Heading for Default?
Gregory Makoff, Sovereign Debt Management Expert
Willy Walker: Good afternoon, everybody. It is a real pleasure for me to have Gregory joining me today. I'm going to do a quick bio, and then we will dive into our discussion on sovereign debt, Argentina, his great book is entitled “Default.” We will talk in detail about how all that led to certain sovereign debt holders getting more money back from the Argentine government than others. That will then lead to a conversation on where Argentina sits today. And we actually might switch that around because Greg would like to start there. And then, I want to talk about the US debt situation and the global sovereign debt picture as it relates to the United States having $26 trillion of debt outstanding, China having upwards of $50 trillion of debt outstanding, $11 trillion of emerging market debt outstanding, etc. So let me dive in and do a quick bio on you, Greg, and then we'll dive in.
Gregory Makoff has been writing about sovereign debt for the past decade and is the author of Default: The Landmark Court Battle over Argentina's $100 Billion Debt Restructuring. Greg's career began as an investment banker and debt transaction specialist, advising companies, financial institutions, and countries including Jamaica, Colombia, the Philippines, and Turkey regarding their debt management operations. Since 2015, he has published papers as a Senior Fellow at the Center for International Governance Innovation, CIGI. He worked with the U.S. Treasury on a team that supported the enactment of the Puerto Rico Oversight Management and Economic Stability Act. This law has been facilitating the reform of Puerto Rico's public sector and the restructuring of its debt. Greg holds a Ph.D. in physics from the University of Chicago and a BSC in Physics and Political Science from MIT. He's a senior fellow at Harvard Kennedy School, where he focuses on sovereign debt restructuring. So, Greg, as you and I were talking previously, you said, “Let's start with President Javier Milei, who's now the new president of Argentina. And his going around during his campaign last year with a chainsaw to exemplify what he planned to do with the fiscal situation in Argentina today.” Let me just open it up with what about Milei makes you either think that he has a chance to pull this off or not a chance in the world, given what he is facing with the Argentine economy.
Gregory Makoff: Well, thank you, Willy, for having me on the broadcast. And this is a fascinating revolutionary situation going on in Argentina. When I finished the book a year and a half ago, I was writing the conclusion and I had to address, what should Argentina do? 200 years, 9 or 10 defaults? How did they get out of the mess? I couldn't imagine in Argentina, the people elected a president holding a chainsaw, and he was promising the opposite of any other politician in history. He promised pain now, party later. Every other politician is saying, “I'll give you tax cuts, I'll give you benefits, and I'll make the world great.” Instead, he said, “This is going to hurt.” But people voted for them because they were tired. They had a crisis in the ‘80s. Their wonderful reform plan of the ‘90s crashed and burned in the default of 2001. That sets off my book. And then they're back in the mess. And the people are exhausted. They want change. And what he said made sense. He said, “You spend too much. Then the central bank prints too much money. And then we have inflation. And when it comes to the debt crisis, it's often not default. It's often just inflation. And it hurts people, poor people, working people.” And they understood that. And so against any expectation, this outsider, an economist who's basically telling the truth, it wasn't foreigners who caused our problem, it was us. And so, in some odd way, I wrote this book about Argentina's political problems, dealing with its default of 2001. And at the same time, out of this messy history, the people had said “enough.” He has not had a majority in Congress. He's allied with some of former president Macri's forces. But there's a big standoff in Argentina in that he's ruling by decree, not getting laws passed. So there are a lot of questions about whether it will succeed by executive order. But this is the news of this year in Latin America. If he succeeds, this is going to be a complete change in the trajectory of Argentine history. If he doesn't, it's just more of the same Argentina unable to bridge differences, unable to compromise at home, and falling back into crisis. So that's the context of talking about Argentina and its repeat problems with debt.
Willy Walker: So Greg, let's back up a little bit to the mid to late 1990s. So Carlos Menem is the president of Argentina. He has done two major things. One pegged the Argentine peso to the US dollar and began a huge privatization plan which is taking big state-owned enterprises YPF and selling them off. In that case, he sold them to Repsol, which is a big Spanish company. Sold the airline, sold a bunch of other things. And GDP growth in 1996, 1997, and 1998, in Argentina was between 5 and 10%. It was one of the hottest economies on the face of the planet. And so it seemed like everything was running very well until the Brazilian Real devalued in ‘98. Talk for a moment, if you would, Greg, as it relates to why the devaluation of the Brazilian Real was the first domino to fall as it relates to the reforms that Menem had put in and to the degree possible, then why is that playbook not accessible to Milei today?
