Of Default and "Default"

0
Ceci n'est pas splitting hairs
Ceci n'est pas splitting hairs
Ceci n’est pas splitting hairs

Consider “default”. It’s a tricky one: both an ordinary English word and a term of art with a specific, legal definition in the field of finance. There’s a reason why this ordinary word is used to label that legal concept: the two meanings usually map onto each other reasonably well. But not always.

Today, the debate about Venezuela’s shockingly mismanaged economy fell right into the space between one kind of default and the other.

In ordinary language, “default” just means failing to live up to your obligations. As a financial term-of-art, defaulting means “violating the provisions of a formal loan contract” – usually, but not always, by failing to pay back what you owe for a loan on time.

Here’s the thing: governments have plenty of financial obligations that arise from things other than formal loan contracts. The U.S. government, to give just one example, has a clear obligation to pay a certain amount each month to its pensioners, through the Social Security Administration. If one day the U.S. is unable to make that payment in full, people will certainly talk of the country “defaulting on its senior citizens”, and in the ordinary sense of the word they’ll be right, of course.

But that obligation does not arise from a formal loan contract. In a technical sense, failing to pay social security would not really constitute default. Not as the markets understand the term, anyway.

Now, think of Venezuela.

In their now famous piece, Ricardo Hausmann and Miguel Angel Santos argue the country is in default with pretty much every domestic constituency. And in the everyday sense of the word, that’s true: Venezuela is behind on its obligations to its cancer patients, to the airlines that connect it with the world, to PDVSA’s suppliers and everyone in between.

But we should be clear, when financial economists use the word “default” in this broader, ordinary-language sense they’re at best engaged in a bit of an intellectual provocation. At worse, they might be seen as openly courting misunderstanding.

The reality is that, in Venezuela, just about the only group the government still pays on time is…the holders of bolivar denominated bonds. The guys (or, well, the banks) holding DPN bonds and Letras del Tesoro, keep collecting their coupons like clockwork. The interest on those coupons may be way behind the rate of inflation, but that’s still better than many alternatives. (They don’t call it “financial repression” for nothing.)

This means that, in the technical sense that’s relevant in market terms, Venezuela is not in domestic default.

Yes, Venezuela has a strange situation with bolivar holders who’ve applied to CADIVI/CENCOEX to buy dollars and have had their requests “approved” at one rate but not executed for years. In some cases, the execution has come at a higher rate than the original approval.

But let’s be clear: an AAD is not a debt contract. It can’t be traded, isn’t really negotiated, it’s just not a bond. There’s zero jurisprudence for treating failure to honor an AAD at the original exchange rate as default in the legal sense.

Just the opposite: the exchange rate risks inherent in investing in a country with a non-convertible currency have been baked into investment decisions regarding Venezuela for more than a decade.

In the Venezuelan context, failure to discount your paper profits by the expected probability of devaluation before you get a chance to repatriate them amounts to dereliction of duty on the part of an MNE executive. If it’s not a firing offence, it ought to be.

Everybody’s known this is the deal for years: under conditions of very limited competition, you get to pile on bolivar profits ad infinitum, but you do so in full knowledge that those profits are de mentirita, contingent on an enormously iffy “if” that has the CADIVI logo stamped all over it. When you take a risk like that and it goes bad, it’s the height of churlishness to call it default: you just took a risk you understood perfectly well ahead of time and it didn’t pan out. That’s all.

So this is my first bone to pick with Reinhart and Rogoff’s Project Syndicate piece: they’ve just mixed up their defaults. They have a pile of research about what happens to countries in domestic default, and they use it to make a prediction about a country that’s not, legally speaking, in domestic default. That in itself is pretty shocking for a pair with better reason to be extra-scrupulous about the details than most.

But the bigger problem with R&R’s piece is that it begs the question: it just presumes that the reason Venezuela is failing to meet all its domestic obligations is that it’s insolvent. In normal circumstances, you might reasonably conclude that. But Venezuela’s circumstances are anything but normal: we have the world’s most misaligned foreign exchange rate. The split between the official and the parallel exchange rate is now 13-to-1!

This is the crux of the Great Venezuela Macro Debate of 2013-2014: to what extent can the government’s failure to meet its domestic obligations be ascribed to a basic inability to pay, and to what extent is it just the Nth insane distortion you get when the government makes it illegal to pay a penny more than 77 cents for a $10 bill?

Alas, in discussing Venezuela’s ordinary-language-default, Reinhart and Rogoff never refer to exchange rate misalignment at all. That’s a bit like writing about the sinking of the Titanic without mentioning the iceberg.

Starting with their conclusion and failing to engage the meat of the discussion, they just don’t seem very familiar with the specifics of the macro debate Venezuela-heads have been having for the last couple of years. It’s really unfortunate.

