Chicago Booth’s Brent Neiman explains that some practices in the issuance of debt—such as reliance on the US dollar to denominate corporate bonds and the indirect issuance of bonds through offshore subsidiaries—could become international economic problems during the COVID-19 pandemic.
Our response right now to the virus has been to focus on the public health crisis, and I think rightly so. We should, in the short term, do all we can to save lives and to stem the spread of the disease.
But it is true that at some point, when hopefully the public health crisis abates, we are going to be facing, or seeing a world that faces, some very important and difficult economic challenges.
I work in international economics, and there are a few issues related to the international economy that I’m concerned about and that will be important for the world to turn its attention to.
One issue, which I’ve emphasized in some work together with Matteo Maggiori and Jesse Schreger, is that in the run up to the crisis—in the decade, really, preceding the crisis—the global use of the US dollar to denominate, for instance, corporate bonds, has gone up significantly compared to before the 2008 global financial crisis. And one thing that this means is that if countries’ exchange rates depreciate relative to the US dollar, if they weaken relative to the US dollar, in fact, the real debt loads might go up. And so there’s a possibility that this crisis, coupled with a depreciation of foreign currencies, leads to a real increase in the debt burdens faced by countries. We have a real risk that debt crises ensue. So that’s one area that I think we all need to keep an eye on and that I’m worried about and looking into looking forward.
A second issue that is of importance and relates to the international economy that may be important to think about in a state of the world where there is a debt crisis, where companies and countries are having a hard time repaying their debts, is the fact that increasingly over the last 10 years, companies don’t issue their debts directly, but rather issue them indirectly through affiliates or subsidiaries that themselves are headquartered or domiciled offshore, oftentimes in tax havens like the Cayman Islands.
For example, if a Brazilian firm issues a bond only through an affiliate that’s located in the Cayman Islands, and that bond, or that company, gets into trouble, there’s a question as to whether the bailout of the bondholders or the resolution of that situation is made more complicated by the fact that now three jurisdictions—namely the jurisdiction of the bondholder, Brazil, and the Cayman Islands—are all involved. And if you go back some decades, I don’t believe that these offshore issuances—which, again, bring into play the idea that any resolution of bad debts would have to cross multiple national jurisdictions—I don’t believe that this issue was nearly as salient. This is an issue that, as shown in work with Antonio Coppola, Matteo Maggiori, and Jesse Schreger, has become much more important in recent decades.
It’s true that companies headquarter all over the place try to minimize tax exposures, but when General Motors issues a bond, it’s usually General Motors that’s issuing the bond, not General Motors Bermuda. And when Telecom Italia issues a bond, it’s usually Telecom Italia, not Telecom Italia Guernsey.