Gregory Makoff: I actually sidestep in my book why Argentina defaulted. Because I focus on the clean-up story. Why did Argentina take 15 years to clean up its debt default to vote one when other countries took a year or two? I helped Jamaica clean up its debt problem in three months. So this is the worst cleanup operation ever. But it is an important question. In July 2002, Economics pulled together a bunch of economists to talk about why it failed. You had ten economists with ten opinions, and the most common one was fixing the dollar to the peso was a mistake because they faced a competitive devaluation in that their nearest neighbor with the biggest economic linkages devalued 30%, which created a big term of trade shock. Now the dollar was strong, which set the pressure on Brazil to do it. That because Argentina had pegged to the dollar, it couldn't follow Brazil, and that had an immediate effect. But the backdrop, there are always multiple causes in a debt crisis, and Argentina was left with probably a bit too much debt in its Brady restructurings of the ‘90s. And it just always kept growing from ‘93, ‘94, ‘95, ‘96. Even though it's growing as an economy, the debt is growing more. There is also something underappreciated about the ‘90s the Convertibility Law, which caused the one-for-one, also outlawed indexation. You are not allowed to index a wage contract to inflation. And so when they defaulted in 2001. The country could do a Real devaluation. In that, when the currency went from 1:1 to 3:1. Wages went down and the economy recovered pretty quickly. Unfortunately, the problem Milei has today is the government since reindexed the whole of society, pensions, and wages have completely indexed to inflation. So in an odd sense, Argentina's economic recovery in 2002, 2003, 2004 was eased by the discipline of the reforms of the ‘90s. So once you fix the currency peg, and once you reduce some of that excess debt load, then the economy boomed again. But then some of the mistakes of the ‘80s came back. And that's in the story. While Argentina is restructuring its debt in a big fight, it is overspending and making some historical mistakes.
Willy Walker: But on that, if I can double click for a second Greg on the indexing, and the peg to the dollar. Does that necessarily mean that unless the United States of America is your largest trading partner, you shouldn't peg your currency to the dollar? Isn't it that Brazil was such a large trading partner of them? By the way, today, as you well know, China and Brazil are their two largest trading partners. So right now Milei is going to go and peg his currency to the US dollar, even though he does three times as much trade with China and Brazil as he does with the United States. So isn't he setting the economy up for the same type of shock that it incurred in 1998 when Brazil devalued of not having control over its own currency to be able to do that and therefore become price uncompetitive?
Gregory Makoff: Well, Milei is heterodox. And he said a lot of things before being elected, and he pretty much dropped the free fixing of the currency to the dollar. Now, he doesn't say it's completely off the agenda, but I think a lot of people in the government wish it would disappear. They said, “Let's stabilize the economy first.” So the question is, if the plan didn't work before, why go back and do that? So there's a question mark. The immediate thing he's doing is a massive budget cut. He is using the chainsaw even today in the news. To balance the budget, is cutting a lot of jobs. As much as he can without the coordination of the Congress. So there was a lot of discussion in December, will he or will he not drop the dollar peg? And that's really not in the day-to-day conversation anymore. And I think a lot of economists will complain if that gets back on the agenda. But I think that's for two years from now. What he needs to do is win in the midterm elections. He needs to bring inflation down. He needs some confidence to return. In reality, bomb prices are coming up. There are some good signs, but it's uncharted territory to be locked in a war with another political party and be unable to pass legislation. But the monetary effect was true. But the initial idea of the currency fix is that they have a fixed supply of money, which will stop the country from spending because it can’t print money to pay excess wages. Lock up the currency supply and throw away the key. But then the country borrowed dollar bonds so they could stop it from printing pesos. But the bond market was open. And in the ‘90s the international bond market was very forgiving. And even though Argentina's debt kept growing and growing, there was so much money to invest they kept funding Argentina, and the debt grew to more and more dangerous levels. Unfortunately, while I said the law said the country couldn't index, it broke its rule when it sold its utilities with the help of the World Bank, it indexed the power contracts to the US dollar, which shouldn't have been allowed under the law but they finagled it. And so when they defaulted, they defaulted all the utilities who borrowed in dollars because they thought they would get US revenues. And if Argentina has had a fiscal problem since 2001, it's because instead of raising utility rates, they've subsidized them, which has been a gigantic drain on their treasury until today.
Willy Walker: One of the things that you point out in the book is that the utilities had been indexed, that right when De La Rue left in 2000, what was it.
Gregory Makoff: 2001, December.
Willy Walker: 2001, when De La Rue gets evacuated from the Castle Rosada by a helicopter off the roof and social strife hits in Argentina, one of the big concerns was that you had foreign investors of Spanish, American, and European companies who had gone and bought into these companies, thinking that in some instances, as you just said, on the utility side, their prices were indexed. And all that fell apart. So as he tries to do all the things that you just talked about, this time around for a second time, how do you get the confidence of the international community to go in and invest in companies and try to bring fresh new foreign direct investment into Argentina, given that track record?