But I really feel I need to be on record here: that OpEd is awful.

1 COMMENT

  1. I totally agree that it’s a dreadful op-ed. It appears mostly to be an ad for their book, which hopefully is better. It is depressing that so many smart followers of Venezuelan finances immediately tweeted out that R&R consider the probability of Venez default to be nearly 100%. Be the odds as they may, they have nothing to do with the evidence R&R present.

    One other issue here. If you do accept R&R’s use of “default” to mean something more than bond default, and extend it to other promises such as a promise to pay a pensioner $X in year Y, you can immediately find dozens of example where domestic default headed off sovereign default. Their claim that there is a nearly 1:1 relation between the two must be based on a cherry-picked data set. Not that these two would know anything about that.

    • Right, but if you start accepting the ordinary-language-default as “default”, your data is junk almost by definition. Virtually every government there ever was routinely finds itself unable to meet one obligation or another to some domestic constituency. The Canadian government just took 24 months to process my citizenship application, though by law they’re supposed to target 6 months. I guess Ottawa is in domestic default and will default on its foreign debt any moment now.

      • a. I’ve never heard of a consistent 6-month deadline on processing citizenship applications, moreover with so many variables among immigrants from a wide variety of countries, some lax in presenting the needed documents for verification. Would like to know more details.
        b. Can we stick to the “legal definition in the field of finance”, as noted in the post, rather than the default by a government’s delay of paperwork to one Francisco Toro?
        TIA

        • I’m happy to, but it seems that R&R want to use some undefined loosey goosey version of default. Hence my comment that such a version of default — even the relatively formal kind, where a firm financial contract is being abrogated (as in cutting pensions) — is no sign of a coming default on bonds.

      • R&R have been involved in some sloppy analysis for the last little while. Their paper on the effect of high debt to GDP ratio on economic growth and the 90% cliff turned out to be made up by convenient suppression of data to make their point, and it had a huge impact on government actions in the US and Europe for years. It seems that they dropped all pretense of academic thoroughness to get their editorial ideas out… There are enough things that the Venezuelan government does wrong to have to make up stuff.

    • Technicalities aside, debt in Venezuela (maybe not in other countries) is fungible: the government denies people access to basic services, medicine etc. in order to pay bond coupons and principal and it does this by manipulating the exchange rate and denying the people access to the dollars they need to import almost everything because Venezuela does not produce practically anything internally. The relation between the formal debt accounts of the country and the exchange rate/access to dollars is kept opaque quite on purpose by the government, but that does not mean it does not exist. Quite the contrary!

      Then there is the issue of contractual debt vs. other debt. Is one less real than the other? Are you saying that the government of Venezuela can just “default” on it’s most basic constitutional obligations regarding the physical well being of citizens because those citizens do not have a contract in their pockets that they can bring to court or because, even if they did, the Supreme court wipes its behind with the constitution?

      Yes, it is true: the authors you criticize above are left with moral discourse and pointing the finger at what everybody can see: hospital beds filled with maggots and bond holder pockets filled with cash. Are we going to say that the authors of the op-ed are at fault for attempting to bring this issue into discussion for lack of numbers and contracts?

      Is moral discourse (for lack of a better description) that cannot point to hard numbers or contracts but is backed by hard realities evident for all to see, is that moral discourse irresponsible, lacking in intellectual honesty, irrational and opportunistic? Because, at bottom, this is really what your are saying: that opposition thinkers are intellectually dishonest, opportunistic, slothful, mediocre faux scholars.

      If you are going to be that hard on the opposition thinkers, maybe you should apply the same standard to your own discourse! It is not enough to say “not honouring foreign debt is worse than the boogey man”. What would a foreign debt default entail for Venezuela, if it was done correctly, that is, with good planning and the support of international institutions that are there to help out countries in distress? What would China’s role be in that eventuality? You can’t leave out China. Would default be really THAT bad?

      By the way, I am not even Venezuelan. It’s just that the default position of many well educated Venezuelans, at least in my experience, is this revolting holier than thou attitude that makes it impossible for them to coalesce into any initiative for the common good.

  2. I hate to bring this discussion again. But the fact remains that IF the government keeps the government controls as they are they are inevitably going to default within the next two years. The question is whether chavistas are stupid enough not to depreciate the Bolivar enough to avoid defaulting… I’m not sure the answer is “yes”

  3. Hello Juan,
    I totally agree with you! I too think that Venezuela is not in internal default, however, its not only R&R who said this. Wasn’t that also Hausmann and Santos thesis? That since Venezuela was defaulting with its commercial debt (which as you said it isn’t), then it should also default on its international debt? (theory which i personally find irresponsible given the cost of an international default to be much worse than not exchanging dollars for Bs).

