The top of the front page in today’s Financial Times shows Steve Forbes’ scowling face with the caption, “We want our money!” Really, that should be there every day — it could be their new logo.
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Further down the page, the big story is the election of the opposition candidate Mauricio Macri as president of Argentina. I’ll wait to see what Marc Weisbrot has to say before guessing what this means substantively for the direction of the Argentine state. What I want to call attention to now is the consistent theme of the coverage.
The front page headline in the FT is “Markets cheer Argentina’s new order”; the opening words of the article are “Investors hailed the election of Mauricio Macri….” After mentioning his call for the leaders of Argentina’s central bank to step down — the apparent unobjectionableness of which is evidence on the real content of central bank “independence” — the first substantive claims of the article are that “markets reacted positively” and that “Macri has promised to eliminate strict exchange controls” — evidently the most important policy issue from the perspective of the FT reporter.
Over the fold, we learn again that “Investors yesterday cheered the election of Mauricio Macri”; that “dollar bonds issued by Argentina … extended their winning streak”; and that “markets have hoped for an end to ‘Kirchnerismo’.” The only people quoted in the article other than Macri himself are three European investment bankers. One says that “Macri understands what the country needs to do to regain the confidence of international investors and get the country back on its feet” — presumably in that order. Another instructs the new government that “Argentina must normalise relations with the capital markets and start attracting the all- important foreign investors”.
The accompanying think piece explains that among the “most pressing issues” for Macri are that “the country is shut out of international markets by its long court case with holdout creditors” and that “the economy suffers from a web of distortions, including energy subsidies that can shrink a household’s monthly energy bill to the price of a cup of coffee.” (The horror!) It emphasizes again that Macri’s only firm policy commitment at this point is to remove capital controls, and suggests that “Argentina will need to have recourse to multilateral financial support.” The conclusion: “The biggest area where Macri needs to effect change is the investment climate. Investors have cheered his rise … but Mr Macri’s job is to convert Argentina into a destination for real money investment rather than hedge fund speculation … a decisive change for a country that … is unique in having lost its ‘rich nation status’.”
So that’s the job of the president of Argentina, making the country a destination for real money. Good to have that clear!
Now, you might say, if you don’t want to read every story through the frame of “Is it good for the bondholders,” then why are you reading the FT? Fair enough — but the FT is a good newspaper. (The Forbes story is fascinating.) Anyway, it’s worth being reminded every so often that in the higher consciousness of the bourgeoisie, nations and all other social arrangements exist only in order to generate payments to owners of financial assets. [1]
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The question I’m interested in, though, is the converse one — are the bondholders good for Argentina? The claim that foreign investors are “all-important” is obviously an expression of the extraordinary narcissism of finance. But is there a rational core to it? Are foreign investors at least somewhat important?
This is a question that critical economists need to investigate more systematically. Even among heterodox writers, there’s a disproportionate focus on the development of the financial superstructure and the ways in which it can break down. [2] The importance of this superstructure for the concrete activities of social production and reproduction is too often taken for granted. Or else we make the case against free cross-border financial commitments too quickly, without assessing what might be the arguments for them.
So, concretely, what is the benefit to Argentina of regaining “access to the markets,” to enjoying the goodwill of foreign investors, to being a destination for real money? To answer this properly would involve citing lots of literature and looking at data. I’m not going to do that. The rest of this post is just me thinking through this issue, without directly referring to the literature. One result of this is that the post is too long.
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Let’s start by distinguishing foreign direct investment (FDI) from portfolio investment.
The case for FDI is essentially that there are productive processes that can be carried out successfully only if owned and managed by foreigners. Now, obviously there are real advantages to the ways in which production is organized in rich countries, which poorer countries can benefit from adopting. But the idea that the only way this technical knowledge can reach poorer countries is via foreign ownership rests, I think, on racism, that simple. The claim that domestically-owned firms cannot adopt foreign technology is contradicted by, basically, the entire history of industrialization.