Gregory Makoff: We've gotten to December 2001. And between the currency and other decisions, the program of the ‘90s didn't work. It needed a devaluation, it needed a debt restructuring. And the utilities did not add up. So they had a twin default on all their utility contracts on $100 billion of bonds. And then there came this 15 year period leading to today of not cleaning it up the right way. And Argentina started pretty well. It tried to work with the IMF, and the IMF was saying, “Well, you got to fix this, you've got to fix that.” In Argentina, there was a lot of finger-pointing. Well, you gave us bad advice in the ‘90s. We want to do it our way, and Argentina was right about a lot of things. But one of the problems was the president, after the temporary president [Eduardo] Duhalde left President Kirchner, he wanted to slowly walk around fixing the utilities because he didn't want to raise utility prices. And in the end, there was a big and moral fight over the bonds, which you could argue both ways. How deep the haircut should have been and how it was negotiated. The fact is that the Underbelly was not dealing with the utilities, which by 2010, 2011, 2012 was costing 4% of GDP in the budget, which is what kills the country.
But in Argentina's perspective, it was willing, under Minister Lavagna, when it did its deal and brought it to the market to run a 3% primary surplus. This means your revenue, above your expenses, before your debt payments. So that leaves your economy generating 3% of GDP to pay interest in principle going forward. That's what he was willing to do. And that's pretty big. But corresponding to that, he needed a 75% reduction of his foreign debt. His Eurobonds, his dollar bonds, his yen bonds. Creditors were shocked because in the ‘90 Brady restructurings, they'd gotten $0.75 on the dollar. In a sense, they got 65% on the dollar plus all their past-due interest. And he's a third of what they used to get. And the creditors are going crazy. But he says, “We don't want to find ourselves in default again in ten years. We were stuck in the ‘80s. Our plan for the '90s failed. In ten years we don't want to be in trouble again. We will run a 3% surplus, but we need this deep haircut.” The creditors organized, they are lobbying in the Financial Times and other newspapers. They went to the board of the IMF and said, “Cut off the money. Argentina is breaking all the rules. You have to stop that.” And that caused a big fight with Argentina. Very arcane rule stuff. Argentina said, “I don't want to listen to you anymore. I'm pausing the relationship, and I'm going to sell this deal without your help.”
We have to keep something in mind, the technical aspect. You tend to think you have the debtor in the creditor. Well, the creditor was complicated, 152 bonds in eight different laws under seven different currencies. 80 billion nominal, 20 billion past due interest, a lot of institutional investors in London and New York, all the financial centers, but over half a million retail investors, including 450,000 moms and pops in Europe who were sold these bonds by their local banks. In Italy, they have, let's say, 350 small banks. We buy CDs. We buy mutual funds. We buy individual stocks. That's how we save. They bought government bonds because, in the ‘80s and ‘90s, Italian government bonds yielded 13%. Why go anywhere else? But by 2000, when Italy joined the euro, the yield has fallen to three and a half and the 50, 65-year-old retirees, or the old lady from the mountains said, “How can I reinvest my maturing Italian government bond to get 10%?” And they said, “How about Argentina?” And a third of Argentines are of Italian origin, and they love Argentine soccer players. So they bought the Pele bonds. The Argentine famous player bonds. So really, it was that simple. And Argentina had a big reputation, but it was a horrible credit. It was a horrible human mistake. And so you don't only have the country suffering and really needs this haircut, you have a disaster on the savings of a bunch of Italians. And the Italian banks organize because they don't want to be sued by their clients. And they say, “Let's fight this deal.” And they push very hard against the deal. And to get this deal done, Argentina sold it famously on threats. And this is important because, in court, the judge didn't like the threats. They jawbone verbal threats. We won't pay you a penny if you don't come in. Contractual threats, something in the contract, if we pay the other guy more will pay you more, which would be impossible. Third, they passed a law in Congress called a lock law, saying we forbid the executive department to ever make another offer, to ever talk to or hold out, to ever pay a court judgment. Now the pilots come to New York, and they show that to the judge, who gets really mad.
Willy Walker: Let’s talk about the judge for a moment. And let's also talk about the holdout of Elliott Management. So Elliott Management between ‘96 and 2000 had been a holdout on the Peruvian debt crisis. And it actually won that case, by making a case as it relates to pari-passu payments. And I want to get you to talk about that second on the pari-passu. But before we do that, talk about Thomas Grecia, the Southern District judge, give a little bit of background, if you would, Greg, he's a Nixon appointee. At that time, he was in his mid-70s when this case came to his desk.
Gregory Makoff: He was 70.
Willy Walker: So he's a little long in the tooth. He's appointed by a Republican president. And yet he had two previous cases that showed that he had a soft spot for the small guy. Talk for a moment, give a little bit on why Griesa was, to a great degree, the perfect judge for Elliott Management as being a holdout here.
Gregory Makoff: He really does not like the abuse of governments. And in time, he was convinced Argentina was horribly abusive to creditors, to himself, into his own people. But it didn't start that way. But in his earlier cases, in one, the US had spied on the Socialist Workers Party and had sued to get the records of it. And the attorney general of the US, Griffin Bell, didn't want to give them back. And so he found the attorney general of the United States in contempt of court. Which was an extraordinary thing for a district court judge to do. It was overturned, but he made his point in the ‘70s. And then there was this big to do, overbuilding this highway off the west side of Manhattan where I live. Which would have been sunk underneath right off the water and destroyed the breeding grounds of the striped bass. Now, the issue really wasn't the striped bass. It's the proponents who wanted to block it said that every time you build another bridge, you just got more cars and more traffic. If we have $5 billion of federal transit money redirect it to the subways. And so he ended up putting up stays of federal funding, finding technical problems with the environmental impact report. Remember, the environmental laws were pretty new back then, and the state was pushing scientists to quickly do them, and they weren't well done. So they kept finding technical problems. And he held the funding hostage enough. New York State was in a use it or lose its position, and billions went to the subway instead of to under the west side roadway, which would have been swamped by Hurricane Sandy.
