Watch out – vultures about

By Mick Brooks

Argentina’s President Cristina Kirchner is having a little difficulty with vultures. ‘Vulture funds’ are trying to suck Argentina dry. A case in point is hedge fund Elliott Associates, run by American billionaire and Republican supporter Paul Singer.  

This is their modus operandi. In 2001 Argentina defaulted on foreign debts and 93% of bondholders agreed to take a loss. The vultures are the ‘holdouts’, the 7% of bondholders who refused to take a loss on their bonds and are now pursuing Argentina through the courts to get all their money back. They are vultures because they want to pick the carcass clean even though they don’t have the strength to kill the creature outright.

Argentine debts have been rolled over many times but they were ultimately incurred by military dictatorships that tortured and murdered thousands of Argentinean citizens. Why should ordinary Argentineans have to pay for their debts?

Whatever the outcome of the present quarrel, the existence of these vultures is evidence of the useless and parasitic forms of capitalism knocking around. It is normal under capitalism for failing firms to go bankrupt and for creditors to take a loss. Yet this process is not allowed to happen in the case of nation states.

In the old days they used to send a gunboat to collect the debts. Now the pressure is more subtle. The Argentinean case has been taken to a US court. Judge Griesa found in favour of the vultures. Among other things the judgement depended on his novel interpretation of the Latin phrase ‘pari passu’. It seems that an obscure New York judge can ignore the wishes of the elected government of Argentina and tell an entire country of 41 million people what they must do. He is acting as the hired gunslinger of Singer and the rest of the holdouts. An Argentine naval vessel has already been impounded in Ghana by an American court order. Such is the global reach of US law and US imperialism.

The USA is the most powerful country in the world. How did it build up this wealth and power?  Nobody now remembers that states such as Mississippi in the 1830s repudiated its debt to British bankers – and got away with it.

If the American judgement is confirmed, Argentina may have to repudiate all its debts, since the 93% who took a ‘haircut’ (a loss) on their bonds will be back for the rest of their money too. This could cause an international crash, and send the world economy back into recession. The USA would then lose, as well as the rest of the world. And all because some greedy speculator was let loose by a maverick American court!

Mainstream economists are unhappy at the judgement. Anne Krueger, former chief economist at the World Bank, comments, “Unless the Griesa ruling is overturned, this will open a can of worms that will have to be dealt with.”

The problems posed by the vultures pursuing Argentina are of general application. Greece is trying to buy off its creditors at a discount and bring down its mountain of debt. Again the perverse incentive applies: let everybody else cash in their bonds so the risk of Greek default fades and bond prices rise; then demand your money back. As economist Gabriel Stern notes, “The more you raise the price and the more you encourage participation, the better it is for those who don’t participate.” It’s a free ride for the vultures.

Already hedge funds have been in operation applying this principle. They bought Greek bonds when they were regarded as most useful as toilet paper and sold for just 11% of their face value. They gambled that the authorities would do all in their power to prevent a default and therefore Greek bond prices would rise one day. They were right. The rumour is that they stand to make 200% profit in six months.

The good news is that the European authorities intend to introduce Collective Action Clauses (CACs) to whip holdouts into line in debt restructuring deals in future. The bad news is that the main lawyer dealing with the Greek debt problem affirms that it will take decades before CAC clauses are fully incorporated into a government’s debt stock.

The shenanigans of the vulture funds are all instances of what Adair Turner, head of the Financial Services Authority called “socially useless activity.” At least vultures keep the veldt clean. The vulture funds are a case of capitalism devouring its own entrails.

EU dominos - who's next?

The chart below (from the Bank of England's Charles Bean) shows the 10-year government bond spreads for selected EU nations: Portugal, Ireland, Italy and Spain, as well as France and the UK.



Where is Greece in this 'who's next for disaster' chart? You might ask. Well, Greece is off the chart with its 10 year bond spreads currently attracting interest at somewhere north of 26%, according to Bloomberg.