      • heh, Juan liked R&R’s piece…we’ve been fighting about it all day! (Who’d ever come to CC if Juan and I didn’t fight, though?!)

        As opposed to H&S, R&R style themselves as making an empirical point, not a moral one. They reason:

        1-Almost all countries in domestic default end up in external default
        2-Venezuela is in domestic default
        ergo
        3-Venezuela will default externally

        2- is where the problem is, not just because Venezuela is not in domestic default, but because to the extent that it isn’t paying its domestic obligations that has much more to do with the insane crazy CADIVI system than with its solvency.

        • Yes. I totally agree with you on R&R’s piece, and I think your criticism is eye opening. I myself make the mistake of sometimes not analyzing the big name pieces and just take them at face value, considering myself a lesser economist since I don’t “practice” economics anymore.

          However I did analyze the H&S piece, and just because it studies the “morality” of default it doesn’t mean it shouldn’t analyze the effect that a default on foreign bonds would have on the Venezuelan economy, and that it would be far worse than defaulting on their 30 million citizens. I think the fact that the were practically daring Maduro to do it, although is not grounds for legal action (like Maduro wanted) should be frowned upon.

          Also, I should have known it wasn’t Juan’s piece but yours. I tend to agree with you much more than I do with him. But I guess that is the beauty of this blog. You can always come here to reflect on the issues. So, thanks!

          F.

        • Quico,
          When the government approves a Cadivi allocation, it creates an asset for the firm getting the approval. It also creates a liability on the part of the government. You might not think that’s a real liability, Hausmann, Reinhart, and Rogoff obviously do, and the government’s failure to honor that liability is what they term “default.”

          If you think Venezuela is not defaulting on its internal obligations, then you should probably go work at Minci. You would do great there.

          • Juan, I don’t know why you think that only because someone uses judgement and logic to be objective means they are pro-government or leftist. I believe I can completely abhor this government and still be critical and objective, when analyzing a piece and I believe that is also what Quico is doing.

          • Hey, it’s a funny kind of asset they’re creating: one that can’t be transacted, nor can it be redeemed through the courts (and not just because the courts are chavista, look up what happened to the importers who sued the Herrera Campins government in 1983 when their paper-profits went all “Adios, Miami” after the viernes negro.)

            Gather 100 Wall Street lawyers and ask them “is failing to execute an AAD at the original FX rate default?” (Ok, ya sé, primero tienes que pasar 3 horas explicándoles qué coño es un AAD, pero suponiendo…)

            How many yeses you think you’d get? One? Two?

          • Quico, some assets are not traded in the market and they still hold value. You never took an accounting class, did you?

          • I’ll have you know I got a C+ y a mucha honra in my 10th grade Bookkeeping Class with Mrs. Krause at http://www.rochesterschool.org (que tiempos aquellos)

            But I digress. You’re right, of course you book the asset.

            Here’s how you book it:

            CADIVI Allocation for Profit Repatriation: Bs.630 – USD100* (así, con el asterisco en negrillas)

            then, at the foot of the page,

            * Allocation assumes foreign exchange is paid out at a rate of Bs.6.30. Company may consider exciting opportunities in Brooklyn-Manhattan road transport infrastructure if it’s expecting disbursement to be made at that rate.

            Real present value of CADIVI allocation is a weighted average of the values of disbursement at different exchange rates based on estimated likelihood of each.

            Exchange rateat Bs.6.30:$ -> Bs.630=$100 – Likelihood: 5%
            Exchange rateat Bs.12.60:$ -> Bs.630=$50 – Likelihood: 20%
            Exchange rateat Bs.18:$ -> Bs.630=$35 – Likelihood: 25%
            Exchange rateat Bs.25.20:$ -> Bs.630=$25 – Likelihood: 25%
            Exchange rateat Bs.63:$ -> Bs.630=$10 – Likelihood 25%

            Weighted average probability disbursment Bs.630 = $32.50

            Any MNE manager that doesn’t have a calculation like this somewhere in a spreadsheet that they’re sending back to headquarters on a regular basis isn’t doing his job. For some finance professionals in Venezuela since 2003, tweaking that spreadsheet *is* the job.

          • I am with Juan here, we are not talking one pension here, one debt there. we are talking of knowingly and purposefully deceiving investors and business owners with rules and promises they never meant to honor. What is more dangerous to the economy and the possible future recovery of the country? To keep refusing to call it default as to not scare of investors? It’s like when some used to refuse to call this a dictatorship in fear of seeming “extremist”, where do we draw the line on what a “contract” or legal obligation is? I grew up hearing my word was as bonding as a written contract, and it pains me when I realize how much I fail to uphold that principle, that’s a principle that this thieves can’t begin to fathom!

