Almost one

Tirade coming their way?

On the heels of Nicolás Maduro’s absurd attacks on Ricardo Hausmann and Miguel Ángel Santos, today we hear from Harvard professors Carmen Reinhart and Kenneth Rogoff on the issue of Venezuela.

In a blistering piece for Project Syndicate, they address the main issue in Hausmann and Santos’ controversial article: that Maduro has defaulted on Venezuela’s domestic obligations in order to keep paying for its foreign ones.

The authors make the point that, while you can find historical instances where countries have defaulted on their external obligations but not on its domestic ones, they have never found the opposite – a default on domestic obligations and not external ones, as Maduro seems to be doing. They claim that, given how the government is already defaulting on domestic obligations, “the historical cross-country probability of an external default is close to one.”

In other words, the two things go hand in hand, and it’s only a matter of time before Wall Street bond-holders are treated like foreign airlines.

The part that stood out for me (aside from the obvious indicators of Venezuela being a policy train wreck):

“In our book This Time Is Different, we document how domestic defaults are associated with deeper and longer-lasting recessions and much higher inflation than “purely” external defaults. Though we proceed to observe that historically there have been many external defaults without domestic defaults, the converse is not true: nearly all domestic defaults are “twin defaults” that also involve external creditors. Will the Venezuelan case be different?

Hausmann and Santos are right that the huge extent of domestic default suggests a high risk of external default. They are also probably right that, for most Venezuelans, external default would be a good thing. Default on foreign creditors, as we have noted in the past, is a risky strategy that needs to be compared to other options. But let’s not pretend that such a step is unprecedented in Venezuela’s history. Since Venezuela became independent, defaults on its bonded external debt have occurred in 1826, 1848, 1860, 1865, 1892, 1898, 1983, 1990, 1995, and 2004.”

It’s a good article. Go read it.

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  1. I thought the piece was weak. It just adds nothing to the conversation. They don’t seem to be very familiar with the specifics of the Venezuelan debate.

    Once again from the top.

    There are three things we can all agree on:

    1-Venezuela isn’t honoring a wide swathe of domestic obligations.
    2-Venezuela has the world’s most misaligned exchange rate.
    3-Venezuela has some of the world’s least transparent National Accounts, making its real ability to pay difficult to assess.

    Is 1- a sign of fundamental insolvency? Is 3- simply a gambit to cover-up bankruptcy?

    Or is 1- a side-effect of the enormous macroeconomic distortions generated by -2?

    Could it be that 3- is just a function of a culture of opacity built deep into the regime’s military soul, rather than a sign of bankruptcy?

    That’s the debate.

    But Reinhart and Rogoff never notice 2- and never address 3-, so they add nothing to this debate.

    All they do is assume 1- reflects underlying insolvency. That might be a logical position in the absence of 2-, but in a setting where 2- is so obviously central to the political economy, failing to even consider 2- as a driver of 1- is to beg the question (in the proper sense of the term.)

    Look, due to 3-, we can’t really tell if Venezuela is insolvent or not. We know all about 1-, and some people think 1- is caused by 2-, while others think 1- is called by insolvency covered up by 3-. I dunno which is right, but I do know what the debate is, and Reinhart and Rogoff don’t.

    • I am not sure I agree. In some ways, looking at the current situation from a pure view of economic statistics without any historical or political context somehow makes the policy failures of the country even more stark.

    • I have two theories regarding the authors:

      1. They are used to the fallacious use of historical data to make a prediction that’s pretty much meaningless.
      2. Chavez los tiene locos.

      • Sin vaina…their damn piece is ruining my Canadian Thanksgiving…I just can’t believe two people who’ve gotten in SO much trouble for sloppiness in publication could publish something this…sloppy!

        • Of course it’s a domestic default. It’s just not in the way that you want it defined. The moment the government approves a Cadivi disbursement, it’s a liability according to R&R, the same thing as a bond. It is a promise to provide dollars.

          • OK, in that case almost every municipality in California is in “domestic default” because they are all retroactively renegotiating pensions with public employees. And yet very few of them have gone into default on their publicly traded bonds. Maybe R&R give a more coherent argument in their book. For now it looks like they cherry-picked these “domestic defaults” to match their conclusions.

    • I think you are right. They do say that, as a historic phenomenon, internal defaults are commonly associate with external ones. So the question is, is there some mechanism that requires this, and if so, what is it?

      They don’t say. The obvious one, “there is no money left” is the one that

  2. They can’t even pay the colectivos anymore.

    “(…) pero para mantenelos hace falta una buena cantidad de dinero, de la cual el régimen ya no tiene, debido a la abrupta caída de los precios del petróleo y de la crisis interna que se ha generado en Venezuela. El plan consistiría en desarticular a estos grupos violentos acusándolos de cosas que no han hecho y llevándose detenidos a sus líderes, o simplemente desaparecerlos como lo hicieron con Odreman y otros 4 líderes de un colectivo que existe en un edificio invadido de la Avenida Baralt.”