Off the chart and out of the game. It's debt is unrepayable. The question is if Greece defaults will that have a domino effect? The potential domino effect is twofold:

1. German and French banks are most exposed (see Dexia already), but some debt is held by Spanish, Italian and Portuguese banks. A default or severe 'haircut' (partial write-off) of say 80% would have an impact. These nations would then be faced with a choice: a) let a bank fail; or b) bail-out the bank with more government debt, further worsening the sovereign debt crisis
2. The second domino effect is on the bond markets, which would be spooked by a default and hike interest rates on riskier debtors - in the same way that high street banks have jacked up margins and became more cautious lenderdfollowing the credit crunch, restricting lending to businesses and damaging the economy. This could mean Portugal, Spain, Ireland and Italy paying more for their debt - exacerbating their debt crisis, and potentially sending them into a Greek-style death spiral.

It's worth bearing in mind that if Italy, as the third largest eurozone economy, got in trouble the whole eurozone would be at risk. It currently has 2 trillion euros of debt.

Since the Bank of England produced the above chart, Italy's bond interest rates have risen from around 4% to 6%. If that gets up to Portuguese levels, let alone Greek, then Italy is in serious risk of default. Even a 20 or 30% haircut would be deeply traumatic - crashing banks around the world, with serious domino effects.

That's why the G20 meeting in Cannes is obsessed with this issue: finance capitalism is at risk!

Stop giving in to the markets

From today's Morning Star

Left economists advised governments to stop "kowtowing to the markets" today in the wake of a week of panic and turmoil following the US debt reduction package.

They hit out as David Cameron entered crisis talks with French President Nicolas Sarkozy to discuss doubts over the situation in the US and economic stability in the eurozone.

Left Economics Advisory Panel co-ordinator Andrew Fisher said: "There is a real concern that a further round of bailouts or quantitative easing will be demanded to prop up the markets, but this will only delay and exacerbate the inevitable collapse.

"Any public funds must be used to defend jobs and investment, not prop up overvalued assets and share prices."

Credit ratings agency Standard & Poor's lowered US creditworthiness down a notch to AA+ for the first time in the country's history on Saturday.

It said the cuts plan passed by Congress on Tuesday did not go far enough to stabilise the country's debt situation.

China, Washington's largest creditor called on the US to end its "debt addiction" and even suggested that the dollar may have to cede its position as the world's reserve currency.

Indian Finance Minister Pranab Mukherjee described the situation as "grave."

Mr Fisher said: "It is time for governments to stop kowtowing to markets - and with markets so weakened there has never been a better opportunity for democratic governments to regain some power and control.

"There is an urgent need for politicians to focus on the real economy - to tackle unemployment and to rebalance the economy away from the finance sector."

The 2011 Budget and its global context

Hugo Radice picks apart Osborne's budget, and predicts difficult times ahead for the UK economy.

The massive turnout on March 26 in London provided a vital public repudiation of the ConDems’ austerity programme. But although opinion polls show that a large majority of the public say that the cuts in public spending are unfair and too fast, more than half still think they are necessary. As opposition heats up all over the country, with local opposition groups being set up and public meetings and protests taking place, it is vital that the left continues to argue against the cuts. Far from being based on ‘scientific’ economics, the cuts form a determined attempt to make the poor pay for the bankers’ blunders, and to change fundamentally the relation between the citizen and the state in Britain. And what’s more, the austerity programme may well make the chances of a general economic recovery worse rather than better.

In developing our arguments over the coming months, we need a good understanding of the likely consequences of the budget, in the context of the ConDems’ overall fiscal strategy and the global economic outlook.

The budget

In his 2011 budget, George Osborne was clearly determined to stick with ‘Plan A’, adding little to the barrage of measures already decided in the emergency budget last summer. We are now braced for the full impact of those measures, especially from local authority job cuts, reductions in a range of benefits, and the rise in national insurance contributions. The Institute for Fiscal Studies has once again shown that these cuts will bear most heavily on the poor; although the top 10% will have their incomes reduced significantly by the 50% income tax rate, for the rest of us the proportional fall in income expected over the next 5 years increases as you go down the income scale. And to this, we have to add the hidden extra costs imposed on large numbers of households by the loss of public services such as libraries, day centre provision, rural bus services, and so on.

