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Rivals More Than Ever : Hongkong and Shanghai
China's Suspended Politics
Bush Signs Compromise Economic Stimulus Bill
Free trade : Tangled Up in Textiles

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Saturday April 6, 1:22 pm Eastern Time
Reuters Business
Wall St. Still Sees Fed on Hold Until June

NEW YORK (Reuters) - The Federal Reserve will likely keep short-term U.S. interest rates steady near four-decade lows until at least late June to make sure the economy recovers fully from its first recession in a decade, a Reuters poll of Wall Street bond dealers found on Friday.


None of the 22 primary dealers which transact directly with the Fed expected the central bank to raise its federal funds overnight bank lending rate at its next meeting on May 7, the survey found.

The number of dealers expecting rates to go up at the Fed's late-June meeting fell slightly to 12 from 14 at the last Reuters poll on March 19. But 16 dealers said that by August, a strong, sustainable recovery would be in place to allow benchmark rates to head higher.

While the gears of a broad economic recovery have fired up since the Sept. 11 attacks, a report on Friday showing the U.S. jobless rate rose to 5.7 percent in March from 5.5 percent in February caused many investors and analysts to push back the date for an expected Fed interest rate hike.

``It really underscores that the improvement in the labor markets is very gradual at this point and pretty much blows the idea that the Fed would want to quickly raise rates,'' said Dana Johnson, head of research at Banc One Capital Markets in Chicago.

The poll also found that 16 of 22 dealers expect the fed funds rate, currently at 1.75 percent, to be at least a full percentage point higher by year's end.

At its last meeting in March, the Fed switched its policy stance to say the economy's risks were more balanced between future economic weakness and a buildup in inflation pressures -- a first step before raising interest rates.

Wall Street economists are forecasting robust first-quarter growth of 5 percent to 6 percent, primarily as manufacturers boost production to restock bare shelves after a record-paced inventory liquidation drove the economy into recession last year.

But Fed officials have sounded a note of caution, saying they want to see evidence of solid spending from both consumers and businesses in coming months that will ensure the economic rebound lasts.

Robert McTeer, the president of the Dallas Fed and a member of the Fed rate-setting committee, said in a Reuters interview late on Thursday that he would like to see the unemployment rate fall below 5 percent and factory usage pick up before he would consider lifting rates from their low levels.

``I don't have any time period in mind. We've got slack in the economy,'' McTeer said.

While some economists have argued that the central bank would likely push benchmark rates up in coming months, saying they are unusually ``stimulative'' at 1.75 percent, many said the Fed has room to keep rates steady while inflation remains muted.

``It's awfully early for the Fed to be thinking about tightening,'' said Jim Glassman, senior U.S. economist at J.P. Morgan Chase & Co. ``Everybody's obsessing with the low funds rate. You hear it's the lowest in 40 years. But guess what? So is inflation,'' he said.

Since the last poll, the number of primary dealers has shrunk to 22 from 24. Zions First National Bank and BMO Nesbitt Burns dropped their primary dealer status on April 1.

 

Oil Embargo Threats Carry More Weight
5 April 2002

Summary

The threat of an oil embargo against the West, particularly the United States, has more weight in light of the current violence in the Palestinian territories. However, an embargo seems unlikely for a number of reasons. Any targeted state would be able to procure replacement oil from a number of sources. Furthermore, those that would be hit hardest by an embargo include countries in Asia that are sympathetic to the Palestinian cause and are still struggling with the effects of Asia's own regional recession.

Analysis

Stripped of the Middle East's political complications, the underlying energy market is broadly stable. That does not mean oil prices are likely to drop back into the $15-per-barrel range. The escalation of the Israeli-Palestinian crisis has nurtured a climate in which spurious threats can develop quite long legs. Recent threats of embargos against the United States may not hold any more weight than they did last year, but against a bloodier backdrop, they carry more significance.

Oil prices have moved up from lows of $16.60 a barrel in November 2001 to a high of $27 a barrel on April 5. Yet despite this recent price rise, the oil market's underlying fundamentals are largely stable. Typically spring is the season of weakest demand, but a rapidly recovering American economy is helping pick up the slack. Furthermore, the increase in U.S. military demand for oil is helping prices spike.