            Using poorly chosen data to make this point would be a fair criticism, but for all intent an purposes if Vzla was a company it would already be in chapter 11. I still support Santos & Haussman: Let’s call a spade a spade and let’s not mince words, this country has failed to honor obligations to all it’s stakeholders (except the ones that don’t have a skin in the game) and whoever ignores that fact and lends them money should know a new government would be in it’s right to revise those obligations, most of them signed outside of the constitutional principles.

          • And why do such managers might not be doing their “job” properly? Simple, profits calculated at the lowest rate possible to prop up their year-end bonuses. They will keep playing the game until the music stops and they are forced by HQ to impair the results. In fact, this has already come up in the past and it is not a crazy thought, it is a very reasonable question to ask when corporations have operations in other countries (on top of which you can add it being an emerging economy + currency controls).

            From Feb’14:
            “All of these companies should have seen this coming,” said Ali Dibadj, an analyst at Sanford C. Bernstein & Co. in New York. In a note yesterday, Dibadj said he expects that more companies will make similar announcements.

            http://www.bloomberg.com/news/2014-02-11/procter-gamble-cuts-profit-forecast-on-currency-effects.html

            Why do people keep thinking that Cadivi requests are an obligation? Why do people keep thinking imports are an obligation? Make no mistake, everything can be cut back, even payments on external debt. However, this is the last thing they will do. You don’t cut your head off because you have gangrene on your feet, you amputate the legs.

  4. I find it disappointing that, in order to counter Reinhardt and Rogoff, left-wingers on this blog such as Quico or Setty resort to bashing them on their previous controversies. Reinhardt and Rogoff deserve a little more credit than what they get from those who believe they committed heresy against their patron saint in the White House.

    • I don’t think Quico’s criticism of the OpEd has to do with whether we should use the word “default” or not. I think we all agree on the cleverness of H&S’s original article when framing the current state of affairs as one in whcih the government is defaulting on its people. I think Quico’s point – and if I’m right, I agree with him – is that R&R’s arument is void of the empirical content it pretendes to have. Ok, say we can call this current situation a “default”, but it doesn’t meet the same criteria as the domestic default episodes they have there on their data. Thus, R&& have no forecasting power in this debate.

      Sorry about the english

    • Oh please… Can we please focus on being serious here? How can you believe this is a credible piece of news? Instead of just repeating everything broadcoasted by the media businesses have you considered:

      1) This piece of news is actually recycling old news from June (http://www.bloomberg.com/news/2014-06-05/pdvsa-said-to-seek-bank-loan-to-pay-off-bonds-due-in-2014.html) probably because there is some HF manager short making some money on the back of it

      2) So how is it that we have been hearing from June the same sentence: “according to the official, who asked not to be identified because he isn’t authorized to speak publicly.”. So the official can’t speak publicly but has been speaking publicly since June. Interesting.

      And lets not even get into the fact that for years, it is very well-known that Venz/PDVSA are very active when it comes to repurchasing their debt at secondary market prices, effectively reducing the amounts payable at maturity. But hey, you won’t read this from La Patilla and Ricard Hausmann, you will have to dig a bit deeper.

      Yawn…

  5. “They have a pile of research about what happens to countries in domestic default, and they use it to make a prediction about a country that’s not, legally speaking, in domestic default.” They are shaky on how they classify and compile that data to begin with, even as they apply it unevenly.

    From one critique: “Leave to the side the silliness of simply aggregating across 8 centuries of experience, and adding up debt ratios of countries as disparate as the USA today or, say, Greece in 1932, let alone some feudal state operating on a gold standard a couple of hundred years ago. As I’ve remarked, any real historian would find the methodology ludicrous.

    More importantly, they have no idea what sovereign debt is. They add together government debts issued by states on gold standards, fixed exchange rates and floating rates. They aggregated across governments that issue debt in their own currency and states that issue debt denominated in foreign currency.”

  6. The Hausman-Santos piece committed the original sin of conflating default and “default”. I still find it a convincing piece of rhetoric to suggest that Maduro etc. are defaulting on their promises to the Venezuelan people, while paying off Wall Street.

    The second article seems to miss the fact that this was rhetoric, though, because their one-to-one default data set couldn’t possibly include all the cases when governments “default” in the broader sense. As Quico points out, you can find some unfulfilled governmental promise in almost any country.

    So it’s hard for me to see why the second argument is important.

  7. I think the main point that R&R are making, which gets lost in Quico’s obsession over the technical definition of “default,” is that Venezuela is trying to pull of a very tricky thing: paying off their bondholders while sending everyone else straight to hell.

    They are basically saying: this has never been done before. At some point, the country becomes so screwed up, you have to default in order to provide enough dollars to somewhat satisfy people’s needs. Those 6 billion dollars you need to pay off Wall Street can make the difference between winning or losing an election, between having milk on the shelves for the whole year or not having any. Defaulting in those situations is what countries have always done. In fact, when countries are mired in this much doo-doo, they default on absolutely everyone.

