Debt Relief

Even before the coronavirus arrived in Lebanon in late February, its economy was in freefall. Unemployment was thought to be as high as 25%, inflation was accelerating into double-digit rates, and, according to the World Bank, 40% of Lebanese were classified as poor. As noted in a previous essay (Crises), default on a US$1.2 billion Eurobond repayment due March 9 seemed imminent, especially as net foreign-exchange reserves held by the Banque du Liban, the central bank, were insufficient to pay for even essential imports.

On March 9th, Lebanon did not repay the $1.2 billion Eurobond. This was the first sovereign default in the country’s history; even through the civil war years in the 1980s, Lebanon had managed to meet debt obligations. Upcoming dollar-bond repayments of similar amounts are due this month and in June, but bond investors clearly do not expect anything like orderly maturity, with Lebanon’s Eurobond prices having now sunk to record lows in the range of 30-60 cents on the dollar. The new Lebanese government, perhaps acting on the advice of the IMF, has hired Lazard Ltd. and the New York law firm Cleary Gottlieb Steen & Hamilton as advisers in order to restructure its entire debt load, estimated to have reached 170% of its gross domestic product. Seeking financial aid directly from the IMF is at best complicated; Hezbollah, the Iran-supported militant and political group, strongly objects to IMF involvement, suspecting that institution’s usual program of fiscal austerity would hurt the poor disproportionately and be used by the United States as political leverage.

If Lebanon is the world’s poster child for unsustainable debt load, it’s hardly alone. The government’s efforts to restructure debt come at a time when major international lenders have just this past week agreed to debt relief for some 76 poor countries severely impacted by the coronavirus pandemic. French Finance Minister LeMaire announced debt payments, worth at least a combined $20 billion, would be suspended by official and private creditors, a move fully backed first by Group of Seven finance ministers and central bank governors, and subsequently endorsed by Group of Twenty officials, at least until the end of 2020. As well, the IMF on Monday announced $215 million in initial debt relief grants to 25 countries from its Catastrophe Containment and Relief Trust, a facility the IMF is aiming to expand to $1.4 billion. There are now even calls for outright debt cancellation, with LeMaire saying that African countries should be helped by “massively cancelling their debt”, and calling for broader cancellation on a case-by-case basis in co-ordination with multilateral lenders, particularly the World Bank.

Crises

A crisis is defined as a time of intense trouble or danger, a time when a difficult or important decision must be made. Economic crises have occurred frequently in several Arab states, particularly since the onset of the Arab Spring in 2011. Of the Arab countries without meaningful oil revenue, more than half have needed some form of IMF support over the past decade; three - Egypt, Tunisia and Jordan - took loans.

And so another such crisis has emerged, this time in Lebanon. With its economy collapsing, the country’s newly-formed coalition government, put together in January after months of multi-party haggling, appears united solely in its reluctance to ask the International Monetary Fund (IMF) for help. But ask it has. A first round of discussions with an IMF team was held on February 20, ostensibly to obtain the Fund’s advice in addressing immediate economic issues. Foreign currency reserves to pay for essential imports are nearly depleted; the country’s public debt exceeds 150% of GDP. Funds to address a recent outbreak of the COVID-19 virus infection (three confirmed cases at the end of February) are severely limited. As a $1.2 billion Eurobond payment is due March 9, it seems that more than just advice is needed now - without an advance on an eventual IMF line of credit, it is difficult to think how the government will avoid default on its payment obligation.

And yet, if Lebanon is able to strike a deal for an IMF bailout loan, the economic adjustments stipulated under any agreement will prove onerous for especially Lebanon’s poorest . The World Bank warned in November that the poverty level in Lebanon, estimated at 27% in 2018, could rise to as much as 50% on current trends. The state spends billions on electricity subsidies and make-work projects, expenditures that under typical loan agreements with the IMF would be cut back or eliminated in order to achieve some semblance of fiscal stability. As well, to enhance export competitiveness, Lebanon would likely be required to float its currency, pegged since the 1990s to the US dollar at 1500 pounds to a US dollar but trading on the black market at a rate closer to 2000. (Under an IMF Loan Facility signed in 2016, Egypt unpegged its currency, which almost immediately lost half its value.) A falling currency would, with a lag, lead to more exports, but in the short term the cost of imports would increase, affecting the purchasing power of the poor in Lebanon disproportionately.

IMF-induced austerity may be a necessary condition if economic health is to be restored in Lebanon. But without structural reforms, including measures such as investments in education, and freer trade with neighbouring middle-eastern economies through reductions in tariffs and other trade barriers, an impoverished Lebanon, facing continued political instability (and more refugees from the failed state of Syria), could persist.

o

Perception vs. Reality

At times, the world continues to regard Russia as a super-power. The attention paid today to the Trump/Putin Helsinki summit is just the latest example of a long-standing perception-reality gap.

The perception of a powerful Russia must be based on its nuclear arsenal, or on its vast store of natural resources, or perhaps on its propensity to foster political instability, in a number of countries, in a variety of ways. It certainly has no basis in the size or dynamism of its economy. Thus, Russian nominal GDP in 2016 was US$ 1.28 trillion, below that of, for example, South Korea's $1.4 trillion (and well below China's $11.2 trillion and America's $18.6 trillion). To continue the comparison, South Korea's GDP per capita in 2016 was over $US27,000, compared with Russia's $8,500. Put another way, South Korea's 51 million people have become considerably more productive than the 144 million Russians. Many similar country comparisons can be made; indeed, Russia compares poorly even to just a single American state - New York - with the latter's gross state product of some US$1.5 trillion and its GSP per capita of nearly $60,000.