There are only two systemic factors that might upset this equilibrium before 2003. First, Angola and Russia are both dramatically expanding their production capabilities. By year's end the two countries will likely be pumping another 500,000 bpd collectively. Second, the lack of investment in the oil sector by Venezuelan President Hugo Chavez has gutted that country's long-term ability to function as a major oil supplier. Venezuela may also face a short-term problem, with oil workers from the state-owned Petroleos de Venezuela (PDVSA) threatening a strike that could shut down production temporarily.

But while the oil markets themselves can be analyzed on a long-term basis stripped of political factors, these complications must be included when generating short-term analysis. That is particularly true in the current case given that political factors -- specifically the current Israeli-Palestinian conflicts -- are almost wholly behind the oil price surge in recent weeks. Certainly major U.S. military actions in the region would heighten oil prices. However, despite the latest statements of the Bush administration, current U.S. deployments do not show this as imminent.

The key here is not Palestinian militants, but Israel's reactions to them. While the level of violence may cause the markets to become jittery, Palestinians are neither major producers nor consumers of oil. It is the Israeli retaliation to Palestinian attacks -- and then wider Arab reactions to those Israeli actions -- that really make the oil markets jump. These actions and reactions have added about a $5 per barrel premium in the oil markets.

This premium, however, is likely to hold in place only so long as the region remains tense. If there are no bombings and no retaliation, there will be no international condemnations, and tensions will alleviate, at least in the short term. Meantime the tensions provide a climate that heightens the significance of threats that would previously have been dismissed out of hand.

Iranian supreme leader Ayatollah Ali Khamanei made such a threat April 5 when he called upon all Muslim states to "shake the world" by halting oil exports to "pro-Israel" Western states. Such an embargo is unlikely since without accompanying revenue and production cuts, any targeted state can easily procure oil from alternative producers. Furthermore, any serious embargo that includes real production cuts would inflict far more harm upon countries that are sympathetic to the Palestinian cause, particularly in Asia.

This, obviously, hasn't stopped Khamanei from threatening a potential embargo. Indeed, his simply making the proposal at Friday prayer services in Tehran jacked oil prices up to $27 per barrel, a level not seen since the week immediately after Sept. 11.

Short-term prices would certainly skyrocket if an embargo did indeed occur because other producers lack the spare capacity to cover the shortfall. Under the kindest of estimates, Mexico and Norway can add only 200,000 bpd each. Angola and Russia might be able to accelerate their production plans, but neither has any spare capacity to bring on line. The two non-Muslim OPEC states -- Nigeria and Venezuela -- can add only 400,000 and 300,000 bpd. In the event of massively high prices, Venezuela could tap its vast tank farms and potentially add 1 million bpd for 70 days from existing stocks. But even this could hardly lessen the impact of a concerted effort to cut supplies to the United States by Muslim producers who collectively control over 20 million bpd of production.

Still, in the unlikely event of an actual embargo, the Muslim producers would quickly discover the weaknesses of their actions. The West is not nearly as dependent upon oil as it was in 1973. The United States consumes only 60 percent as much oil per dollar of GDP generated as it did in 1973. It is the reverse situation for most of Asia. For an oil embargo now to deliver the same level of economic shock to the West as did the 1973 energy crisis, the per barrel price would need to hit $90, a target well beyond the Muslim world's ability to deliver. Any oil embargo large enough to actually harm the West would decimate Asia, including Muslim countries, which has yet to recover from the 2001 global recession.

 

When Nations Go Bankrupt

Apr 4th 2002
The Economist Global Agenda


The International Monetary Fund has put forward radical new proposals this week to deal with the problem of sovereign-debt crises. But America seems determined to oppose them


UNDER President George Bush, the American Treasury has argued that the world needs a better way to deal with countries that cannot pay their debts and this week joined the debate with proposals of its own, countering new ideas just put forward by the International Monetary Fund. Argentina’s plight proves the need for changes. Efforts to restructure the debts that caused the biggest sovereign default in history have not even started—and the first bondholder has already sued in a New York court. Sorting out this financial, political and legal mess will be a long, arduous, wealth-destroying process for Argentina and its creditors alike. Unfortunately, America’s proposed remedies hold out little hope of progress.