A more plausible advantage of foreign ownership is that foreign companies have more favorable access to markets and supply networks. It would be at least defensible to claim that Polish manufacturing has benefited from integration into the German auto industry — not because German management has any inherent superiority, but because German car companies are more likely to source from their own subsidiaries than from independent Polish firms. I don’t see this kind of argument being made for Argentina. When we hear about “regaining the confidence of international investors,” that pretty clearly means owners of financial wealth considering whether to include Argentine assets in their portfolios, not multinational corproations considering expanding their operations there. In other words, we are interested in portfolio investment.
So what are the benefits that are supposed to come from attracting portfolio inflows? I wonder if the people quoted in the FT piece, or the author of it, ever even ask this question. This may be a case where the debate over what “capital” means is not just academic. If financial wealth is conflated with concrete means of production, then it’s natural to think that the goodwill of the owners of the first is all-important, since obviously no productive activity can take place without the second. But purchasers of Argentine stocks and bonds are not, in fact, providing the country with new machines or software or engineers or land. (For this reason, I prefer to avoid the terms “capital flows” and “capital mobility”.) What then are the bond buyers providing?
Macroeconomically, it seems to me that there are really only two arguments to be made for portfolio inflows. First, they allow a current account deficit to be financed. Second, they might allow the interest rate to be lower. Beyond macro considerations, we might also want to keep international investors happy because of their political influence, or because they control access to the international (or even domestic) payments system. And of course, if a country is already committed to free financial flows then this commitment will only be sustainable if net financial inflows are kept above a certain level. But that just begs the question of why you would make such a commitment in the first place.
Let’s consider these arguments in turn.
‘The first benefit, that portfolio inflows allow a country to have a deficit on current account, is certainly real. I think this is the only generally credible macroeconomic story for the benefits of capital account liberalization.
In a world with no international financial flows, countries would have to a balanced current account (or in practice balanced trade, since most income flows are the result of past financial flows) in every period. But there might be good reasons for some countries. to have transitory or persistent trade imbalances If a country’s trade balance moves toward deficit for whatever reason, the ability to reduce foreign assets and increase foreign liabilities allows the movement back toward balance to be deferred. If faster growth would lead to higher import demand (which cannot be limited otherwise) or requires specific imported intermediate or capital goods (that cannot be financed otherwise) then the foreign exchange provided by portfolio inflows can allow faster growth than would otherwise be possible.
There are good reasons to be skeptical about the practical value of portfolio inflows as finance of current account deficits. But there’s nothing wrong with the argument in principle. If that is the argument you are making, though, you have to be clear about the implications.
First, if this is your argument, then saying that Argentina has suffered because of its lack of access to foreign capital markets, is equivalent to saying that Argentina suffered because of its inability to run a trade deficit. I don’t think this is what people are saying — and it would not be plausible if they were, since Argentina has had a large trade surplus over the whole Kirchner period. No help from foreign investors would have been needed to reduce that surplus.
Second, if the benefit of portfolio flows is to finance current account imbalances, then only the net flows matter. There is no purpose to the large offsetting gross flows — you could just as well have the central bank alone borrow from abroad, and then sell the resulting foreign exchange at the market price (or distribute it in some other way). That would deliver all the macroeconomic benefits of international financial flows and avoid one of the major costs — the central bank’s inability to act as lender of last resort or resolve financial crises when financial institutions have liabilities that cannot be settled with central bank’ money.
Again, the only unambiguous macroeconomic reason to support capital-account liberalization, or to make attracting portfolio inflows a priority, is if you want to see larger current account deficits. In an undergraduate textbook, this is the whole story — to say that international lending permits countries to substitute present for future expenditure, or to raise investment above domestic saving, are just different ways of saying it permits current account deficits. If you think larger current account imbalances are unnecessary or dangerous, then, it’s not clear what the macroeconomic function of portfolio investment is supposed to be. The only thing that portfolio investment directly provides is foreign exchange.