    And the government is already expecting harsh times:

    “Asegura Freddy Bernal: ‘sucesos como el de Serra podrían repetirse’

    El diputado del PSUV insistió en que la forma atroz con la que le dieron muerte a Serra fue una práctica “terrorista”. “Yo puedo casi asegurar que el asesinato de Robert Serra tuvo la intención premeditada de asesinarlo para causar terror”, expresó.

    “Nadie es invulnerable. Pudiera ser que eventos como estos sigan”, sentenció.”

    Connect the dots.

  3. Actually the thing is gnawing at me now.

    Much hinges on what they mean by Domestic Default. My guess is that they mean what the phrase usually means: failing to pay your legally contracted debt in domestic currency. By that standard, Venezuela is not in domestic default. The republic is paying its DPN bonds and its Letras del Tesoro just fine. “Financial repression” ain’t just a river in Egypt.

    The default Hausmann and Santos were talking about was different: they were using the term loosely, rhetorically. They were talking about the government defaulting on its obligations to HIV patients and to fingerprint owners. That stuff is serious, but it’s also obviously a very different type of default than what R&R are talking about.

    So let’s see what’s really happening here: first, R&R do a bunch of research on countries that stop paying their domestic bonds. They find that virtually all of them also stop paying their international bonds. Then they declare that, because Venezuela is not supplying anti-retrovirals to its HIV patients, it’ll soon be in international default too!

    Ermmm…but Venezuela has never stopped paying its domestic bonds!

    What Venezuela has done is withhold dollars that investors hoped they could buy for Bs.6.30, or offered to sell those dollars at Bs.10 or Bs.50 instead. That’s the “de facto haircut” R&R talking about. But Venezuela has no legal obligation to sell anybody dollars at any given price!

    So they’re using their research about what happens in countries that stop paying their domestic-currency bonds to predict what’s going to happen in a country that hasn’t stopped paying its domestic-currency bonds. De pinga!

    Calling the kind of soto-voce devaluations we’ve been seeing “default” is alright as rhetoric, but very silly as a matter of economic research.

    It’s just apples and oranges.

    • I’m guessing #2 in your list above is the clincher. Take the airlines for instance. Debt that is bolivar denominated buffers the government because they can always select some exchange rate of choice to dilute the dollar value of the debt. Or they can just keep printing money. Not so with dollar denominated debt.

    • I agree with this 100% and I have mentioned a long time ago, now be prepare because the intransigents around here will get harsh. So far I know, they haven’t forfeit any bond payment internally and externally but the article mentioned bonds from 2004? Can anyone help me remind this? Did we default in 2004?

      • *cough*Sidetur*cough*

        When you think about it, the reasoning behind that default could easily be used elsewhere….

        In October, just after the government seized Sidetur’s bank accounts, Industry Minister Ricardo Menéndez said a “fair price” for the assets would be paid but then in February said the previous owners ought to be liable for the debt. “Simply, he who generates the debt pays it,” Mr. Menéndez said at the time. Press officials at the finance and industry ministries didn’t respond to calls seeking comment.

    • Exactly. So far, the government is simply avoiding any default that could trigger cross default provisions in its bond issues. Not paying airlines, pharmaceuticals or importers is clearly an “external” default, these people are owed dollars just like a bondholder is owed dollars.

      • You bring up a very interesting point. Venezuela is thus already in external default to the tune of tens of billion of dollars.

        • And Rogoff and Reinhardt are right: internal default (to the living standard of the people) does go hand in hand with external default: the “de facto” external default in Venezuela´s case that has already happened.

    • I think you’ve hit it. The Hausmann article was just a rhetorical trope to illustrate the hypocrisy of this regime. When poop hits the fan, it’s the bankers they worry about. Just like George W. Bush and his sulphur smell…

  4. It’s worth pointing out that their main claim in “This Time It’s Different”, the book they cite, was the cause of a huge embarrassment to them and the economics profession in general. The main claim in the book, which was subsequently used by right wing politicians in the US and EU to champion austerity policies after the recession, was that high government debt ratios lead to low economic growth.

    When other scholars, attempting to replicate their findings, couldn’t figure out how they arrived at the numbers they did, they requested that Reinhardt and Rogroff provide their data. R&R initially refused to share their data, which is unusual. When other scholars were finally able to get access and analyze their data, they uncovered data omissions, questionable methods of weighting, and elementary coding errors.

    The errors and omissions were of such significance and all in one direction, that others in the academic world made the very serious charge that R&R had stacked the evidence to show a preconcluded result. R&R, for their part, insisted they were just sloppy…

    That wasn’t the only problem…if you’re interested you can find plenty on this scandal online.

    In any event, their argument (or at the very least, the data they use to back up that argument) was largely discredited but it didn’t really matter. Austerity policies had already been put in place, slowing growth in the US and elsewhere before the economy had approached anything resembling to full recovery.

    • Austerity in the US?! I must have missed the evidence for that. It must be hidden underneath Obama’s trillions of dollars of new debt.

      • If you have travelled on a road or visited an airport in the USA recently, I think there is compelling evidence of austerity.

      • Trillions of new debt?

        According to the US CBO it’s 486 Billion: so yes they’re still adding debt but much less than say 6 years ago.