Sovereign-debt crises are messy because there is no clear legal procedure. Countries, unlike companies, cannot seek the protection of a bankruptcy court. Important features of domestic bankruptcy law—an impartial judge, protection from lawsuits, the ability to force restructuring terms on recalcitrant creditors—do not exist for sovereign borrowers. The dilemma facing reformers is how to plug this hole in the international financial system without scaring off investors in emerging markets altogether.


Resolving the debt crisis of the 1980s meant protracted negotiations with banks. Since the 1990s, when emerging-market bonds became popular, the situation has only worsened. Organising the disparate owners of diverse bonds in different jurisdictions has proved a nightmare. Though sovereign restructurings are possible—Russia, Ukraine and Ecuador have all recently restructured their debts—the process clearly needs improvement. For those sceptical of international institutions, like many American conservatives, the idea holds particular attraction since, in their view, it might lessen the need for IMF rescues.

A big challenge is how to encourage collective action among creditors. Although it may be in the interest of creditors as a whole to co-operate with each other and the debtor country in a restructuring, it can be in the interests of an individual creditor to hang on and demand full payment—the so-called “last-man syndrome”. Bonds governed by New York law traditionally encourage rogue creditors. Improving the procedure for sovereign defaults means finding ways to bind in the rogues. Ideally, agreements would be binding across different asset-classes and jurisdictions, and would provide a legal framework for countries to tap new debt.

More radical proposals for sovereign-debt reform involve changing international law, either by creating an international bankruptcy court or by giving the IMF adjudicating powers. More cautious reformers are leery of statutory solutions and of undermining creditor rights. They contend that creditors should still control the terms of restructuring and they propose reforms that improve co-ordination among creditors. A popular proposal is to encourage countries to adopt “majority-action” clauses in their bond contracts. These clauses prevent rogue creditors subverting a restructuring.


A job to be done

Last November, Anne Krueger, first deputy managing director of the IMF, proposed changes that would put the IMF at the heart of bankruptcy procedures. In the face of stiff opposition—from creditors and from governments in both rich and poor countries—she proposed a modified version this week. Her new plan tries to secure the benefits of a legal reform without the political difficulties of expanding the Fund’s power.

Ms Krueger wants to amend international law (by changing the IMF’s articles of agreement) in a way that allows a supermajority (60-75%) of creditors to make the terms of a restructuring binding on all the rest. The Fund—or some other arbitration body—would simply oversee voting and adjudicate disputes. This idea has several merits: it would address all creditors and it would cover all existing debt. Details remain to be filled in, but it is a clever compromise.

Mimicking the features of domestic bankruptcy was once an option touted by America’s treasury secretary. Now, however, the Bush administration has decided it is none too keen. John Taylor, the top international man in America’s Treasury, is against reforms that are too “centralised”, or forced on emerging markets and their creditors by a change in the Fund’s rules. Instead, the administration wants to encourage creditors and borrowing countries to change their bond contracts voluntarily in a way that makes future restructuring easier. New bond contracts could include clauses that allow a majority of bondholders to authorise a debt restructuring (under American law, the financial terms of a bond contract cannot normally be changed unless all bondholders agree). International financial reform, says the Bush administration, should do no more than encourage this shift by, say, offering countries lower interest rates on IMF loans.

Keeping out of it

The Treasury’s new position is politically attractive. It avoids the tough job of cajoling Congress into approving a change in the IMF’s rules; it avoids giving any more power to an institution that the Bush administration views with deep suspicion; it avoids upsetting Wall Street. But there are drawbacks. The new clauses Mr Taylor proposes that borrowing countries add to their debt contracts (potentially bank loans as well as bonds) would “describe as precisely as possible” what happens when a country gets into trouble. That means not only the “majority-action clauses” that cautious reformers have long touted, but also clauses that describe exactly how a default would be initiated, how a restructuring would take place, and how disputes among different creditors would be arbitrated.