One conclusion from this: political corruption combined with one-party political structures do not support economic growth and productivity over the long-run. Chinese leaders should take note, and Russians should be far wealthier. 

Fiscal Imprudence

As the New Year began, reports emerged that Chinese officials were considering reducing or even halting their purchases of US treasury securities. As China is the largest holder of US government debt (their holdings accounting for about 10% of total US debt outstanding), the news rattled financial markets.

Here's some background to these reports. China's foreign exchange reserves, the largest in the world at $3.1 trillion in January 2018, are invested in various financial assets including gold and government securities, the latter of which have typically been comprised principally of US treasuries. Such US holdings stood at some $1.2 trillion at the end of 2017, or nearly 40% of China's total foreign exchange reserves. Given this heavy weighting, it is perhaps not surprising that the Chinese government would begin considering a more diversified investment strategy for its reserves. And another factor may be at play - the Trump administration's mercantilist tendencies have produced world trade tensions, particularly between the US and China, and Chinese officials may be using their foreign exchange clout as something of a geopolitical football. 

So, just as China ponders reducing its financing role in the operation of America's central government, the American government continues along its normal course, spending far more than it collects. Annual budget deficits have averaged 2.8% of GDP between 1967 and 2016, and hit 3.5% in 2017. Data (from the Federal Reserve Board of St. Louis) indicate that US public sector debt, accumulated over years from such deficits, has increased dramatically, especially through the past two decades, from some 50% of GDP in 2000, to 60% in 2010, to nearly 104% by the end of 2017. Given this extraordinary jump in debt - to a level that now exceeds America's GDP - one might reasonably expect Republican Congressional leaders, and the Republican White House, to begin focusing on fiscal prudence, especially as the growth of the US economy - and indeed that of most other major world economies - now appears sustainable and perhaps even accelerating. (Indeed, the Federal Reserve Board is now shifting monetary policy to a less accommodative stance.)

Instead, with apparently no regard to outstanding debt, this is what's happened. First, at the end of 2017, the Republican government passed a massive set of personal and corporate tax reductions, hailing the package as their signature move in the first year of the Trump Administration. While one can easily argue that America's corporate tax structure needed adjustment to be more internationally competitive, and that such a move will spark earnings, employment growth and hence tax receipts, a $1.5 trillion tax-cut package can hardly be viewed as a sure way to, on balance, reduce debt, nor as even necessary to boost an already-growing economy with an unemployment rate of 4.1%, nor as an appropriate policy given ever-higher mandatory projected spending on entitlement programs. Then, late last week, a new, $320 billion bipartisan spending deal was passed by the Congress, increasing spending caps and extending overall spending authorization, thus ending, for now, the latest round of government shut-downs. This extra spending will simply exacerbate deficits and debt. And, just at date of writing, The Trump White House announced their 2018 Budget, a visionary, non-binding document - as all White House Budgets are - that apparently includes a "road map" for offsetting growth in spending "in a responsible manner". Yet even this Republican Budget remains hugely unbalanced, in part because it proposes $200 billion in federal investment as seed money for a $1.5 trillion package of infrastructure projects.

From all the above, it would seem clear that America's budgetary process has been, and remains, very far from its basic purpose - to impose financial order. It is much closer - especially under an erratic Administration - to causing chaos.  Is it any wonder, then, that, as the debt market digests the certain prospect of substantially more T-bond supply from the Treasury Department, the very long bull market in US Treasuries has finally turned bearish? And, thus, can it be at all surprising that the Chinese are considering modifying their foreign-exchange investment strategy?  

Yet Again

In economics, the basic tenet from which all theory and policy emanate is that resources, whether physical or intellectual, are scarce. As such, their optimum allocation as factor inputs to the productive process is critically important to a society's overall well-being. Free-market systems allow scarce resources to be allocated via the pricing mechanism. Within the framework of the predictable application of law, the demand for and supply of a particular good or service meet at an equilibrium price satisfactory to all market participants, and hence sufficient to clear the market and lead to further productive activity. The polar opposite to this system is central planning, which replaces individual decision-making with government edict as the means of determining what, where, when and how much is produced. 

A clear lesson from the 20th century is that centrally-planned economies are not only unproductive but ultimately unsustainable. Think of the collapse of the USSR, or the stark contrast between West and East Germany prior to their merging, or the surge in the Chinese economy once freer markets were permitted. There is thus cause for real concern with what is emerging from the Trump White House regarding American investment and international trade. Starting before his inauguration and continuing thereafter, President Trump has, for example, forced Carrier, a manufacturer of air-conditioning units in Indiana, to maintain 800 jobs in the state rather than shift them to Mexico; he has openly criticized Apple for not producing more iPhone components in the US; he has lashed out at Boeing, and he has threatened auto companies with punitive border duties on vehicles not made domestically.

While none of these actions approaches anything like central planning, they do smack of yet another version of industrial policy, wherein a government - or, in this case, Mr. Trump himself - uses negotiations, tax laws, tweets, and trade talks to favor some industries and punish others. They look worryingly like the failed "Latin American" model of import-substitution prevalent in the 1960s and 1970s. Already they seem to be forcing companies to make investment decisions based not on an unfettered price signal but, rather, on a tax break or, worse, a threatening tweet from the President. While this may seem like good news for workers who keep or re-gain their jobs, it is not good news for the economy in the long-run. Affected companies will be less competitive internationally, and workers, who are also consumers, will pay higher prices or buy lower-quality goods. More interventionist government policy - and ad hoc, erratic, vindictive pronouncements from the new President -  will ultimately have grave economic consequences. Better that Mr. Trump focus solely on his plans for tax and regulatory reform, and infrastructure re-building.