    Some people say that if the country simply devalues, their problems are solved. I am not so optimistic – there comes a point when you have to accept that oil rents are not enough to satisfy everyone’s needs, and no matter how much you tinker with relative domestic prices, the fact remains that Venezuelan consumers are buying everything at international prices, and their income in dollars is going down. No amount of tinkering with the exchange rate can hide the fact that Venezuelans are becoming poorer by the day.

    The fiscal deficit has been in the double digits for several years now. With the price of oil plummeting, defaulting on foreign investors is not a matter of “if” but of “when.”

    I dunno, I think it’s pretty obvious that this is not going to end well for bondholders.

    • The reason I resort to R&R’s prior academic malpractice is that it appears to be a habit for them to use whatever evidence they can find to support their foregone conclusions. In this case their conclusions are probably correct; I don’t see how Venezuela can keep making all its debt payments indefinitely if oil prices remain at current levels. But I think they are pulling a cheap trick by claiming that this supports their research or vice versa.

      There is either a domestic default, in which case lots of countries, states and municipalities are in domestic default (and Juan, I think it’s fair to say that California has wholesale abandoned its obligations to retirees) without going into bond default; or there isn’t a domestic default and this whole article is silly.

      I find it annoying how often a cheap, poorly thought-out argument can gain currency in the Venezuela oppo crowd just because it offers the right conclusions. As you are someone who is seriously looking for solutions and not just looking to score points, I am surprised you find the R&R argument interesting.

      • Well, this blog is not *only* about finding solutions. The whole debate about the Venezuelan bond markets is very interesting. The fact that R&R are weighing in is newsworthy in its own right. Think of the interesting discussions we’ve been having on the blog thanks to their piece!

        I obviously disagree with your assessment of what R&R are doing, but oh well.

  8. “It is obvious today that America has defaulted on this promissory note, insofar as her citizens of color are concerned” <= esto te hubiera quedado bello, men.

  9. Quico, I must say that your argument is weak and you’re missing the point that R&R are trying to make. You seem to get it but not quite. Let me start with R&R’s point. First, They’re simply pointing out an empirical facts. That is, economies that default domestically (which have always happened to default on their external debt as well) tend to have longer and deeper recessions as well as higher inflation rates. Second, In light of this observation, they take Venezuela’s case and say that “the huge extent of domestic default suggests a high risk of external default.” But this is not only an empirical point or a extrapolation of their historical data. It is also a logical conclusion based on theory explaining the empirical fact they present. In short, one can argue that is not optimal to default to domestic creditors only. Once a gov’t chooses to default on its domestic debt, it’s also optimal to default on its external debt. Of course this is not the Law of Gravity and that’s why they only say that this “suggests a high risk of external default.” The big assumption here, as you point out, is that Venezuela has already defaulted domestically, which is you main beef.

    Whether Venezuela has already defaulted domestically or not is obviously debatable. But I think one can make a strong case arguing that the current situation in Venezuela is tantamount of domestic default even if the gov’t has NOT defaulted in its domestic bonds. Clearly, it’s not about the “technical” definition of default because bond holders are getting paid. (Btw, it’s funny that you’re calling out two world-class economist based on your understanding of what economists mean by default.) And it’s not about failing to provide dollars to import medicine and other staple goods or even failing to honor labor liabilities (e.g., prestaciones sociales, social security, etc.). It’s about failing to honor other liabilities which might not have a clear-cut due date as bonds but nonetheless have arguably similar rights. The most clear example is the huge airline debt but we can also include approved CADIVI allocations as Juan pointed out. “Defaulting” on these liabilities has nothing to do with how misaligned the exchange rate might be. Even if the gov’t devalues and set the exchange rate at 100 BsF/$, it stills owes some people/firms a huge amount of dollars at the old exchange rate. It’s about obligations the gov’t contracted in the past! It has nothing to do with risk either. You’re in default when you don’t pay regardless of the risk associated with the debt you issued! And It doesn’t matter whether or not private agents discount the risk either. That’s their problem.

    To conclude, in Venezuela’s case, the government’s failure to meet certain financial obligations might very well be a sign of insolvency, which can be understood as “default” for practical purposes and therefore be analyzed in light of the empirical evidence R&R found. Is it a stretch? It might very well be but it makes a very valid point.

    • The Central Bank announces it’s selling $10 bills for one dollar each. It runs out of $10 bills. It can’t meet its obligations to people who need one dollar bills.

      Your argument is that that “might very well be a sign of insolvency which can be understood as default” and has nothing to do with FX misalignment.

      Don’t you see how that begs the question?! You’re assuming the point you’re trying to prove.