If all debtor countries had these clauses for all their bonds and loans, the framework for sovereign workouts would not be dramatically different from that proposed by Ms Krueger—just weaker. For instance, lawyers argue, contract-based reforms rather than changes to international law do not solve the difficulty of co-ordinating across debt instruments or between jurisdictions. More important, Mr Taylor offered no credible way to persuade countries to adopt these clauses for all their debt.


A big challenge is how to encourage collective action among creditors


If the clauses make both borrowers and creditors better off, as Mr Taylor implies, then the question is why they have not already been introduced. The answer is that clauses describing default are an unattractive prospect when a country issues debt: about as romantic, as one debt lawyer puts it, as a prenuptial agreement. Borrower countries fear such clauses would raise their borrowing costs. Underwriters fear that business would go elsewhere. Ironically, there would be a collective-action problem in getting Mr Taylor’s wide-ranging clauses adopted.

Mr Taylor talks vaguely about offering countries financial incentives to encourage adoption. He suggests making their introduction a condition for receiving IMF loans—a strategy likely to associate such clauses with weaker borrowers in the eyes of investors. Mr Taylor needs a more direct approach. Washington could, for instance, make such contracts mandatory for any bond issued in New York. But, ever suspicious of government meddling, Mr Taylor is unwilling to mandate anything at all. Ms Krueger, to her credit, realises that statutory change is necessary.

Even if the new clauses caught on widely, the Treasury’s approach is somewhat beside the point. It applies only to new debt. It has almost nothing to say about restructuring the existing debt. If the new clauses did come to be commonly used, they would make restructuring smoother, but they would still fail to solve a key problem: today’s sovereign defaults involve numerous creditors holding many kinds of claim, from bonds to trade credits. Modifying individual bond contracts would make it no easier for a country to reach an overall restructuring agreement with its assorted existing creditors. That demands a change in international law. Unfortunately, the Bush administration, with its blocking vote at the IMF, has chosen not to seek it.

 

 

 

Saturday April 6, 1:22 pm Eastern Time
Reuters Business
Wall St. Still Sees Fed on Hold Until June

NEW YORK (Reuters) - The Federal Reserve will likely keep short-term U.S. interest rates steady near four-decade lows until at least late June to make sure the economy recovers fully from its first recession in a decade, a Reuters poll of Wall Street bond dealers found on Friday.


None of the 22 primary dealers which transact directly with the Fed expected the central bank to raise its federal funds overnight bank lending rate at its next meeting on May 7, the survey found.

The number of dealers expecting rates to go up at the Fed's late-June meeting fell slightly to 12 from 14 at the last Reuters poll on March 19. But 16 dealers said that by August, a strong, sustainable recovery would be in place to allow benchmark rates to head higher.

While the gears of a broad economic recovery have fired up since the Sept. 11 attacks, a report on Friday showing the U.S. jobless rate rose to 5.7 percent in March from 5.5 percent in February caused many investors and analysts to push back the date for an expected Fed interest rate hike.

``It really underscores that the improvement in the labor markets is very gradual at this point and pretty much blows the idea that the Fed would want to quickly raise rates,'' said Dana Johnson, head of research at Banc One Capital Markets in Chicago.

The poll also found that 16 of 22 dealers expect the fed funds rate, currently at 1.75 percent, to be at least a full percentage point higher by year's end.

At its last meeting in March, the Fed switched its policy stance to say the economy's risks were more balanced between future economic weakness and a buildup in inflation pressures -- a first step before raising interest rates.

Wall Street economists are forecasting robust first-quarter growth of 5 percent to 6 percent, primarily as manufacturers boost production to restock bare shelves after a record-paced inventory liquidation drove the economy into recession last year.

But Fed officials have sounded a note of caution, saying they want to see evidence of solid spending from both consumers and businesses in coming months that will ensure the economic rebound lasts.