The second possible macroeconomic benefit is that foreign portfolio investment allows the interest rate to be lower than it otherwise could be. This is certainly possible as a matter of logic. Let’s imagine a firm with an investment project that will generate income in the future. The firm needs to issue liabilities in order to exercise claims on the labor and other inputs it needs to carry out the project. Wealth owners must be willing to hold the liabilities of entrepreneur on terms that make the project viable; if they demand a yield that is too high, the project won’t go forward. But there may be some foreign intermediary that is both willing to hold entrepreneur’s liabilities on more favorable terms, and issues liabilities that wealth owners are more willing to hold. In this case, the creation of financial claims across borders is a necessary condition for the project to go forward. Note that this case covers all the macroeconomic benefits of diversification, risk-bearing, etc. — the ability to hold an internationally diversified portfolio may be very valuable to wealth owners, but that matters to the rest of us only insofar as that value allows real activity to be financed on more favorable terms.
That story makes sense where there is no domestic financial system, or a very underdeveloped one; it’s a good reason why financial self-sufficiency is not a realistic goal for small subnational units. But it’s not clear to me how it applies to a country with its own banking system and its own central bank. Is it plausibly the case that in the absence of financial flows, the Argentine central bank would be unable to achieve an interest rate as low as would be macroeconomically desirable? Is it plausibly the case that there are productive enterprises in Argentina that are unable to secure domestic-currency loans from the local banking system even given expansionary policy by the central bank, but would be able to do so from foreign lenders? [3]
If this is your argument, you should at least be able to identify the kinds of firms (or I suppose households) that you think should be borrowing more, are unable to secure loans from the domestic banking system, but would be able to borrow internationally. (Or that would be able to borrow more from domestic banks, if the banks themselves could borrow internationally.)
It’s hard for me to see how a reasonably developed banking system with a central bank could be constrained in its ability to provide domestic-currency liquidity by a lack of portfolio inflows. And I doubt that’s what the gentlemen from Credit Suisse etc. are saying. On the contrary, the usual claim is that portfolio flows reduce the feasible range of domestic interest rates. Of course the people saying this never explain why it is desirable — the ability to conduct financial transactions across borders is just presented as a fact of life, to which policy must adapt. [4]
In any case, my goal here isn’t to dispute the arguments for the importance of portfolio inflows, but to clarify what they are, and their logical implications. Do you think that the benefits of portfolio flows are that they finance current account deficits and allow easier credit than the domestic bank system could provide? Then you can’t, for instance, turn around and blame the euro crisis on current account deficits and too-easy credit. Or at least, you can’t do that and still hold up “free movement of capital” as one of the central virtues of the system.
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There are two other non-macroeconomic arguments you sometimes hear for the importance of foreign investors, focused less on what they offer than with what they can threaten. First, the political importance of international creditors in the US and other states may allow them to use the power of those states against government they are unhappy with.
Historically, this is the decisive argument in factor of keeping foreign investors happy. Through most of the period from the 1870s through the 1950s, the possible consequences of a poor “investment climate” included gunboats in your harbor, the surrender of tariff collection and other basic state functions to creditor governments, military coups, even the end of your national existence. [5] (Let’s not forget that the pretext for the war in which the United States claimed half of Mexico’s territory was the mistreatment of American businessmen there.)
That sort of direct state violence in support of foreign creditors has been less common in recent decades, though of course we shouldn’t exclude the possibility of its revival. But there are less overt versions. The extraordinary steps taken by the Judge Griesa on behalf of Argentina’s holdout creditors go far beyond anything the investors could have done on their own. If the point of the FT pieces is that Argentina needs to settle with its creditors because otherwise it will face endless, escalating harassment from the US legal system, then they may have a point. I’d just like them to come out and say it.
