The Greek debt crisis is on every front page. Behind many of the headlines is an assumption that a Greek default and exit from the euro would be an unprecedented, unthinkable disaster.
However, Athens’ problems are hardly unique. Little more than a decade ago, Argentina’s economy went through a similar process.
Like Greece, Argentina fixed its currency to that of a larger, more powerful neighbour, while running a chronic deficit. And like Greece, Argentina attempted to use cuts, International Monetary Fund bail-outs, and talks with bondholders to solve the problem.
Like Greece, unfortunately, this only led to a bitter recession and riots. And when the country finally devalued, the economic and political pain was huge.
Here’s what happened – and why history could repeat itself.
In 1991, Argentina adopted a currency board that fixed the peso to the dollar at a convertible one-to-one rate. This meant that anyone could swap the peso for an equal number of dollars. For all intents and purposes the dollar became the national currency – just as the euro replaced the drachma in 2002.
Initially, this worked well. The tighter monetary policy helped bring inflation under control. However, from 1995 onwards the US dollar began to strengthen in real terms. This meant that the peso followed suit. In turn, Argentina’s exports became more expensive for its customers, while it began to import more from its local trading partners. This meant that the gap between its exports and imports grew larger.
At the same time, government spending, especially by regions and towns, grew faster than revenues. Corruption was also a major problem. This led to public debts mounting up – just as they did in Greece.
The Russian default in late 1998 led to investors panicking, as the assumption that emerging-market sovereign debt was risk-free collapsed. Brazil’s currency fell sharply. As a result, the 30% of Argentinian exports that went there became even less competitive.
At the same time, the US Federal Reserve began to hike interest rates from 4.75% in the summer of 1999 to 6.50% in May 2000. This caused Argentinian monetary growth (M3) to collapse – indeed, the monetary base started to shrink by the end of 2000 – driving the economy from strong growth into recession.
Faced with its high debt levels and faltering economy, Argentina should have let its currency float freely and focused its efforts on converting any foreign debts denominated in other currencies into pesos. This would have helped exports, boosted demand, and also would have meant that a fall in the value of the peso would not have increased the nation’s debt burden.
Instead, it decided to stick with the currency board. It tried to solve its debt problems by slashing spending. It also sought aid from the IMF. In December 2000, the first of several bail-out packages was announced – contingent on austerity.
The strategy failed badly. Even after the US started cutting interest rates, the peso was simply far too expensive. By the summer of 2001, the government began to change course. The currency board was broadened to include the euro – making the currency slightly cheaper. It also started talking to creditors about a debt swap.
However, the new measures were too little, too late. Later in the year, the money supply plunged further, shrinking at an annual rate of 21%. Unemployment rose to 18%, while the economy shrunk by 5%. This economic collapse, combined with the austerity measures, led to widespread riots, strikes and looting. People started taking cash out of banks. There was political chaos with the country going through four different presidents in eleven days.
On Boxing Day 2001 Argentina’s government threw in the towel, ending the currency peg and defaulting on its debt. The peso halved in value against the dollar. Dollar bank accounts and foreign loans were forcibly converted at a rate that favoured debtors.
Cheaper exports and looser monetary policy saw strong growth return by the end of 2002, with the economy expanding at an annual rate of 9% in both 2003 and 2004. While creditors only got a fraction of their money back, the IMF was repaid in full in 2006 (although it did not get all its interest payments).
However, the chaos caused by the delay in breaking with the dollar peg has created serious long-term problems. At the worst point of the crisis, many business owners shut their firms. Many of these firms were later taken over by complete strangers – with the government backing this theft when the original owners tried to reclaim their property.
The lessons for Greece – and other troubled countries – are simple. Firstly, an ill-considered currency union can cause serious damage to the economy by making exports expensive.
A fixed (or single) currency also prevents a government from using monetary policy to boost growth. The Greek money supply fell at an annual rate of 14.6% in December. This means that action is urgently needed to rescue the economy.
Another lesson is that the longer it takes for Greece to quit the euro, the more extensive the damage to its economy will be. Already the situation is getting worse, with the passage of the debt deal leading to riots, which are hardly good for business. Miserable though it may be in the short term, Greece’s best bet would be to get out of the euro now.
Matthew Partridge
Contributing Editor, MoneyWeek (UK)
Publisher’s Note: This is an edited version of an article that first appeared in MoneyWeek (UK)
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{ 8 comments }
Matthew well said and good indepenedent thinking!
The “HERD” bloggers all said Europe has to printed buy gold hyperinflation is coming.
However the facts are printing money in Europe is quite difficult and hard with the Germans digging in their jack boots against countries with unsustainable debt levels.
Infact Euro maybe a solid currency if this fear of money printing and hyperinflation from the Germans keeps going.
“Argentina should have let its currency float freely and focused its efforts on converting any foreign debts denominated in other currencies into pesos”
I wouldn’t think creditors would allow money owed to be converted into a currency that is likely to be devalued. Please explain how this would be possible.
Same way greasys creditors have let them off the hook
You’re right Freddy – the debts were probably in $USD in those days and creditors wouldn’t have accepted a substitute in a falling currency. The debts would have been hedged, but not against currency manipulation.
I remember watching a documentary on the crisis, and over a decade after the crisis people still couldn’t access their own money from their own bank account.
Funny that after years of railing against printing, they now advocate printing.
Freddy what Matthew is trying to say is that you change all your foreign currency debt into your local strong currency when the market thinks you are a dynamic growing emerging economy.
Do the deal in the local currency before you blow up example Iceland and Southeast Asia countries had strong stable currencies but they left it too late to take advantage of a irrational market?
Does OZ dollar and China story have the same overvalued dynamics?
TRB there will always be some foreign debt because we trade with other countries. We owe them money on goods purchased, and they owe us money for what we sold them.
There is a recent graph near the bottm of this page that should be accurate enough for our discussions.
http://www. mrwood.com.au/unit3/extstab/extstab5.asp
Note that in terms of GDP the foreign debt has falllen recently. On memory I believe that our banks have reduced reliance on foreign borrowings from 60% to 40% and in dollar terms they owe around $300 Bn in foreign currency.
Australians have saved more recently, so our reliance on foreign money has reduced.
However APRA require our banks to go long on a large percentage of borrowings by raising money over a 5 year term. APRA believes that brings added stability to the lending market by locking in long term loans, rather than just relying on short term borrowings, which are usually cheaper but have to be constantly rolled over. In a global credit crunch lenders are unwilling to roll over loans, and when they do they want high interest returns on them.
Because Australia doesn’t have an active 5 – 10 year bond market, our banks are forced to borrow overseas where they do have mid and long term term bond markets.
That’s the chink in our armour – if they fixed that then almost all of our banks borrowings would be in $AUD and that would insulate us from the vageries of foreign currency fluctuations.
The money might still come from overseas, but the debt would be in $AUD – and at the moment investors are falling over themselves to invest in $AUD. Even the Rudd/Gillard political stoush has only reduced the $AUD by about 1 cent.
Now would be an excellent time for our bond market to be allowed to expand and accomodate the market.
You will have to join up that url.
understood…
Cheers PF
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