Willy Walker: I hadn't thought about that after having read that in your book, I hadn't thought that it would have been probably destroyed subsequently.
Gregory Makoff: But let me build on what you said because every Argentine reporter I talked to asked me, “Why did this cranky judge hate us?” And that is not true at all. Between 2001 default and 2005 restructuring, he did everything in his power to help Argentina. He stayed in litigation as far as he could. He even yelled at the plaintiffs. He said, “There's no evidence you can collect a penny. You'd be wasting your time running around the world trying to attach things with little result. Sometimes it's better to take a little bit than to get nothing.” So if you face the decision to take Argentina's offer, which ended up being $0.34 on the dollar plus some extra payments if the economy did well. Or this cranky judge who is saying good luck trying to attach. He was Argentina's best friend for at least five years. He only got tired with Argentina later, which Elliott took advantage of.
Willy Walker: And so Elliott has Ted Olson. So to anyone who doesn't know the intricacies of this case, Ted Olson is an extremely famous litigator who has gone in front of the Supreme Court many times and actually was involved with the gay marriage case that made gay marriage in the United States legal. I can't remember exactly what the date is on that, Greg. But back in the early, what? ‘11, ‘12.
Gregory Makoff: 2012 or 2013.
Willy Walker: Exactly.
Gregory Makoff: Hollingsworth versus Perry.
Willy Walker: So Olson goes in front of Grecia and says, “on behalf of Elliott Management and points back to the Peru pari-passu claim and holds it up against Argentina.” Explain to our listeners what Ted Olson was arguing in front of Grecia with that claim that Elliot had successfully put in place against Peru.
Gregory Makoff: Yeah, I think we have to fill in the gap from the 2005 default to 2010. So Argentina does this deal. It sells it on the threat, 76% of creditors take it, and 20 billion don't. And there are hundreds of lawsuits, a total mess. So this relatively friendly judge gets swamped with chaotic mass litigation, big plaintiffs, small plaintiffs, class action plaintiffs, day and night motion suits, judgments, hearings, and attachments, it's horrible. And it's all failing because the sovereign immunity laws make it easy to sue. But every time they found an asset, the judge would read the rule. And it's very hard to keep an asset because the Foreign Sovereign Immunity Act of 1976 puts a very high bar to keeping it. And without going into the details, it was catch and release. Here we found a satellite part of Argentina. The judge reads the rules release it. We found a bank account. Release it. We found a ship, release it. At 2010, most creditors were exhausted and unsophisticated. Argentina reopens its offer. It went to Congress, got approval to do it again, and it raised the success rate to 92%. The judge is exhausted with Argentina. It wants them to pay. It wants the litigation over. In September 2010, only 8% of the original plaintiffs left. Led now by Elliott, who organizes them all. The chaos is gone, and Elliott sends Ted Olson to court to make an argument, saying, “Argentina is not helping us here. They won't pay this last 8%. Their economy is doing well. They had $50 billion in the bank. We're owed a couple of billion dollars. They are willfully ignoring the jurisdiction of your court, and we have a way to fix it.”
Now the clause has to do with how he justified the remedy. The breach is this, since 2001, the 8% hadn't received a penny. They were in default. They didn't take a restructuring offer. Argentina paid nothing. Those who took its deal in 2005 and ‘10 were getting their semiannual payments on their new bonds, a smaller amount of bonds, but they weren't getting paid regularly. How is it fair that one set of securities is getting paid in full, as due on time, and another gets zero every time? He says, “This is not equal treatment in Argentina's bonds have a clause saying you have to treat them equally.” What that meant was subject to much legal discussion. But when you looked at it any way you looked at it, it was unequal. Especially when Argentina passed a law saying they would never pay those who don't come in. With that argument, they convinced Judge Griesa to find a violation of a covenant but the art of it was the remedy. Because of the problem with a bond from a foreign country even under New York law. The courts up here, I'm sitting here in New York, and South America is down there. Whatever the court says, the government is a sovereign. They can say, “I won't do it.” But the clever remedy was the plaintiff's figured out reading the documents. All the cash flows from Argentina's bonds go from the central bank in Argentina by contract to New York City to the Bank of New York Mellon, who distributes it to the rest of the world. And because the judge sits in New York and has authority over any institution in New York. If the judge made an injunction against Argentina to not make payments to the 92% and sent that injunction over to the Bank of New York, they're not going to make the payment because violating an injunction on behalf of a client would be aiding and abetting a crime. And so they said, “See, you could do an injunction, and Argentina can't thumb its nose at it, and it will stop all this litigation in your misery processing these hundreds of cases will be over. It will be simple and over with. Finally, they will pay their just debts.” And the judge liked it. But he didn't just say yes, he didn't want to blockade the payment to the 92% who took a loss. Blockade them until they paid the 8% to get paid in full which was the proposal. That's not fair. 92% get $0.34 on the dollar, and 8% get full payment plus all past-due interest. He didn't want to do it, but he turned Argentina's table and said, “Well, okay, how are you going to pay off these judgments?” And they said, “I think I'll get around to it sometime.” And he said, “Well, I'm gonna rule for the breach.” And then it came to the injunction, and before he gave the injunction, he turned to Argentina's table, and they had no constructive solution. He said, “Well, I'm going to impose the injunction.” And they went to the Second Circuit, and the Second Circuit said, “Well, I'm going to affirm this injunction. Would you like a different payment plan?” It's kind of harsh to pay the 8% of everything owed. Now winning that future up front if they pay a penny to the 92%. And Argentina sent a letter to the Second Circuit saying my way or the highway? So the Second Circuit wrote in their final opinion that Argentina was a uniquely recalcitrant debtor and affirmed Judge Griesa. So it's a very odd situation because Argentina got a great deal on 92% of its debt, a historically deep haircut, but really stubbed its toe with the courts on this last 8%.
