Worlds apart not that “apart” anymore

An introduction to Argentina’s woes

In 2001 a South American economic powerhouse known as Argentina, had to default on $132 billion in sovereign debt. This was the largest public debt default in the history of the world and caused the entire national economy to contract by 18%. One might not realise the magnitude of this default but a comparative illustration shows us just how much money just had to disappear in order to try and save a faltering economy.

So what happened in Argentina and what did they do about it?

Aside from developing burgeoning debt levels, Argentina also had to deal with another “bad” decision made in relation to the exchange rate policy set in place by the Argentinean Currency Board in 1991. This decision was to peg the Argentinean Peso to the US Dollar, on a one to one basis, in an attempt to stave off the dangers faced as a result of rising levels of hyperinflation and slower economic growth. That is why the local authorities attempted to stimulate growth while gaining a tighter grip on the fiscal deficit simultaneously.

This to shed light on all the details behind the Argentinean economic meltdown resulting from debt, as explained by Time World.

Fresh private investment was expected to follow, thus escalating the financial sector’s liquidity. Along with this, tariffs on capital goods would be reduced and higher charges would be raised on consumer goods. Thus shifting the focus from a consumer driven economy to a capital driven one. Furthermore tax levies were raised on all financial transactions by fiscal policymakers. All in all government needed to increase overall revenue in order to be able to service debt.

Argentinean debt levels as a percentage of GDP- See the increase leading up until 2001
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The Argentinean Peso exchange rate and the strengthening in line with the US/$ before 2000 and then the depreciation when the peg was disbanded 

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Collective failure of all these policy measures eventually not only led to the astronomically large debt default but also to a process known as the “corralito”. The immediate run on banks that happened after the default would cause policymakers to freeze all of the funds held in any US/$ denominated depository institution. This whole process lasted approximately a full year. Imagine not being able to access your own personal spending funds for an entire year?
Exports and Foreign direct investment nearly froze as the decision by neighbouring Brazil to devalue their Real would give international buyers more bang for their buck and incentivise higher relative Brazilian exports. As these two countries are geographically located so close to one another, a high degree of competitiveness in relation to export revenue does exist. A huge current account deficit came into existence in Argentina, with little remaining resources available to p to be done about the situation

A video shedding a little bit more light on the true effects of a debt default and eventual currency crisis that led to a run on the banks


What eventually followed was that all Dollar denominated funds were to be converted to the Argentinean Peso at an 1.2 exchange rate. After the uncoupling of these two currencies the value of funds would be severely threatened as a result of expected inflationary pressures and weak purchasing power throughout the whole of Argentina.

 

The aftermath for Argentina and what the Eurozone might learn from it 
A decade after the debt default, and even after the global meltdown in 2007, the Argentineans have returned to being an economic powerhouse with GDP growth of approximately 9% for 2011. They have experienced a 62% growth in their national economy from 2002 until 2007.

The question does exist whether Europe might be able to learn from the Argentinean woes and whether the disbanding of some of the Eurozone countries would have a positive or negative effect.
In Europe some countries including Greece and in fact most of the other PIIGS nations are experiencing the same problem by being tied down to the Euro as a dominant and sole currency. These countries are experiencing deflationary price movements that are placing the private sector under pressure. The relatively fixed exchange rate that the Euro represents isn’t reacting in line with basic economic theory and this has caused even more heartache as well as protests throughout these zones. This occurrence is actually quite similar to what happened in Argentina when the Peso was pegged to the US/$.
Some more similarities between Argentina and Greece in their respective problematic times
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Some of the problems with the disbanding of some countries including a “Grexit”:

  • These disbanded countries would need to start using a singular currency again which would probably encounter a huge decline in value as investors have lost all confidence in the intrinsic value. It has been speculated that most Greeks would face a 50% decline in the values of their savings should Greece leave the Eurozone.
  • Once Greece leaves the Eurozone, investors with funds in other smaller Eurozone members would start to panic and possible runs on the bank would threaten economies such as Spain, Italy and Portugal.
  • If these countries aren’t disbanded from the Eurozone they would need to be supported by the European rescue fund that only has €500billion at their disposal, which is widely regarded by many as way too little to make a difference.

So should the Eurozone or at least some of its members be disbanded?
If there was any one easy solution to this problem, it would’ve been implemented a long time ago. A possible breakup of the Eurozone would most probably entail a chain reaction of astronomical proportions. This  would quite possibly dump the global financial system into chaos, as a number of institutions are still holders of some of these countries’ debt instruments. This time it would just be on a much larger scale than the Lehman Brothers effect of 2007.
A solution similar to Argentina would probably present unacceptable levels of risk as Europe as a whole is one of the key Economic players in the world. Defaulting on the debt of some of these countries would result in a huge foreign capital outflow and a rapidly depreciating Euro. This solution would place the zone under more pressure as the area is more weighted to being consumer driven as opposed to Argentina which largely relied on commodities in order to generate revenue after the default. A weaker currency would prolong the suffering of most of the European population.
A last possible solution would be to follow the approach taken by the US after the 2007 crisis. A program similar to quantitative easing might be a viable option. Inflation would also represent a problem but it would be in a more closely controlled environment. The obstacle of this solution is however the same as was faced by US banks when QE1 was proposed. Some countries, such as Germany, are not really in the need for these funds. Capital injections into the Eurozone might seriously  endanger these countries’  economic stability as a result of the collective currency.

Humanity has been left to decide whether greed remains good or if irresponsible use of debt has destroyed the fact that we used to be too big to fail. But in the meanwhile since no solution seems to be  in reach, it is the opinion of most that we have just failed!

Hermann Harris.

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