  10. “But that obligation does not arise from a formal loan contract. In a technical sense, failing to pay social security would not really constitute default. Not as the markets understand the term, anyway.”

    This is not correct, not even about the United States. See, for example: http://www.nytimes.com/2014/08/01/opinion/laurence-kotlikoff-on-fiscal-gap-accounting.html

    See also http://www.theinformact.org/ and http://mercatus.org/sites/default/files/Kotlikoff_FiscalSustainability_v2.pdf

  11. Does nobody else really feel that defaulting on foreign debt would also be defaulting on the Venezuelan people? Don’t you know what are the consequences of that on an economy? A default in Venezuela wouldn’t be well done. There wouldn’t be any IMF swooping in and giving us money. There would be no nice restructuring. If you think the government is not honoring their “contract” with the Venezuelan people by not having milk on the shelves, imagine what would happen if they default.

    Do you really think that defaulting on foreign debt would have no consequences for those of us who live here? In my head I see riots, and more shortages and death. THAT is why I don’t want the government to default. I think it would make us worse off. I don’t see the morality in that. Besides, there is nothing moral about this government to start with, because we wouldn’t be in this situation if the were.

    Besides, how do you know who are the people who have bought those dollars, not financing the government, but in the secondary market? It is true they knew the risk, but so do the companies who are here and expect the government to give them $ when there is an exchange control, that is why they charge so much in Bs. (airlines). They know the risks and they can always leave, which they have and I don’t blame them.

    Perhaps some of you are thinking that if the government defaults then there will be a change in regime. I think you don’t really care what price we have to pay for that to happen. And what if it happens. What if the government defaults, and there is hunger, and death, and more poverty, and the government doesn’t change. Then what? Where is the morality in that?

    • Fabiana, you make a great point but I think Haussman & Santos were very clear in the fact that this will NOT be done by the current government. My interpretation is that they are preparing the ground for future policy makers to have this discussion, it’s not the 90’s and the IMF and the Washington consensus are not the only (not even the main) players in the global economy game. Someone above mentioned China and they are right, Brazil might well be heading to a new government not aligned with the current government. So this negotiation might well be with the Chinese or the Brazilian firms working in Vzla. But what I see as the moral dilemma is that every day that this government doesn’t default and pays the interest rates we are paying and keeps holding off to power by a hot nail, it makes it more likely that the riots and hunger will occur EVEN if we don’t default on bond holders. Si no nos agarra el mocho nos agarra el sin nariz.

    • Bravo.

      What is even more concerning is that H&S actually send such stupid messages out there thinking that it won’t hurt their reputation, the opposition’s reputation and more importantly, the country’s reputation going forward? I believe Santos was Capriles’ economic advisor? How do you think international investors reacted to such simplistic analysis made in their piece? The same investors that their la-la land economic plan suggests they plan to reach out to when they eventually take office.

      No suprise why opposition and their “think thanks” have consistenly failed for the past 15 yrs.

  12. Vennys and PDVs bonds opened today around 2 points down from last close.

    Shorter maturity bonds are yielding more than longer maturity bonds, so el mundo al reves also translates to the yield curve. I mean that is craaaaazy. The reason, at least for me, is that people are expecting extreme difficulty is paying until 2017 (or so) but then the government (chavista or not) would mend the ways and pay… that is as much sense as I could find in the yield curve. Still I don buy it.

    Security Px Px Px YTW YTW ZSpr ZSpr
    Bid Ask CHG Bid Ask Bid Ask
    ———————————————————-
    VENZ 5 3/4 16 80.00-81.50 -1.7 23.81/22.24 2322/2165
    VENZ 13 5/8 18 84.00-86.00 -2.0 19.75/18.90 1853/1768
    VENZ 7 18 64.00-65.00 -2.1 20.29/19.80 1894/1846
    VENZ 7 3/4 19 62.00-63.00 -2.1 20.18/19.74 1865/1821
    VENZ 6 20 56.50-57.50 -2.1 17.97/17.58 1622/1582
    VENZ 12 3/4 22 76.75-77.75 -2.5 18.96/18.64 1662/1632
    VENZ 9 23 60.75-61.75 -2.2 18.22/17.89 1626/1593
    VENZ 8 1/4 24 57.75-58.75 -2.2 17.27/16.96 1518/1487
    VENZ 7.65 25 56.25-57.25 -2.2 16.58/16.27 1444/1413
    VENZ 11 3/4 26 70.75-71.75 -2.2 17.70/17.44 1560/1533
    VENZ 9 1/4 27 61.75-62.75 -2.2 16.49/16.22 1429/1401
    VENZ 9 1/4 28 59.25-59.75 -2.2 17.04/16.90 1484/1469
    VENZ 11.95 31 70.40-71.40 -2.2 17.52/17.27 1523/1498
    VENZ 9 3/8 34 59.25-60.25 -2.2 16.38/16.12 1410/1382
    VENZ 7 38 53.00-54.00 -1.7 13.77/13.52 1134/1108
    PDVSA 4.9 14 97.50-98.50 -1.2 80.07/49.51 9678/5553
    PDVSA 5 15 81.00-82.00 -1.7 27.31/25.95 2675/2539
    PDVSA 5 1/4 17 63.65-64.65 -2.0 25.98/25.22 2515/2439
    PDVSA 8 1/2 17 73.00-74.00 -2.2 27.17/26.30 1991/1935
    PDVSA 9 21 61.50-62.50 -2.2 20.38/19.97 1732/1696
    PDVSA 12 3/4 22 76.75-77.75 -2.5 19.28/18.94 1689/1658
    PDVSA 6 24 47.00-48.25 -1.5 18.65/18.25 1555/1518
    PDVSA 6 26 46.00-47.25 -1.6 17.00/16.65 1415/1381
    PDVSA 5 3/8 27 44.25-45.25 -1.7 15.60/15.27 1329/1296
    PDVSA 9 3/4 35 58.00-59.50 -1.7 17.17/16.88 1483/1454