Robert McTeer, the president of the Dallas Fed and a member of the Fed rate-setting committee, said in a Reuters interview late on Thursday that he would like to see the unemployment rate fall below 5 percent and factory usage pick up before he would consider lifting rates from their low levels.

``I don't have any time period in mind. We've got slack in the economy,'' McTeer said.

While some economists have argued that the central bank would likely push benchmark rates up in coming months, saying they are unusually ``stimulative'' at 1.75 percent, many said the Fed has room to keep rates steady while inflation remains muted.

``It's awfully early for the Fed to be thinking about tightening,'' said Jim Glassman, senior U.S. economist at J.P. Morgan Chase & Co. ``Everybody's obsessing with the low funds rate. You hear it's the lowest in 40 years. But guess what? So is inflation,'' he said.

Since the last poll, the number of primary dealers has shrunk to 22 from 24. Zions First National Bank and BMO Nesbitt Burns dropped their primary dealer status on April 1.

 

Oil Embargo Threats Carry More Weight
5 April 2002

Summary

The threat of an oil embargo against the West, particularly the United States, has more weight in light of the current violence in the Palestinian territories. However, an embargo seems unlikely for a number of reasons. Any targeted state would be able to procure replacement oil from a number of sources. Furthermore, those that would be hit hardest by an embargo include countries in Asia that are sympathetic to the Palestinian cause and are still struggling with the effects of Asia's own regional recession.

Analysis

Stripped of the Middle East's political complications, the underlying energy market is broadly stable. That does not mean oil prices are likely to drop back into the $15-per-barrel range. The escalation of the Israeli-Palestinian crisis has nurtured a climate in which spurious threats can develop quite long legs. Recent threats of embargos against the United States may not hold any more weight than they did last year, but against a bloodier backdrop, they carry more significance.

Oil prices have moved up from lows of $16.60 a barrel in November 2001 to a high of $27 a barrel on April 5. Yet despite this recent price rise, the oil market's underlying fundamentals are largely stable. Typically spring is the season of weakest demand, but a rapidly recovering American economy is helping pick up the slack. Furthermore, the increase in U.S. military demand for oil is helping prices spike.

There are only two systemic factors that might upset this equilibrium before 2003. First, Angola and Russia are both dramatically expanding their production capabilities. By year's end the two countries will likely be pumping another 500,000 bpd collectively. Second, the lack of investment in the oil sector by Venezuelan President Hugo Chavez has gutted that country's long-term ability to function as a major oil supplier. Venezuela may also face a short-term problem, with oil workers from the state-owned Petroleos de Venezuela (PDVSA) threatening a strike that could shut down production temporarily.

But while the oil markets themselves can be analyzed on a long-term basis stripped of political factors, these complications must be included when generating short-term analysis. That is particularly true in the current case given that political factors -- specifically the current Israeli-Palestinian conflicts -- are almost wholly behind the oil price surge in recent weeks. Certainly major U.S. military actions in the region would heighten oil prices. However, despite the latest statements of the Bush administration, current U.S. deployments do not show this as imminent.

The key here is not Palestinian militants, but Israel's reactions to them. While the level of violence may cause the markets to become jittery, Palestinians are neither major producers nor consumers of oil. It is the Israeli retaliation to Palestinian attacks -- and then wider Arab reactions to those Israeli actions -- that really make the oil markets jump. These actions and reactions have added about a $5 per barrel premium in the oil markets.

This premium, however, is likely to hold in place only so long as the region remains tense. If there are no bombings and no retaliation, there will be no international condemnations, and tensions will alleviate, at least in the short term. Meantime the tensions provide a climate that heightens the significance of threats that would previously have been dismissed out of hand.

Iranian supreme leader Ayatollah Ali Khamanei made such a threat April 5 when he called upon all Muslim states to "shake the world" by halting oil exports to "pro-Israel" Western states. Such an embargo is unlikely since without accompanying revenue and production cuts, any targeted state can easily procure oil from alternative producers. Furthermore, any serious embargo that includes real production cuts would inflict far more harm upon countries that are sympathetic to the Palestinian cause, particularly in Asia.