Willy Walker: And it wasn't until Macri came in as president in ‘16, where he comes in as the new president and says, “I'm done with all this stuff, settle it and get it done.” Do you think what would have happened if Macri hadn't come into Greg and said, “We're done here? I'm a new face to the Argentine government. I need to get this economy going. I don't need this. Sitting is an albatross around the country's international reputation. Solve it.” Do you think it would have kept on going, or Macri coming in at the end of the day the ultimate solution to all this?
Gregory Makoff: So we skipped over the step. When Argentina's appeals ran out in June 2014, this injunction went into effect, and Argentina had a choice. Given it was blocked from making these payments, it could either capitulate and pay the 8% in full to be able to process its payment to the 92%, though, as a payment due June 30, 2014, it had a one-month grace period. Or it can say I don't care, thumb its nose, not pay the 92% in order not to pay the 8% and unwind all of its progress since 2001, the worst case scenario. And the president, even though it sent a minister up and tried to negotiate a bit, eventually said, “No, thank you.” And Macri was going to be running for president. And they eventually decided, well, let's deal with this after the next election in 2015, and we'll have more bargaining power. So it looked very bad because Elliott was kind of the hero to the market fighting the big bad government. But then they got this injunction that led to a default on $30 billion in bonds, and the rest of the market was mad at them. And everybody looks bad here. But surprisingly, the Reformists Party led by Macri, won the election in 2015 by an inch and surprised everybody. He sent two really smart former investment bankers who were assigned to the secretary of finance and undersecretary of finance and sent him to New York and said, “Do not come back until you to fix the problem.” But instead of just telling the judge, I will pay and go home. They made a big issue with the special master named Daniel Pollack, hired by Judge Griesa, actually an old friend of his. And he said, “They don't want a hundred.” The old government offered $0.34 on the dollar. We'll offer 100, and we'll pay some interest. But these guys want ten times a hundred because they bought these funny bonds with these derivatives embedded so if they lent 100, they get a thousand back. And we don't want to do that. We want a discount and eventually with some other creditors on funny bonds, they negotiated a 30% discount with a bunch of the remaining 60,000 Italian holders. They paid 100 plus 50%, so 150% of par. And they went to the judge and said, “Well, we're being reasonable now. We're negotiating. Will you lift this injunction?” But Elliott and the other big plaintiffs didn't want that to happen. They wanted more and they didn't want to be dictated to. But the judge said, “Well, Argentina's not being uniquely recalcitrant anymore. I am going to lift the injunction.” So they were basically forced to settle at what became $0.75 on the dollar, plus payment of legal expenses and stuff. So it was a very dramatic twist ending. And this made Caputo and Bausili the two people sent up. Luis Caputo and Santiago Bausili very famous for not only settling it but also getting almost $1 billion in savings. Guess who is that minister of economy today under Milei? Luis Caputo, and the head of the central bank Santiago Bausili, are the stars of my last chapter. So I couldn't have imagined any of this happening when I was sitting in a pizza restaurant, having coffee and interviewing the now minister four years ago for his story about how he settled it.
Willy Walker: Although if Milei gets what he wants, Bausili may not have a job, but that's a whole other issue as it relates to whether the central bank even continues to exist in Argentina. Let me go to one specific thing before we move from that to the current day if you will, as it relates to both Argentina as well as the world in the US and China.
One of the things you write about, Greg, in the book is that the collective action clause could not be retroactively put on the Argentine bonds. My question to you is, are all sovereign issuances today, do they have a collection active clause that doesn't allow for the breakout of investors, like happened in the Argentine situation? Or are most sovereign bonds that are out there today do not have a collection action clause, which then allows for what happens in this case where you've got disparate investor groups that some settle, and others don't. You have this long, protracted, played-out legal battle.