  13. The central point to these posts/studies is to determine whether it makes financial sense to invest in Venezuelan government bonds. I think we should steer the discussion to whether it makes sense morally to invest in this government (ex. Palestinian Boycott Divestment and Sanctions Movement, Anti-Apartheid Divestment Campaign, environmentally led divestment from fossil fuels)

  14. Francisco’s point is quite valid. In their book, This Time Is Different, they address the many ways governments may try to exit excess debt, including financial repression. The fact that the choose not to make such distinctions between financial repression and other non debt instrument defaults, versus a debt restructuring is detrimental to their assertion of near 100% probability of Venezuela defaulting given its domestic default. I applaud Francisco’s keeping them honest.

    In addition, R&R were quite cursory in making their statements, failing to provide proper data, definition, and background initial conditions. It was indeed more of a statement rather than some empirical observation.

    Where I differ with Francisco’s observations is the presumption that Venezuela needs to be insolvent to default on its external debt. It clearly does not. In fact, a sovereign will default on external debt when the political will no longer supports paying it. This typically surfaces in situations like Venezuela. When the local economy is in shambles and the owners of the external debt are mainly foreigners. That last part is critical. There are many cases where the sovereign will choose to default on the debt that has the larger portion of foreign investments as this is politically more feasible.

    This is why the points about the disparity in FX is more academic than reality. While it is true Venezuela could easily adjust its currency problem with a massive devaluation, or plug its expenditures by raising gasolina prices to fair market value, these moves now are deemed politically impossible, especially at the cost of servicing external debt. I fully agree with Hausmann, expect the foreigners to help pay the coming collapse.

  15. Don’t draw a straw man here. To be clearer, here you have a simple numerical example: If the gov’t owes you Bs.100 and you two agree that it will paid in dollars at the current exchange rate, say 10 Bs/$, this amounts to writing a debt contract where you’re now owed $10. If that contract really exists, it doesn’t matter whether the same gov’t devalues or not. You’re still owed $10, which is what the contract says. Of course, the question is whether or not that “contract” or agreement exists. If it doesn’t exists, which is normally the case with importers, then we cannot call it default. But in the case of airlines, for instance, the gov’t did commit to sell them dollars at a *specific* exchange rate. I’m not saying that airlines deserves to be paid at that bat-crazy exchange rate. I’m just saying that the gov’t “committed” to do that and then changed its mind. That looks and smells like a default to me. Like the airlines case, which grabs the headlines, there are other similar cases for more modest amounts.

    As for your second point, maybe what I wrote was a bit confusing. First, let me clarify what I meant by “the government’s failure to meet certain financial obligations might very well be a sign of insolvency, which can be understood as ‘default’”. What I meant was that a gov’t might fail to meet some financial obligations (“prestaciones sociales” to some public sector workers), which by definition is already insolvency, but it is not necessarily in “default” technically speaking. However, failing to meet other types of financial obligations (and not only bonds) might very well be viewed as “default” even if it still pays domestic bondholders.

    Whether or not these events of “domestic default” have anything to do with FX misalignment is NOT very important. It is actually irrelevant. Let me illustrate this point as follows.

