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Argentina’s Ultra-Long Bond Sale: Is the US Next?

by | Jun 22, 2017 | Economic Affairs News

ANDREW MORAN

Over the last eighteen months, a popular tool for governments facing a fiscal mess is an ultra-long bond. This is exactly what Argentina utilized on Monday when it sold $2.75 billion worth of 100-year bonds. The South American nation joins the likes of Ireland, Mexico and the U.K. in hopping on the long-term bond bandwagon. Will the U.S. be next? The Treasury has already hinted at just this very financial maneuver.

It turns out that there was immense demand for the bond. Argentina received $9.75 billion in orders for it, causing an oversubscription rate 3.5 times what the government initially sold, reports Reuters. This is because it offered a yield of 8.25% – it later declined to 7.9% because of the heavy volume.

Despite the various warnings from financial experts and the volatility regularly experienced in Argentina, investors dove right in. The Ministry of Finance declared the sale a success, explaining that Argentina has regained the confidence from international investors and renewed its credibility on the world stage.

Argentina’s excitement was slightly diminished when its other bonds dipped. The nation’s 2032 par bond slid 1.5 percent, the 2038 dollar bond tumbled 1.5 cents and the 2046 bond issue dropped 2.6 cents.

Money managers questioned if this bond will finally encourage the government to end its borrowing and default cycles. Others, including Jorge Piedrahita, CEO of Puma Investments, wondered if it is still a bit early for Argentina to begin issuing long-term bonds, especially since it has only been a year since the government completed a 10-year-long battle with creditors pertaining to its 2002 default:

It’s awfully premature for Argentina to issue 100-year bonds. When you look back in history, I’m not sure we can find a 20-year period where Argentina has not defaulted.

If Argentina has such a shaky financial past, why would investors park their funds into these bonds? It’s simple: the yield. In today’s fixed-income market, the yields are low; Japan’s 40-year bond, for example, offers just 0.345%. With about $1 trillion of government debt offering negative rates, investors need to get their hands on any kind of yield, and Argentina’s is one of the most attractive yields today.

In a country where many citizens remain hesitant about accumulating debt in dollars, Argentines took to social media making fun of the situation. One tweeted if Argentina would even be around in the next century, while another person jested that at least cockroaches would pay off the debt in 100 years.

Ultimately, the Argentine government is kicking the can down the road as it saddles the next ten generations with vast amounts of debt that will likely never be paid off.

Can the same thing happen to the U.S.? The wheels are already in motion.

Speaking in an interview with CNBC in February, Treasury Secretary Steven Mnuchin revealed that the Trump administration is studying the U.S. government perhaps offering 50- and 100-year bonds. With interest rates still at historic lows and Washington awash in debt, Mnuchin says the administration thinks it can save taxpayers a lot of money by issuing ultra-long bonds:

I think it’s something we should seriously look at. I’ve already begun to talk to the staff about looking at that. We’ll reach out to the market, investors, different people, but I think it’s something that is a very serious issue of whether we should explore whether we can raise 50- or 100-year money at a very slight premium. That’s something that makes sense for Treasury to look at.

Should the U.S. channel the spirit of Alexander Hamilton – he was a strong advocate of these bonds – the nation would join several countries, including Austria, Japan, Spain, Belgium, France, and Italy. This would please Barron’s magazine, Larry Kudlow, and fans of the hit Broadway musical “Hamilton.”

However, if the U.S. does move ahead with 100-year bonds, it would be getting in at the wrong time. There is a looming bubble in long-term debt, which could morph ultra-long bonds into junk territory.

Although these bonds provide better overall yields, the primary concern is when rates begin to go higher. With a tidal wave of inflation inevitable in the U.S., the Federal Reserve will have no other choice but to pull the trigger on multiple rate hikes to combat inflation, as Paul Volcker did in the 1970s and 1980s.

Mark Tiberius of the Mises Institute makes a great point:

Goldman Sachs, for instance, forecasts that a simple 1 percent increase in interest rates could inflict $1.1 trillion in losses to the Bloomberg Barclays U.S. Aggregate Index, representing a larger loss for bondholders than any other time in history! This figure doesn’t include other forms of securities such as bank loans on company balance sheets or interest rate derivative contracts. The institutions mentioned above hold many of the assets that comprise this index — and thanks to years of monetary policy stimulus we have a major duration bubble on our hands.

If President Donald Trump does decide to issue 100-year bonds, he could potentially inflict a lot of pain in the bond market and maintain the pecuniary status quo in Washington. This wouldn’t necessarily mean that President Trump would be entirely to blame, considering that the national debt stands at $20 trillion and there is $120 trillion worth of unfunded liabilities and expenditures. That said, under his watch, the can would be kicked further down the road, and the long-term debt bubble would burst.

For so many years, the U.S. has spent money it didn’t have, and politicians continued to portray themselves as Santa Claus. It would be preferable for governments to rein in their spending now rather than delaying massive spending cuts once again to produce long-term pain. When the next financial crisis occurs, the U.S. government won’t have the Federal Reserve to bail them out. With a $4.5 trillion balance sheet, historically low-interest rates, asset bubbles and malinvestments, there is nothing left for the U.S. central bank to do.

This means Washington can only perform one act: purge.

But, like legendary free-market economist Milton Friedman said:

Governments never learn. Only people do.

Isn’t that the truth?

Read More From Andrew Moran

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