Gregory Makoff: Yeah. Let me back up a little and explain it generally for those not familiar with the lingo. Sovereigns can't file for bankruptcy. Just like chapter 11, they say in the news. The company filed for protection from its creditors. Protection means a stay of litigation. So when a country defaults, it can't file under the bankruptcy code and ask the judge fora stay. There is no filing, and the litigation starts the next day. The other thing bankruptcy does in Chapter 11 is there's a plan, and there's a vote on the plan. And when it's accepted and the judge blesses it, and there's a vote of two-thirds of the creditors, the plan is accepted, and all the debt is discharged. The company is clean, and it has a new life. There is no bankruptcy filing for countries, so they don't have a vote and a discharge. So if Argentina's settled 76% of its debt in a voluntary offer, the other 24% is still there and still suits. Then in 2010, Argentina settled 92% of its debt, and the 8% is still left over, and it still sues. And after 2016, Argentina's settled 99% of its debt. And there are still some people suing today. So the market really did not like this re-default in 2014. The 92% the majority of the market. The black rocks of this world, the Fidelity's of this world. The PIMCO's of this world. We don't like these specialist funds who ask courts for blockades on payments to me, and they agree to buy new bonds where there's a voting provision, like in bankruptcy. But it's in the contract. So when you buy a bond in the contract, it says if 75% of us agree to a 50% haircut, it's binding on 100. Since 2014, every bond has had a very powerful version of these. From 2003, every bond had a moderately powerful version. As of now, I would say about 70% of bonds have these. In ten years, it'll be over 90%. And so, really, the market has solved this problem. Ecuador and Argentina defaulted and restructured in 2020. In COVID they had no holdout problems. They use these clauses. It works. You solve 80% of the problem with 10% of the effort. It's one of those things that works a lot, but it's not a full bankruptcy system solving every problem. And so the market is much improved. Argentina is still a mess, but Argentina's saga changed the world.
Willy Walker: I think it's important, as we talk about Argentina and the size of the Argentine economy. Many people probably don't know how to size Argentina's economy versus the United States or whatever else. So one data point that I went and pulled out is that the Argentine economy is about $650 billion a year economy, which is about the size of the state of Michigan's economy. So just to give people a sense here of the state of Michigan, for instance, today, I think, has just about $40 billion of debt at the state level at Michigan, which is about the same amount of debt as the country of Argentina has outstanding as well, except for the fact that Michigan happens to be part of the United States of America, whereas Argentina is out on its own. Anything else that people ought to keep in mind as we talk about, Argentina, the size of its GDP, its position on the world stage, and then also emerging market debt.
Gregory Makoff: Well, I can put it this way. My comparison of what matters in this world is that Argentina's GDP is about $600 billion, and the U.S. budget deficit last year was $1.7 trillion. You can fit three Argentine economies into our budget deficit. The biggest problem in the world of finance is US finances. Look what happened in the '80s when Volcker raised rates. It toppled all of Latin America. If we don't deal with our problems and our rates are going up a lot, it's global as a problem. So for me, yes, post-COVID, a lot of emerging markets countries are struggling. Everybody spent a lot of money to stimulate their economies and buy COVID vaccines and stuff. And that's feeding through in the poorest countries like Zambia, Suriname, Ghana, and Sri Lanka. Places like Egypt and Pakistan, which are much bigger, like $300 billion, $400 billion economies are stressed but not toppled. But when you come to stuff that matters to every mom and pop in America, your listeners, the thing that matters, what do we learn from Argentina about where we are today?
Willy Walker: But when you say that Greg, US GDP to debt is about a 1:1 ratio where $26 trillion here, $26 trillion there. You look at China. China is a $17.7 trillion economy. And it has $52 trillion of total debt outstanding, not foreign debt, because its central bank hasn't borrowed that much. But why doesn't that 3:1 debt-to-GDP ratio in China concern you a lot more than a 1:1 ratio in the United States?
Gregory Makoff: I am very focused in the work I'm doing now at Harvard on China. It's a closed economy. It's not really a market. So they have capital controls. It's a domestic problem. And people have noticed their growth is going down. It's because President Xi wisely understood they were having too much debt and started pulling it back. But the cost of slowing down debt creation is lower growth, and they're going to be dealing with that for a long time like Japan dealt with the crash of its ‘80s program for a long time.
Here we're an open market economy, and if you have an imbalance, you get punished for it. And it's very transparent and people understand it. And we are at a much lower level and safer level, and we're the best country in the world by every measure. But people are beginning to talk about it because while our debt is at a relatively benign 100, now we're in the hockey stick where it's beginning to accelerate. One reason it's been low for the last ten years is that interest rates have been artificially low since the global credit crisis. And now that rates are normalizing, then the interest expense builds and the accumulated debt is higher, and then it's compounding faster. Before 2050, we'll be at 150% debt to GDP. And there's a funny dialog going on in the paper. You have yesterday, the head of the Congressional Budget Office.
