Harming a country by dumping their sovereign debt

Factual Questions
1

Dear Dopers,

I’m back to work (intermittently) on the novel I started so long ago. It remains a political thriller, and I’m still hacking away at it.

One of the plot points I’ve got going so far is that the country where it takes place (the one with the shitty electoral system y’all helped me articulate) is, for lack of a better word, trying to hold another country hostage. Country B, in this case, recently fought a big war, and in order to do it they had to, among other things, sell tons of sovereign debt. Country A, the evil one where the action takes place, is now a major holder of it.

What kind of leverage does this give Country A over Country B? If A decided to simply dump B’s bonds on the market at well below their market price, what kind of effect would that have on their currency and their economy? Keep in mind that Country B is already in pretty bad shakes because of the war; a lot of their capital assets have been destroyed and their currency’s lost 2/3rds of its value.

And, conversely, what kind of damage could this move do to Country A? If they liquidate all their bonds in a hurry, doesn’t this imply some structural damage to their own economy if they need all this fast cash? Could this be a ‘dig two graves’ situation, especially if, as is the case here, Country A actually owns enough of Country B’s sovereign debt that the coupon payments from it are a significant part of Country A’s government budget?

My gut tells me that this either would be minimally damaging to both, or it would be catastrophically damaging to both; I can’t quite tell which.

2

Significant harm to Country A, which has sold a major asset at a needless loss (i.e., it gathered a bunch of money in a pile and burned it). Little effect on Country B, which continues making the same payments on the bonds to the new buyers.

3

If country B needs to go to the debt market again soon, it might have to offer higher rates on its new bonds to get the market to absorb them all. If it doesn’t have to borrow again soon, then there should be minor effects only of reputation perhaps. But everyone knows already that A hates B.

A will lose something in its quick sale as they’ll probably depress the price of B’s debt in the secondary market depending on how liquid the bonds are.

4

IF B is dependent on continuous new bond sales to redeem bonds coming due and/or to fund current government spending, THEN when A dumps their bond holdings that’ll crowd out B’s ability to sell similar new bonds. In effect it becomes a play to, in the short term, strangle B’s cashflow. If B is close enough to economic meltdown already, it might be enough to push B over the edge.

Naturally this gets easier if A is much bigger than B. e.g. The US could accumulate a huge holding (percentage-wise) of Uraguayan bonds and sell them all for a penny on the dollar paid while having a negligible direct impact on the US budget or US government’s total assets. Meanwhile, Uraguay would be devastated by the impact.

Conversely, if the protagonists are of similar size, A will do some harm to itself in harming B. If B is much the larger, albeit weaker, player, then A may hurt itself worse than it hurts B.

Considering that all warfare consists of harming yourself in the course of harming the other guy more, this tactic may simply be a less painful (and maybe even less costly) way for A to achieve regime change in B versus direct military action.

One thing about this tactic: It’s essentially a one-shot deal. A can dump their B bonds quickly or slowly, in one tranche or several. But once they’re all sold, A is out of ammo for that weapon forever. They can’t buy more B bonds to reload without mostly undoing the effects of the original dumping.

To succeed A has to be to able to rapidly create a fiscal or monetary crisis that tips B into a death spiral or into civil chaos.

5

I would have thought that holding all that debt puts ‘A’ in a weaker position. If they destabilise ‘B’ to the extent that their economy fails, the debt itself will become worthless. As mentioned above - it depends a lot on the relative sizes of the two economies.

If you could buy up all your neighbour’s debt, you might think you have him by the nuts. But if he has no assets you can seize, he could default and leave you with a big hole in your own finances.

Are there any parallels with the current Argentina vs US bondholders situation?

6

There’s an old saying in finance. if you owe the bank $10,000 they own your a$$. If you owe them $100,000,000 you own their a$$.
IMO the Argentina thing is complicated because there’s really 3 players: The argentine government, the bond holders, and the US court system. Argentina can, and has, told the bondholders to go pound sand. And Argentina is bigger enough to make that stick in the marketplace without undue strain.

BUT the US court has sided with the bondholders. So now Argentina went from being the big guy to being the small guy in the fight. What they lose by telling the US court to go pound sand is rather a lot. And IIRC that’s exactly where they’re all stuck right now: Argentina is considering their next move & the US is thinking about what they’d do in response to various Argentine moves. The US itself has no vital interest in the specific bondholder’s dispute. But they do have a huge interest in having all their courts’ rulings generally obeyed.

7

There are actually four players in the Argentine dispute. The Argentine government, the US Court System, the regular bondholders, and the “holdout” bondholders.

Basically, in 2001, Argentina defaulted on its bonds in the conventional way. It said “I can’t pay these” and negotiated with its bondholders for a reduction in the amount of debt owed. Most of the bondholders said, “Ugh, I don’t like taking a 70% haircut, but at least I’m getting something when I could be getting nothing”, and Argentina swapped the bonds for ones with a lower face value, and almost everyone was not happy exactly, but satisfied that what happened happened, and now it was over…

…Except for some small fraction (like single-digit-percentage) of the 2002 bondholders who said, “I never agreed to this! You have to pay us the full, original amount”. Some fund manager bought up all those bonds and sued Argentina for full repayment. And that was the court case they won. And those were the bondholders that Argentina told to pound sand.

(Additional complication: Due to a clause on the new bonds, arguably if some investors get a better deal, Argentina has to give all the new bondholders the same better deal, so there may not be the option for Argentina to just pay the holdouts without it becoming too expensive for it to handle).

The problem that comes in is that the custodial bank for all current Argentine bonds is based in New York, and therefore in the jurisdiction of the lawsuit. Argentina has the money to pay its current bondholders, but can’t because that money needs to go through BNY Mellon, who is obligated now to hold that money until the holdout bond holders have been paid off, effectively making Argentina in default with their current bond holders, despite having the money to pay them.

So while the sound bite is “Argentina fucked up and now can’t pay its debt”, it’s really more like “Argentina fucked up and couldn’t pay its debt a decade ago, but got its shit in order and has been relatively good since until some old debt holders used some technicalities to make bad things happen”.

8

Yeah. I left the haircut-accepting bondholders out of the explanation because they’re mostly interested bystanders at this point.

9

Well at this point they’re getting screwed over for no reason that they have any control over. Argentina can pay them, and has deposited money to BNY Mellon for the purposes of paying them, but they’re not getting paid.

One of the interesting things is the value of the non-holdout bonds has not plummeted, and I think has even risen. The general consensus is that Argentina will make these bold holders whole at some point, and since they payment is now late, by the conditions of the bonds they are owned interest on the payment of something like 6%, which is better than anything else is giving.

10

Well, If Argentina bites the bullet and pays all the bondholders the full amount, then the ones who took the haircut will get the full amount plus interest. So they’d be better off in that case.