpriced money isn’t greater than what it’s costing them, they’re just digging themselves into another hole. And there’s no reason to expect they’re going to make more than 7.9% on it.
Isn’t that what motivates borrowing – the expectation that you’ll make more on it than what it costs? Isn’t that why people borrow to buy a house, to get ahead by avoiding rent and accumulating equity? Isn’t that why people borrow for college, to get a job that pays a lot more than the cost of the loan? Isn’t that why people borrow to buy a car, to get to work and make a living? Isn’t that why businesses borrow, because they’ll make more on that money than what the bank is charging them for it?
It seems a lot of people borrow money just because they want something they can’t afford, and don’t want to understand that they’re going to end up paying too much for something they can’t afford, all because they’re clueless about the nature of finance. There’s constructive debt and there’s destructive debt, and they might look the same but they’re really opposites.
Argentina’s different. They borrow, divide op the cash among political leaders, and put the money back into Wall Street. Then they move to Miami. Taxpayers are then on the hook. So they elect a leftist who reneges. Everyone wins except me and my pension fund.
So they’re not digging themselves into a hole. They’re digging you into a hole so they can profit by burying you in their debt.
Well, that explains it.
Bonds are a promise.
In real life, a promise engages only those who believe it.
Plus ca change plus c’est la meme chose!
I think all the 100 year bonds denominated in dollars are a bet that America won’t be around in 100 years and they can pay them off in other script or nothing at all. At this point, I don’t know if that’s such a bad bet.
So who, in Argentina, gets any benefit now from the $2.75 Billions? Obviously no one cares about a 100 years from now in this transaction. Just a silly question about where that money goes. How much stays in Argentina? How much goes to “financiers”? How much goes to those in Argentina who negotiated these “terms”? How much goes to benefit the people of Argentina? My suspicions don’t count for much, I know, but it would be useful information to know some answers.
The title is somewhat…tame. Could have been: “Peak casino. Argentina…”. Also mentioned are pension fund managers who buy this and move on. But by my math, five default in hundred years is 100/5 = 20 years. Twenty years from now most FED members would have retired or be safely underground, too. But then, some plans can go horribly wrong.
My guess is that the buyers are getting paid more than the coupon rate. What’s probably not disclosed is that they’ve also sold a put option that makes the effective rate even higher.
Some fund is going to blow up in the future when the option is exercised. Calling Illinois Pension Fund, calling Illinois Pension Fund!!!
18% Anual for Bonds in peso is too low since you can get between 16% to 20% Anual for a FD in pesos in Argentina. Also let’s all remember that between December 2015 to today the Dollar rose it’s price about 60% in Argentina and 2016 inflation rate was about 40% there. They later said it was less but no one honestly believes that.
Just shows you that some people are stupid enough to buy anything.
i saw this in the wall street journal today, and thought i had picked up the onion.
maybe i did, after all. will check.
they’ll be a good buy if soft commodity prices pick back up.
There’s actually pretty nices places for tourisms and some regions are charming but not much more. the dollars should be around 30 pesos to attract tourists and investors Morgan Stanley says it,s not an emerging market and considers the bonds junk.They are right there is no industry.the shops are all like la salada and half buenos aires is like a villa.Real estate prices are too high all in dollars no deals all overprices.the rich are investing there money in Miami Saint Barth Sint Maarten París and New York no money left in the country
They have some nice hotels, like the Vetiver, Belleclaire and Novotel. Then you can probably extend that into a “day and a half.” If you’re on a limited budget the Vetiver is a good idea.