        And what Rory mentions is right: Rogoff and Reinhart’s argument that about the debt to GDP ratio was the rationale used by the likes of Paul Ryan to demand major cuts in the US budget. Since the US congress never found common ground. they got a round of automatic cuts known as sequestration:

        Rogoff and Reinhart’s argument was eventually found to have several errors that made their conclusions debatable:

        Paul Krugman whom according to the US Right Wing is to the left of Chavez and Maduro had a field day with it:

        Having said all that, I do think that R&R probably aren’t wrong on this one though.

          • Juan, putting in the books things that were committed by the previous administration and not put in the books (transparency anyone?) should not constitute a qualifier for “adding to the debt”, but this is so typical of the debate here in the US, polarized public discourse that can’t even agree on what’s fact and what’s not, I keep having a sense of Deja Vu… But that’s topic for a blog on US economic policy…

        • Its about a net change of $7 trillion, given or take $100 billion in actual deficit. Publicly held debt has increased from $5.8 trillion in 2008 to just under 12 trillion in 2013.

          While you are correct in the shift to less deficit spending, this is due to an improved economy (and thereby increased revenues) rather than any effort on the government’s part in real reductions. 2013 was a pretty good year in general and bloody spectacular compared to 2008 or 2009. But since Obama’s been president since 2008, its only fair to include those as part of his deficit total, even if he inherited a steaming pile of crap masquerading as an economy when he entered office.

          • Depends on what you’re calling “New Debt”. Obviously, government spending rose rapidly during the Great Recession. Even if we assume that they made major cuts (which Keynesians claim they shouldn’t, but I am NOT going to get into Keynesian-Austrian School debate because I don’t know enough about it). With all those people on unemployment insurance and depending on government assistance (as meager as it might or might not be), not to mention bailing out GM, all those huge banks that failed, etc. Somebody had to pay for it, and since they are unable to really raise taxes (just restore part of the ones Bush cut, and that happened just in January 2013, quite a coincidence ain’t it?), I guess that means getting in debt.

            Sure, you can say that during Obama’s watch, their national debt grew sharply, I am not denying that. But what do you call “New Debt”, everything from 2008 till now? They still claim to be dealing with a major recession, even if it seems to be on recovery.

            My point is they’re not longer adding “trillions” to the national debt. Which is the usual claim.

          • Yes, “adding trillions to the national debt” is a refrain that says little about macroeconomic realities or context.

            Bush tax cuts and increased spending had made the government deficit structural, as opposed to cyclical. Meaning, even in a good economic year we were operating at a significant deficit. Bush came to office with the government running at a surplus, yet due to massive tax cuts and spending hikes the best deficit year while he was in office was a $200 billion dollar deficit.

            Then throw in the biggest financial collapse in a century, meaning bailouts, drastic reduction of tax revenue, more people on unemployment or retiring early, states on the verge of bankruptcy, etc, than of course you are going to have massive deficit. On top of that, each year the demographic shift is coming closer, with the baby boomers reaching retirement age. Long story short, if we did not have a trillion dollar deficit, we could have fallen into a far more severe depression. But it’s easy to scream about the deficit, voters don’t understand much about the economy or deficits, even in supposedly educated countries.

      • The widespread belief that we are experiencing runaway government spending is unfounded. After a brief surge in 2009, government spending began falling in both Europe and the United States, and is now well below its normal trend. Certainly, it’s significantly below the spending growth rate seen in response to earlier (less severe) recessions.

        But don’t take my word for it. Check out that obscure group, the IMF, and their April 2013 publication “World Economic Outlook”. Page 33.

  5. As I read it Hausmann and Santos did not go into any legalistic matters about default but referred to the de facto moral default with its own people and that suggested Venezuela should also have a moral obligation to ask foreign creditors to share in the sacrifices. That angle is not covered by Reinhart’s and Rogoff’s article.

    I on the other hand, as a citizen, would like a system that calls any sovereign debt that pays more than x percent higher interest rates than what the safest sovereign pays, a de facto defaulted sovereign… and so under that Venezuela has already defaulted.

    It is not only that Venezuela pays punctually its debt… it is that it also pays interest rates that would correspond to high unpunctuality… and I truly hate foreign creditors eating the cake and having it too.

  6. Dear Juan,

    I must correct you in your piece on the following statement:

    “The authors make the point that, while you can find historical instances where countries have defaulted on their external obligations but not on its domestic ones, they have never found the opposite – a default on domestic obligations and not external ones, as Maduro seems to be doing. ”

    This statement is categorically false. First, R&R do not say they never found such a case, they say a bit misleadingly “the historical cross-country probability of an external default is close to one”. If there never was a case it would have a probability of one.

    That said they also don’t really begin to distinguish which cases they are looking at. This is very important cause there are very important cases of domestic default with only selective external debt (such a restructured paris club debt), and not for example, eurobond debt (the great majority of Venezuela’s foreign debt).

    I am already disappointed with R&R Venezuela commentary as it seeks to state rather than show their conclusions and in such a way as to be truly conclusive, with near 100% probability. Seems R&R are late to calling the clear signs of an imminent sovereign default, and a very important one. They should have been the first to read the writing on the walls given their extensive research.


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