Willy Walker: What's his name?
Gregory Makoff: Phillip Swagel saying.
Willy Walker: I met with him, Greg, he came to the real estate roundtable last year. First of all, just a quick anecdote. If you had to do central casting in Hollywood for a movie, the head of the Congressional Budget Office, Phillip Swagel, is the person you would cast in that role. He just fits the mold perfectly as being a very straight-shooting, sort of accountant-based type of person. And go ahead, you dive into what he said yesterday.
Gregory Makoff: Yesterday, he said at a conference that we're on an unprecedented trajectory, and he's worried we'll have a debt crash and currency crash like the UK had in September 2022, when Liz Truss's new secretary of Exchequer, he announced a kind of imprudent tax cut on the highest wage earners and the market puked. And he says our debt is getting so big, that's a risk. Now, I've been thinking about that a lot. It is shocking as a market’s person. I've worked in markets since I got my PhD in ‘93 every day. To see the UK pound in the UK bond market crash is absolutely shocking, and you have to ask could that happen here? But I worked in the UK for seven years. They have a very narrow market, with five big investors on most of the bonds. It's not liquid like ours is. We have an infinite liquid market. If our debt goes bad, the yields will go up, but it won't crash because there's another buyer. But the problem is that I agree with Mr. Swagel's concern. Our debt is too high. But what happens is then you get Eisman, the guy from The Big Short, saying, “Oh well, I'm not really worried about debt.” So do you believe as a listener to Mr. Swagel, who says, “It's urgent,” or Mr. Eisman, who says, “Oh, I'm not worried about it, we'll be fine”? The problem is that you have to think of the 100% debt to GDP like you think about your bank account.
Let’s say you have $100,000 in your savings account for retirement. And you look at it, and next year it goes to $110,000, and you're happy with it. And you pay attention to it because it matters because you're going to live on that in your retirement. Nobody's paying attention and thinking of this 100% of GDP, $30 trillion of debt, which we all owe. And that's future taxes we have to pay. And that’s future, benefits from the government that are going to be cut. Things we're used to, like Social Security and Medicare. And so we should be concerned if that little account that we're not bothering with now goes from $100 to $150 in the next 20 years because we will have to pay it. We're acting like Argentine politicians who always party now and pay later. And as much as we have different people pointing fingers at each other, we have nobody here compared to Milei saying, “I'm going to make tough decisions for the stability of the long term,” and I don't think we have to do what he is doing. I think we need a rational conversation about bending the curve. We're this far apart, our parties. In the ‘90s, we were pretty close. We could compromise. We made decent fiscal decisions and ended the decade of the ‘90s in the best shape we've ever been as a nation. Then we had wars, crises, COVID, tax cuts, and this horrible partisan divide. We need to get back towards the center, where we can have conferences and conventions of people from both parties who can come up with a plan that's going to include compromise on both sides.
Willy Walker: I guess on that, we've got two candidates. Both will be former presidents, whichever one is either getting reelected for the second time after taking some time off or another one who's being reelected as a sitting president. One seems to be a profligate spender with no thought of the fiscal House and having a proposed budget of $7.5 trillion. And as you said previously, a deficit of $1.5 trillion on $7.5 trillion. You have another one who is proposing the reinstatement of tax credits, which will add $5 trillion to the federal deficit if those tax cuts get extended when they're supposed to expire in 2025. So this issue that you just talked about eloquently, directly, is clearly on the two major party candidates, nowhere to be found on either one of their platforms. So how is it that smart scholars like you, very smart practitioners like Phillip Swagel at the Congressional Budget Office, are basically jumping up and down saying, “Beware, this is a train wreck ready to happen. And yet neither of the major parties are actually putting forth proposals that would exacerbate the problem”.
Gregory Makoff: I'm worried. And I think the problem isn't just the one issue, it's every issue. We're not talking about global warming the right way. I'm worried about where our debt is in 2050, but I'm worried that parts per million of carbon dioxide is 425, and it's going to be a lot higher. We're going to have a lot more damage happening on our coasts and stuff. We are not having rational discussions. So I'm thinking for the Congress, for the House, for the Senate, for every single office, even local and state, we need to vote in centrists. So I'm not saying Republican or Democrat. We need both types. We need people who want lower taxes. And we need people that argue for benefits that are humanly needed. Look, we need spending. We need to deal with the competition from China. We need to deal with climate change. But it's a question of calibrating. If we spend, it needs to support real growth, it can't be handouts. And if we tax, it has to be efficient. But we're not talking about efficiency and logic. We have a politics of divide. We have a politics of emotion. And so I offer my book. I'm an analytical person and how to think about debt, how to ask the right questions about it, and understand how painful it is if you screw up with it. That sort of message, I want to leave.