Osborne’s only substantial change in the budget was a reduction in corporation tax. He claimed that this would encourage businesses to invest more and take on more workers, but as Keynes pointed out long ago, changes of this kind – a few percent off tax or a small reduction in the cost of borrowing – have no effect if business confidence is low and if households are cutting back on spending. And as the cuts work through and spending falls, confidence is very likely to fall.

He also tried to appease the growing public discontent over the cuts with new measures helping motorists, first-time housebuyers and jobseekers. These were fully funded by new revenues from North Sea oil, tax avoiders and the banks, so the net effect on total demand is precisely zero. But the measures were in themselves so modest that they are unlikely to lift the encircling economic gloom. Although he may have thought he would win public support by taking more tax from the North Sea oil producers, a penny less a litre is not going to cut much ice given that the price has risen by 20-25 pence since the election.

The second issue for this budget was whether Osborne could find some way to increase the chances of economic recovery, given Labour’s persistent accusations that he had no strategy for growth. He knows very well that even if the coalition succeeds in its efforts to ensure that the present parliament lasts a full five years, there is little chance of re-election if the recovery is not in full swing well before that deadline. For this reason, the main emphasis in his speech was on ‘reform’ and ‘rebalancing’. He painted a picture of an entrepreneurial economy in which manufacturing, supported by a slimmed-down and efficient public sector, becomes the new engine of growth. For this purpose, he put together a menu of measures on enterprise zones, apprenticeships, technical education and tax breaks for innovation.

Such measures are all too familiar from the history of economic policy over the last half century, during which manufacturing has continually declined in terms of its relative weight in economic activity. Is there any reason why these measures will work this time round? Part of the problem is undoubtedly that most of the proposals will take a good while to implement, and even longer for their effects to feed through into jobs and incomes. The creation of new enterprise zones looks helpful on the face of it, especially in those regions of the UK which will be hit hardest by the decline in public sector employment. But the enterprise zones will have to be managed by the public sector, and the main reservoirs of expertise on regeneration, the Regional Development Agencies, are even now being dismantled and their staff dispersed. On top of this, many experts on regional development have argued that enterprise zones merely shift jobs from one part of a depressed region to another, with little net increase in employment. Proposals for expanding apprenticeships and technical colleges, and to extend tax reliefs for innovation and business start-ups, have likewise been a staple of many past attempts to revive British industry, but will take time to have any effect.

The Chancellor’s theme of ‘reform’ seems to involve cutting the cost and complexity of both taxation and regulation. While no-one in their right mind would oppose such a worthy aim, history suggests that this will prove extremely difficult. The complexity of public policy reflects the complexity of modern society; the red tape that supposedly strangles local development proposals has evolved in response to the greater importance that citizens have come to place on their environment and amenities. The furore over the proposed high-speed railway through the Tory-voting Chilterns provides a case in point.

The global context

Overall, the success of the Chancellor’s 2011 budget depends in any case on matters outside his control, matters about which he remained very largely silent. The economic forecasts published on 23 March by the Office for Budget Responsibility reflect the widespread view that economic prospects for the UK look weaker than they did last summer: growth in 2011 is now expected to be 1.7% rather than 2.1%, while the forecast for 2012 is marginally reduced from 2.6% to 2.5%. This revision is based largely on concerns that higher-than-expected inflation will cut into household spending, and therefore a slower growth of output. In turn, that will also make for a worse fiscal outturn, due to lower tax revenues and higher welfare spending.

But the OBR also points to an improving outlook for the world economy as a whole in the next two years, which raises the questions of whether this optimism is justified, and whether the UK can participate fully in the global recovery.

How do our rulers currently view the world economic context? First, the concerns widely expressed earlier in the year over tensions between the USA and China seem to have abated; the interests of their political and business élites are too closely intertwined for either side to risk a serious rupture. Instead, the last three months have seen three different areas of concern for global capitalism.

