Dear member,


In 2001, Argentina was responsible for the largest sovereign debt default in history. Once again, just 13 years later, Argentina is on the verge of default. The story as to why Argentina is facing its second default in the 21st century, if it fails to oblige by a U.S. court ruling that has ordered full payment to US hedge funds no later than July 30th, is a long and convoluted one.


Key fact: Just last year Argentina was rated the most corrupt nation in Latin America, according to Transparency International.

source: http://www.transparency.org/gcb2013

With so many countries weighed down by historically high levels of debt and struggling to maintain minuscule economic growth, due to stagflation, Argentina's impending outcome may provide a road map or precedence for future defaulters and creditors.


Corruption and failed socialist policies aside, Argentina's potential debt disaster is also relevant because it highlights the power of the U.S. court system and deep-rooted role the US dollar has played in global lending facilities for decades. However, as we will explain shortly, that leadership role America has thrived on is being aggressively challenged by the leaders of the BRICS.

Providing Alternatives

A country such as Argentina has had very limited options for emergency credit outside of turning to the US in past decades. But that may change. With the recent formation of the BRICS New Development Bank, which we discussed in length last weekend, (click here in case you missed it) there is strong potential that China and Russia will seize opportunities which arise from international debt crises.


In a bid to seize some international monetary influence away from the IMF and World Bank, the BRICS want to offer countries that find themselves in a state of economic chaos, just as Argentina did in 2001, a helping hand.


Being a lender of last resort has its perks for aspiring superpowers such as China and Russia. Providing emergency capital gives the lender tremendous political, financial and natural resource gain through contracts and trade.


In moments of financial emergency, the BRICS have the cash reserves to follow through and look like a guardian angel to countries such as Argentina. A quick look at how the United States has benefited from being the lender of last resort to much of South America over the past century has not gone unnoticed by Russia and China. Just as China is gaining influence in Africa by providing emergency capital in return for natural resources (read our report on this subject titled, The World's Next Battleground), there is no doubt the world's second largest economy wants to do the same in resource-rich South America.

Argentina on the Brink

Below is an excerpt from a February, 2013, CRS Report for Congress, titled, Argentina's Defaulted Sovereign Debt: Dealing with the "Holdouts".

In 2005, after prolonged, contentious, and unsuccessful attempts to restructure the debt, Argentina abandoned the negotiation process and made a unilateral offer. The terms were highly unfavorable to creditors, but $62.3 billion of the $81.8 billion in principal owed was exchanged. A diverse group of "holdouts" representing $18.6 billion did not tender their bonds and some have opted to litigate instead. These actions resulted in attachments orders against Argentine assets, leaving the country unable to access the international credit markets and mired in litigation.

A further excerpt is as follows:

The lingering effects of the debt default became a legacy problem for Argentina. The government decided to open another bond exchange in 2010 to deal with remaining holdouts, on slightly less favorable terms than before. Argentina reduced its outstanding defaulted debt by another $12.4 billion. As of December 31, 2010, Argentina reported that it owed private investors $11.2 billion ($6.8 billion in principal and $4.4 billion in past due interest). Holdout creditors estimate that with additional interest, this number could be as high as $15 billion by 2013, with $1.3 billion under litigation in federal court.

source: fas.org/sgp/crs/row/R41029.pdf

That $1.3 billion has come home to roost and Argentina is being forced to deal with it prior to repaying its remaining bondholders. While it is not a lot of money considering the times we are in, and the hundreds of billions in bailouts we've seen, that $1.3 billion is very symbolic.


Argentina does not recognize the remaining private holdout debt in its official financial statements and the country is legislatively barred from making another offer to bondholders.


On Friday, Argentine cabinet chief Jorge Capitanich, commented, "With the good faith of the vulture funds and a rational attitude from Griesa, this litigation can be resolved."


However, later on Friday it was reported by Reuters that "Argentine debt negotiators left their meeting with a U.S. court-appointed mediator in New York after barely one hour on Friday..."


The Reuters report continued "It was the shortest meeting yet held between Argentine officials and Daniel Pollack, raising more questions over the likelihood of the country striking a deal before July 30 with the "holdout" investors suing it for full payment on their bonds."


New York district-court judge, Thomas Griesa ruled that Argentina was banned from paying the creditors who in 2005 and 2010 swapped over 90% of previously defaulted debt for performing securities, if the country did not also pay NML Capital and other hedge funds what they demanded.


If Argentina fulfills the demands, its President, Cristina Fernandez, fears other creditors who took unfavorable hits in 2005 and 2010 will then want to be repaid and made whole. She is right to fear such an outcome. The above excerpt from the CRS Report for Congress clarifies this.


As of this moment, Argentina's only leg to stand on is the Rights Upon Future Offers (RUFO) clause that was written into its restructured bonds. The clause expires on December 31st and specifies Argentina cannot voluntarily offer holdouts a better deal than it did during its 2005 and 2010 restructurings without extending the offer to all bondholders. Argentina is clinging desperately to this law. The Supreme Court in the US has ignored this and likely believes that because Argentina wrote the law, it can't be trusted.

A Struggling Economy Desperate for Help

In late June, Argentina reported that its economy contracted during the first quarter of 2014. High inflation and weak exports, specifically to its top trading partner Brazil, had a devastating impact.


It is important to note that Argentina is the third largest economy in Latin America and its government has been suspected of providing false inflation reports, continually understating the real rate.


Reuters reported in May that,

"In those years, Argentina reported inflation at about half the rate estimated privately. The discrepancy hurt confidence in the government, widened Argentina's sovereign risk spreads and got the country censured by the International Monetary Fund."

source: http://www.reuters.com/article/2014/05/07/argentina-inflation-idUSL2N0NR0QZ20140507

Reuters went on to report in May that "The official inflation rate last year was 10.9 percent versus private sector estimates of about 25 percent."


The national statistics agency, Indec, reported that GDP contracted by 0.2% on the year and 0.8% in Q1 2014. Argentina's central bank began issuing notes with interest rates near 30% in February.


In a statement derived from Bloomberg, Claudio Loser, a former International Monetary Fund director, said on July 18th that a default would probably deepen the current recession, fuel inflation and prompt a selloff in the peso.

It has been estimated that the Argentine peso has lost as much as 30% of its value in the last two years

PINNACLEDIGEST.COM