Willy Walker: Do you think that the broader debt, problem/crisis, that you articulated a moment ago has the ability in the short term, not 2050. We're talking 2024 into ’25, ‘26 to make it so that as the Fed starts to cut the Fed funds rate, that the ten-year stays begrudgingly high. Because of this concern, the fiscal house in the United States is affected overall. That investors sit there and say, “Yeah, you might have the short bond coming down, but for me to go buy a ten-year Treasury, I need a yield of 4.5% because I think there's a heightened risk on the long bond.”
Gregory Makoff: Not at all. What I think you have with Mr. Swagle and the other smart scholars, including at Harvard, who are raising their hand and saying debt is a problem. They're going to be called Chicken Little because we're not going to crash today and we're not going to crash next year, and we're not going to crash the next year, or the following year. For those like me who predict a crash, people are going to say the crash didn't come, so I'm not going to listen to you. That's why I suggest watch the slow creep up of our liability, which we all owe. And I honestly think most of the market is a commodity market going off of supply and demand. There's a huge demand for investment in those ten-year bonds that are going to rally, and that's going to be good for the world. So in the short run, in the four to eight year horizon, I'm with Mr. Eisman. It's not a problem. Because it's not a problem for your stock market investments in two years and four years in ten years. That doesn't mean you can ignore it because it's a time bomb that's getting bigger. And the thing about Chicken Little in the children's story is the sky never falls. There were analysts at my bank in the mid-'90s saying Argentina was going to default because the numbers didn't add up. As soon as the Brazil devaluation, people didn't want him to talk out loud. The Argentines complained he could only talk to hedge funds privately. People don't want to hear that. But they're always right. Because the day of reckoning comes. So you have to be analytical. But as you said, politically, you kind of need a crisis to shock people into doing anything about it. And I would rather we elect thoughtful people who can use analysis to decide to do something prudent ahead of us hitting a very painful crash and extra painful adjustment.
Willy Walker: My final question, as I think about currency, and you talked about the UK a moment ago, clearly the UK economy, the liquidity in the market, its currency, it's nothing close to the United States. We happen to have the great benefit of being the reserve currency in the world. As the euro was gaining more market share, there was very clearly a potential alternative to the dollar. We now know that the amount of euros outstanding versus dollars is no comparison. Does crypto present the opportunity to continue to grow and be a viable competitor to the dollar as it relates to the reserve currency? Or is that just so far out there that so many different things would have to happen, that crypto really isn't a viable alternative to the dollar?
Gregory Makoff: I don't think it's safe at all. If I have $10,000, I want to put it in JP Morgan. It's a regulated institution where the money is safe. You're really in the Wild West if you're putting any substantial amount of your money in crypto. I can't see mainline investors or central banks really trusting this asset class, especially when there are so many of them. Think about it. We have the dollar. The $1 markets love one bond. When I traded at Solomon Brothers we always talked about the on the run. You have the 30-year bond. But when the new 30 went to auction, nobody traded the old bond. Everybody switched to the third to the new bond. Everybody trades that on the run. They only want to trade one thing. So if anything survives, it's only Bitcoin. And all those other cryptos should be worth zero. So that kills a lot of value there. And then there's the question, does this really work? So I think the dollar is like a central bank digital currency to make it easier to transfer. So you don't have to pay so much for Mastercard and visa and stuff like that. You can further digitize payments without having to buy into trading puka shells or whatever. The new thing everyone agrees on, I think it's a fad. I think it's dangerous. I think for people who have some speculative money around, it's you're playing a trading game with bigger fool theory. So I'd rather buy real bonds from real countries that are being prudent. Mexican bonds, Peruvian bonds, or South African bonds. You get a good yield. And if you've studied the country, maybe you trust they'll pay for the next ten years. American bonds, but I think crypto, you might get zero.
Willy Walker: I said that was going to be my final question, but I want to loop back to Argentina for one final one, which is this. Hard to define what success will be for Milei. So I guess the way I would ask it, I would think this would be a success, which is that he gets reelected to a second term. What do you think the odds are that Milei gets elected to a second term as just a proxy for, “success or failure”?
Gregory Makoff: I would say the success or failure is the midterm election. If he can pick up seats and get a critical majority to start passing his plan, then he has a chance of winning the long-term battle. So that would be 2025 October, I think. And that's all eyes on that.
And the question is, can he rule by decree and keep the economy improving until he has the power of Congress? Look, I want Argentina to succeed. I want the people to be out of crisis. I'm an optimist. And you get paid handsomely. If you bet on Argentina and they work on their bonds now, and you make a good return. You're betting against history. So I can't give financial advice, but I do talk to investors about this very bet. And I really want it to work, but I really hope that people compromise. They find a center, they agree on a program, and they're not fighting. It is suboptimal to wait for the next election to actually come up with a plan.
Willy Walker: Gregory, I greatly appreciate you taking the time. Your book Default is fantastic. Anyone who hasn't read it, I would strongly recommend it. And I really appreciate you spending the time talking about all this. This is a topic that fascinates me, and I'm super happy and thankful for your insight.
Gregory Makoff: Thank you very much. This has been great.
Willy Walker: Have a great day. Take care.
Gregory Makoff: Bye bye.