First and foremost, turmoil in the Middle East has had both immediate and longer-term consequences. The loss of Libyan supplies has dramatically affected the price of oil, not so much because of the volume – Libya is a minor global exporter – but because the specific characteristics of Libyan oil and its regional delivery patterns had knock-on effects on other parts of the global oil market. The price rise in itself, alongside continuing global increases in food prices, has increased inflationary pressures, the UK being a case in point. This affects the short-term prospects for global economic growth, by forcing consumers to cut their expenditure on other goods and services. Higher inflation has also encouraged the City to increase their pressure for a rise in the Bank of England’s lending rate: the government’s Keynesian critics argue that such a rise would reduce growth prospects still more. In the longer term, for global capitalism the emergence of stable democracies may mean that at last, economic progress in the Middle East will be commensurate with their wealth of natural resources, but the picture will remain unclear for many months, if not years.

Second, the disasters in Japan have disrupted supplies in some sectors and countries, but the overall economic impact for global business is mixed. Many economists argue that it will be positive, because reconstruction will provide business opportunities for many sectors which will stimulate their growth. But there are concerns about the fiscal health of the Japanese state, which has one of the highest domestic debt levels in the world, and about the rising tide of criticism aimed at the Japanese political class over the way the crises have been handled. In addition, the global consequences of the Fukushima nuclear disaster for nuclear energy policy have already been felt on the other side of the world in the state elections on 27 March in Germany: the CDU was roundly defeated in Baden-Württemburg, and the leader of the Greens is likely to become Minister-President.

Thirdly, the management of the sovereign debt of weaker Eurozone economies continue to be a source of uncertainty for global financial markets. The fall of the Socialist government in Portugal was the direct result of the conservative opposition’s refusal to endorse a cuts programme of Osborne proportions. The opposition instead advocate a bail-out by the EU and IMF, presumably on the grounds that Portugal’s politicians can then blame the cuts on external forces. But no-one questions the role of bond market speculators. They have developed the habit, ever since the first doubts surfaced about Greece’s financial health in late 2009, of picking on targets for their favourite practice of ‘short-selling’.

How does this work? First, they place bets that the market price of a country’s bonds will fall; then they spread rumours of impending default, hopefully leading the ratings agencies to downgrade the bonds; then the price falls and they snap up the bonds on the cheap; and finally, an external intervention restores market confidence, the bond prices rise again, and they walk off with the profits.

Despite these three potential hits to global business prospects, there is little sign that bodies such as the International Monetary Fund and the Organisation for Economic Cooperation and Development are revising downwards their optimistic forecasts of global growth. They expect the BRIC (Brazil, Russia, India and China) and other ‘emerging’ economies to continue their very rapid growth in the next 4-5 years, and the ConDems clearly hope that some of this growth will take the form of increased demand for British goods and services: hence, for example, the current high-level trade promotion trip to Mexico led by Nick Clegg.

But even if the global growth forecasts turn out to be correct, there must be concern about how UK-based businesses will fare in competing in these markets. In 2010, the economies which import from the UK increased their total imports by 10.7%, but UK exports only grew by 5.8%, so our share of those markets declined. Indeed, the OBR in its Economic and Fiscal Outlook says that

“relatively little of the recent strength in nominal spending has translated into domestic household wages or corporate profits. The majority of last year’s increase in spending was accounted for by higher spending on imports and higher taxes, generating income flows for overseas companies and the government rather than UK households or firms.” (p.51)

In other words, growth in exports did not feed into growth in domestic output and incomes, because of tax rises and higher imports! Nevertheless, the OBR still forecasts that for the next three years, we will increase our share of overseas markets. Likewise, business investment is expected to grow by an average of nearly 9% per year from 2011 to 2015, more than offsetting a steady decline in government investment.

If UK exports and business investment both meet these targets, which are very ambitious by historical standards, then George Osborne’s Plan A will certainly be judged a success - in terms of conventional economic measures of performance, and ignoring the devastating effects of the cuts on households and communities. Otherwise, he will be hard put to restore the coalition’s popularity in time for the next election.

This article first appeared in Red Pepper