    First, let me lay out a simple gov’t problem and certain assumptions. Let’s assume that there is no domestic debt, and external debt payments and revenues are given. The gov’t chooses whether to meet its external debt obligations or not, and how much dollars to supply and at what exchange rate. To make the problem interesting, let’s assume that revenues are not enough. That is, if the gov’t does pay external bondholders, it doesn’t have enough for all the imports that the economy “requires”. In that case it can do two things: 1) CADIVI becomes more stringent (say that it rations by allowing a longer queue at CADIVI’s front door, which is what is doing now) or 2) it devalues sufficiently the currency to discourage importers (and “raspacupos”) from even queuing in the first place (assuming that CADIVI is still in place because a third option is to get rid of it all together but that’s a different story). Either way, the result is the same (except for the raspacupos bit which might actually be huge and the composition of imports). Venezuela gets to import the same amount, that is, what’s left after paying external bondholders. The difference is how the gov’t chooses to *ration* the dollars left over, which again are not enough to import everything the economy “needs”.

    The alternative is to default on foreign bondholders. In such a case, the gov’t has to pay a cost (reputational, exclusion from international trade and financial markets, political, etc.). What the gov’t needs to figure out is how large this cost is. Once it figures that out, the decision should be clear.

    Notice that external revenues and obligations are exactly the same regardless of a devaluation. No amount of devaluation changes those figures and, therefore, it doesn’t really change the gov’t problem and its optimal choice!

    Up until now, the gov’t seems to have chosen to pay foreign bondholders and make CADIVI’s queue longer, which has resulted in what R&R and H&S interpret as “domestic default”. If the gov’t had devalued instead, we could also interpret some of its effects as “domestic default”. In that sense, the current FX misalignment is irrelevant. The problem is that there is no enough revenue and something gotta give!

    Of course, if you also consider that the gov’t not only uses part of its revenues (or what is left of them) to pay for imports but also domestic spending/bandholders, then a devaluation can also ease both the fiscal and external accounts in the short run. To what extent can it relax the external accounts? I don’t know exactly, but my guts tell me that not by much, especially with the inflation rate we are currently observing. So, a devaluation would only postpone the hard choices.

    What R&R’s empirical evidence seems to show is that it doesn’t make much sense for a gov’t to subject its citizens to hardship without defaulting on its external debt as well. In their data, what I call “to subject its citizens to hardship” is simply domestic default, which can defined and observed more easily. The lesson is simply that there is a limit to how much a government is willing or is able to make its people suffer in favor of foreign bondholders. I think that the current situation in Venezuela begs the question whether or not we have reached that limit or how close we are.

    • OK, we’re not understanding each other.

      You write as though there was ONE level of imports the economy needs that is fixed and unrelated to the FX rate.

      “Notice that external revenues and obligations are exactly the same regardless of a devaluation. No amount of devaluation changes those figures and, therefore, it doesn’t really change the gov’t problem and its optimal choice!”

      I find this totally incomprehensible.

      How many Daiquiris do you need? Do you “need” the same number of daiquiris if they’re 10 cents a pop as you do if they’re $150 each? Does “need” have an economic meaning in this context? I’d argue it doesn’t. There isn’t a given amount of imports “needed” separate and prior to the price if those imports. All you can observe is the amount *demanded*…

      All we can say is that the level of imports is “not enough” AT THE CURRENT PRICE OF THE DOLLAR. Raise the price of the dollar, and the level of imports “needed” drops! That’s how markets work…that’s how markets clear!

      • Ok, let’s try one more time.

        You can assume that there is ONE fixed level of imports, which by the way goes against my argument, and still reach quantitatively the same conclusion. That’s because the current level of imports already results in scarcity of many basic staples. (Of course, that could partly be because there is way too much corruption and a big fraction of the dollars Cadivi allocates disappear into thin air, which part of it finds its way to the black market. But let’s put that aside for now.) If you let imports depend negatively on the exchange rate, as its logical, then a devaluation would make the problem even worse. Imports would even be lower and scarcity would rise, especially if the domestic private sector is unable to make up for that, which is not a crazy assumption given all the problems domestic firms currently face. Thus, fixing imports to a specific level (lower than a imaginary “required” level) strengthen my conclusions.

        So, when the gov’t chooses to pay foreign bondholders, there is no devaluation that converts the dollars the gov’t is left with into more dollars! Recall that gov’t revenues are already in dollars as well. Moreover, the non-oil export sector is tiny and a devaluation would not bring significantly more dollars into the economy. So a devaluation is immaterial for the amount of dollars available to the domestic economy. The only decision left is how the gov’t “rations” those dollars. As I said before, it could be via prices (devaluation), “queues”, or a combination of both (CADIVI & devaluation…lovely!)

        The point is that the decision NOT to default is necessarily associated with insufficient dollars to cover a “non-scarcity” level of imports as well as other financial obligations (airlines, etc.). That implies a level of domestic hardship and “default” that is questionable. The question is whether that is optimal. Would the county be better off by defaulting or renegotiating its foreign debt? I don’t know. What I do know is that the greater the level of “domestic default”, the greater the probability of default. And that’s what R&R point out.

Leave a Reply