A related argument is that failure to get on good terms with finance as a cartel of asset owners, will mean loss of access to finance as a routine service. The version of this you hear most often is that defaulting on or otherwise annoying foreign investors will result in loss of access to trade finance. So that even if the country has a current account in overall balance, its imports and/or exports will be restricted by a sudden need to conduct trade on a pure cash basis. I’ve seen this claim made much more than I’ve seen any evidence for it — which doesn’t mean it’s wrong, of course. But who are the providers of trade finance? Are they so resolutely class-conscious that they would refuse otherwise profitable transactions out of solidarity with their investor brethren? It doesn’t seem terribly likely — if foreign investors are willing to continue buying sovereign bonds post-default, as they unequivocally are, it’s hard to see them refusing this basic financial service to private businesses. Or coming back to Argentina, is there any evidence that the demand for Argentine exports was reduced by the default, or that Argentina was unable to convert its foreign exchange earnings into imports because foreign exporters couldn’t finance the usual 60- or 90- or whatever-day delay before receiving payment?
Another version of this argument — which Nathan Cedric Tankus in particular made in the case of Greece — is that a country that breaks with its creditors will lose access to the routine payment system — credit cards and so on — since it is all administered by foreign banks. In the case of a eurosystem country this may have some plausibility, at least as an acute problem of the transition — over a longer term, I can’t see any reason why this is a service that can’t be provided domestically. But leave aside how plausible they are, let’s be clear what these claims mean. They are arguments that foreign investors matter not because of anything of value they themselves provide, but because of their ability to provoke a sort of secondary strike or embargo by other segments of finance if they don’t get what they want. These are political arguments, not economic ones. In the longer view, they also support Keynes’ argument that finance should be “homespun” wherever possible. If trade finance really is so critical, and so readily withdrawn, wouldn’t it be wise to develop those facilities yourself?
The final argument is that, if you have committed yourself to permitting the free creation of cross-border payment commitments, you will be unable to honor those commitments without a sufficient willingness of foreign units to take net long positions in your country’s assets. [6]
This one is correct. If, let’s say, banks in Argentina have accumulated large foreign currency liabilities (on their own, or more likely, as counterparties to other units accumulating net foreign asset positions) then their ability to meet their survival constraint will at some point depend on the willingness of foreign units to continue holding their liabilities. And unlike in the case of a bank with only domestic-currency liabilities, the central bank cannot act as lender of resort. In other words, the central bank can always maintain the integrity of the payment system as long as its own liabilities serve as the ultimate means of settlement; but it loses this ability insofar as the balance sheets of the domestic financial system includes commitments to pay foreign moneys. [7]
This, probably, is the real practical content of stories about how important it is to maintain the goodwill of footloose capital. If you don’t honor your promises to foreign investors, you won’t be able to honor your promises to foreign investors. The weird circularity is part of the fact of the matter.
[1] Needless to say, not every political development is covered this way. The fact that the bondholder’s view of the world so dominates coverage of Argentine politics is evidently related to the specific way that Argentina is integrated into the global circuits of capital.
[2] I really wish people would stop talking about “the crisis” as some kind of watershed or vindication for radical ideas.
[3] I emphasize domestic currency. Of course domestic banks cannot provide foreign -currency loans. But again, this is only a macroeconomic issue if the country is running a trade deficit. Otherwise, the foreign exchange needed for imports will, in the aggregate, be provided by exports. The same goes for arguments that portfolio flows allow the central bank to target a lower interest rate, as opposed to achieving one.
[4] It would be worth going back and seeing what positive arguments the original framers of the policy trilemma made in favor of “capital mobility.” Or is it just treated as unavoidable?
[5] In the 19th century, “default might even be welcomed as a way of enhancing political influence.”
[6] It would be more conventional to express this thought in the language of capital mobility or international financial flows, but I think the metaphor of “capital” as a fluid “flowing” from one country to another is particularly misleading here.
[7] The capacity of the central bank to maintain payments integrity by substituting its own liabilities for impaired institutions’ is preserved even in the case of foreign-currency liabilities insofar as the central bank’s liabilities are accepted by foreign units. So the development of unlimited swap lines between major central banks represents, at least potentially, an important relaxation of the external constraint and a closer approximation of at least the rich-country portion of the global economy to an ideal closed economy. I’m glad to see that the question of swap lines is being taken up by MMT.