This, obviously, hasn't stopped Khamanei from threatening a potential embargo. Indeed, his simply making the proposal at Friday prayer services in Tehran jacked oil prices up to $27 per barrel, a level not seen since the week immediately after Sept. 11.

Short-term prices would certainly skyrocket if an embargo did indeed occur because other producers lack the spare capacity to cover the shortfall. Under the kindest of estimates, Mexico and Norway can add only 200,000 bpd each. Angola and Russia might be able to accelerate their production plans, but neither has any spare capacity to bring on line. The two non-Muslim OPEC states -- Nigeria and Venezuela -- can add only 400,000 and 300,000 bpd. In the event of massively high prices, Venezuela could tap its vast tank farms and potentially add 1 million bpd for 70 days from existing stocks. But even this could hardly lessen the impact of a concerted effort to cut supplies to the United States by Muslim producers who collectively control over 20 million bpd of production.

Still, in the unlikely event of an actual embargo, the Muslim producers would quickly discover the weaknesses of their actions. The West is not nearly as dependent upon oil as it was in 1973. The United States consumes only 60 percent as much oil per dollar of GDP generated as it did in 1973. It is the reverse situation for most of Asia. For an oil embargo now to deliver the same level of economic shock to the West as did the 1973 energy crisis, the per barrel price would need to hit $90, a target well beyond the Muslim world's ability to deliver. Any oil embargo large enough to actually harm the West would decimate Asia, including Muslim countries, which has yet to recover from the 2001 global recession.

 

When Nations Go Bankrupt

Apr 4th 2002
The Economist Global Agenda


The International Monetary Fund has put forward radical new proposals this week to deal with the problem of sovereign-debt crises. But America seems determined to oppose them


UNDER President George Bush, the American Treasury has argued that the world needs a better way to deal with countries that cannot pay their debts and this week joined the debate with proposals of its own, countering new ideas just put forward by the International Monetary Fund. Argentina’s plight proves the need for changes. Efforts to restructure the debts that caused the biggest sovereign default in history have not even started—and the first bondholder has already sued in a New York court. Sorting out this financial, political and legal mess will be a long, arduous, wealth-destroying process for Argentina and its creditors alike. Unfortunately, America’s proposed remedies hold out little hope of progress.

Sovereign-debt crises are messy because there is no clear legal procedure. Countries, unlike companies, cannot seek the protection of a bankruptcy court. Important features of domestic bankruptcy law—an impartial judge, protection from lawsuits, the ability to force restructuring terms on recalcitrant creditors—do not exist for sovereign borrowers. The dilemma facing reformers is how to plug this hole in the international financial system without scaring off investors in emerging markets altogether.


Resolving the debt crisis of the 1980s meant protracted negotiations with banks. Since the 1990s, when emerging-market bonds became popular, the situation has only worsened. Organising the disparate owners of diverse bonds in different jurisdictions has proved a nightmare. Though sovereign restructurings are possible—Russia, Ukraine and Ecuador have all recently restructured their debts—the process clearly needs improvement. For those sceptical of international institutions, like many American conservatives, the idea holds particular attraction since, in their view, it might lessen the need for IMF rescues.

A big challenge is how to encourage collective action among creditors. Although it may be in the interest of creditors as a whole to co-operate with each other and the debtor country in a restructuring, it can be in the interests of an individual creditor to hang on and demand full payment—the so-called “last-man syndrome”. Bonds governed by New York law traditionally encourage rogue creditors. Improving the procedure for sovereign defaults means finding ways to bind in the rogues. Ideally, agreements would be binding across different asset-classes and jurisdictions, and would provide a legal framework for countries to tap new debt.

More radical proposals for sovereign-debt reform involve changing international law, either by creating an international bankruptcy court or by giving the IMF adjudicating powers. More cautious reformers are leery of statutory solutions and of undermining creditor rights. They contend that creditors should still control the terms of restructuring and they propose reforms that improve co-ordination among creditors. A popular proposal is to encourage countries to adopt “majority-action” clauses in their bond contracts. These clauses prevent rogue creditors subverting a restructuring.


A job to be done

Last November, Anne Krueger, first deputy managing director of the IMF, proposed changes that would put the IMF at the heart of bankruptcy procedures. In the face of stiff opposition—from creditors and from governments in both rich and poor countries—she proposed a modified version this week. Her new plan tries to secure the benefits of a legal reform without the political difficulties of expanding the Fund’s power.

Ms Krueger wants to amend international law (by changing the IMF’s articles of agreement) in a way that allows a supermajority (60-75%) of creditors to make the terms of a restructuring binding on all the rest. The Fund—or some other arbitration body—would simply oversee voting and adjudicate disputes. This idea has several merits: it would address all creditors and it would cover all existing debt. Details remain to be filled in, but it is a clever compromise.

Mimicking the features of domestic bankruptcy was once an option touted by America’s treasury secretary. Now, however, the Bush administration has decided it is none too keen. John Taylor, the top international man in America’s Treasury, is against reforms that are too “centralised”, or forced on emerging markets and their creditors by a change in the Fund’s rules. Instead, the administration wants to encourage creditors and borrowing countries to change their bond contracts voluntarily in a way that makes future restructuring easier. New bond contracts could include clauses that allow a majority of bondholders to authorise a debt restructuring (under American law, the financial terms of a bond contract cannot normally be changed unless all bondholders agree). International financial reform, says the Bush administration, should do no more than encourage this shift by, say, offering countries lower interest rates on IMF loans.

Keeping out of it

The Treasury’s new position is politically attractive. It avoids the tough job of cajoling Congress into approving a change in the IMF’s rules; it avoids giving any more power to an institution that the Bush administration views with deep suspicion; it avoids upsetting Wall Street. But there are drawbacks. The new clauses Mr Taylor proposes that borrowing countries add to their debt contracts (potentially bank loans as well as bonds) would “describe as precisely as possible” what happens when a country gets into trouble. That means not only the “majority-action clauses” that cautious reformers have long touted, but also clauses that describe exactly how a default would be initiated, how a restructuring would take place, and how disputes among different creditors would be arbitrated.

If all debtor countries had these clauses for all their bonds and loans, the framework for sovereign workouts would not be dramatically different from that proposed by Ms Krueger—just weaker. For instance, lawyers argue, contract-based reforms rather than changes to international law do not solve the difficulty of co-ordinating across debt instruments or between jurisdictions. More important, Mr Taylor offered no credible way to persuade countries to adopt these clauses for all their debt.


A big challenge is how to encourage collective action among creditors


If the clauses make both borrowers and creditors better off, as Mr Taylor implies, then the question is why they have not already been introduced. The answer is that clauses describing default are an unattractive prospect when a country issues debt: about as romantic, as one debt lawyer puts it, as a prenuptial agreement. Borrower countries fear such clauses would raise their borrowing costs. Underwriters fear that business would go elsewhere. Ironically, there would be a collective-action problem in getting Mr Taylor’s wide-ranging clauses adopted.

Mr Taylor talks vaguely about offering countries financial incentives to encourage adoption. He suggests making their introduction a condition for receiving IMF loans—a strategy likely to associate such clauses with weaker borrowers in the eyes of investors. Mr Taylor needs a more direct approach. Washington could, for instance, make such contracts mandatory for any bond issued in New York. But, ever suspicious of government meddling, Mr Taylor is unwilling to mandate anything at all. Ms Krueger, to her credit, realises that statutory change is necessary.

Even if the new clauses caught on widely, the Treasury’s approach is somewhat beside the point. It applies only to new debt. It has almost nothing to say about restructuring the existing debt. If the new clauses did come to be commonly used, they would make restructuring smoother, but they would still fail to solve a key problem: today’s sovereign defaults involve numerous creditors holding many kinds of claim, from bonds to trade credits. Modifying individual bond contracts would make it no easier for a country to reach an overall restructuring agreement with its assorted existing creditors. That demands a change in international law. Unfortunately, the Bush administration, with its blocking vote at the IMF, has chosen not to seek it.


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