Sign in
Become a MarketWatch member today
Outside the Box
Feb. 20, 2010, 12:01 a.m. EST · Recommend (4) · Post:
View all Outside the Box "º
"¹ Previous Column
Change in law helped REIT's cash position
First Take "º
Volcker Rule dead? Not so fast ...
By James Kostohryz
RIO DE JANEIRO, Brazil (MarketWatch) -- In 1999, the Argentine economy entered into a severe recession that coincided with various recessions and financial crises around the world, a state of affairs that exacerbated the problems in Argentina.
A series of multi-billion-dollar financial "rescue packages" orchestrated by the IMF, World Bank, and the U.S. Treasury -- all of which involved financing to roll over the existing stock of debt and to finance new deficits, in exchange for various austerity measures including spending cuts and tax increases -- culminated in full-blown financial panic, economic depression, social emergency, and political crisis in the 2001-2002 period.
Banks will be back in focus as part-nationalized Lloyds and Royal Bank of Scotland announce their results and give an update on further losses from risky lending. The telecom sector will also be under scrutiny, with earnings reports due from Telefonica and Telecom Italia, which have been linked by merger rumors in recent weeks. German IFO is expected to improve in February, but could still raise questions about the sustainability of a recovery.
Will the Argentine experience be repeated in Greece?
There are striking similarities between the Argentine situation and the current Greek ordeal:
Hard currency regime where officials had no control of monetary policy. Leading up to the crisis Argentina was operating under a "hard currency" monetary regime (a currency board that guaranteed convertibility from pesos to dollars on a 1:1 ratio) that had been adopted a decade earlier. This monetary regime was essentially inflexible and implied that for most intents and purposes Argentine authorities had virtually no control over monetary policy (interest rates, monetary aggregates, etc.). Similarly, Greece adopted the Euro approximately a decade ago, surrendering all control of monetary policy.
Ingrained culture of fiscal indiscipline. Prior to adoption of the hard currency regime, Argentina had been a nation characterized, from its very inception at independence, by its fiscal indiscipline. Historically, chronic deficit spending and debt accumulation was followed by monetary expansion to pay off the deficits and debt, resulting in massive episodes of inflation and devaluation of the currency. The Greek culture of fiscal indiscipline, prior to the inception of the euro, is virtually identical to that of Argentina.
Fiscal indiscipline wasn't sufficiently reigned in after submitting to inflexible monetary regime. Because debt couldn't be paid for by printing money and devaluing the currency, the new currency regime required strict fiscal discipline. This didn't occur and the national debt of Argentina skyrocketed during the decade leading up to the crisis. Ditto for Greece.
Currency overvaluation. Adoption of the hard currency regime initially spurred massive inflows of foreign direct investment and hot money inflows. This excess liquidity (which monetary authorities couldn't control) increased currency in circulation. Furthermore, as alluded to above, government spending grew at an extremely rapid pace, and this pro-cyclical deficit spending contributed greatly to demand-side economic overheating. Consequently, internal inflation grew at a rate far greater than that of Argentina's trading partners. Over time, this situation produced a massive real exchange rate (REER) overvaluation of the currency in purchasing power parity (PPP) terms. This, in turn, reduced the nation's trade competitiveness, producing massive and structural current account deficits. This situation experienced in Argentina in the decade leading up to their crisis is virtually identical to the Greek situation leading up to the current crisis.
Monetary astringency. Due to unsustainable fiscal policies and an unsustainable current account situation, foreign direct investment and hot money inflows suddenly waned and/or reversed. The outflows through the trade account coupled with hot money outflows necessarily (due to the currency regime in place) produced a contraction in the money supply (astringency), triggering a spike in interest rates and a deep recession. Government officials had no way to counteract this contraction in the monetary supply and spike in interest rates. This situation experienced by Argentina is currently being faced in Greece.
Untenable dilemma: Deflation or abandon currency regime. Under the hard currency regime, the only way for Argentina to regain trade competitiveness was to undergo a painful deflation that would alleviate the REER currency overvaluation in PPP terms. This is precisely the situation currently faced by Greece. The Greek economy isn't competitive, but because they have no control over the currency, they cannot correct this problem through devaluation. As in the case of Argentina, excruciating deflation or abandonment of the currency regime are the only alternatives left to Greece.
"Rescue package" deepens crisis. From 1999 thru 2001, Argentina entered into a series of agreements with the IMF and the World Bank. The agreements required Argentina to cut spending and raise taxes in exchange for promises of financing to roll over debt and to pay for limited deficits. Such measures deepened the economic contraction causing a collapse in tax receipts and a ballooning of fiscal deficits. Each agreement with the IMF and World Bank was broken in quick succession. Finally, the U.S. Treasury stepped in and provided bilateral aid in the form of another massive financing package in exchange for deficit reduction. Again, the resulting economic contraction caused tax receipts to fall and Argentina was soon in breach of its covenants.
Fraud to mask breaches. The Argentine government engaged in various cover-ups in order to avoid publicly falling into breach of their covenants. When these cover-ups were unmasked, a loss of confidence by investors ensued, causing a rise in interest rates and complicating the task of obtaining financing. A virtually identical situation has occurred in Greece.
Large sectors of the population unwilling to sacrifice; ready and able to mobilize against regime. In Argentina, populist and nationalist groups railed against the terms of the austerity plans. As the recession worsened, massive violent demonstrations erupted. The government fell. Then another government fell. Financial panic ensued, making the recession even worse. In Greece, there is every indication that much of the population is unwilling to undergo the hardships implied by an austerity program. As in Argentina, history indicates that labor unions and other groups in Greece are willing and able to mobilize violently in order to bring about social and political chaos and hold the nation hostage.
How did the situation in Argentina end? Not too well. Economic depression, mass insolvencies, bank runs, forced seizure of deposits, unemployment and underemployment exceeding 40%, blood in the streets, a fall of the government, a complete reneging of the terms of the "rescue packages," an abandonment of the hard currency monetary regime, a mega-devaluation, and a massive default of foreign debt obligations.
Can Greece escape this same fate? There are no two situations that are exactly alike, but the similarities of the Greek and Argentine situations are striking.
Interestingly, one difference is that Greek levels of deficits and debt are between two and three times as great as they were in Argentina. In principle this would seem to make the situation in Greece even worse. However, this demonstrates that there is no particular amount of deficits or debt that triggers a debt crisis. What triggers a crisis is more a product of psychology on the part of those that finance the deficits and debt.
In this regard, perhaps the main difference that I can detect between the Argentine and Greek situations is that EU nations have a vital stake in avoiding a Greek meltdown and abandonment of the currency regime to an extent that the international community and the U.S. did not in the Argentine case. This "community of interests" could result in more aggressive and intelligent forms of assistance on the part of EU members towards Greece. See also Greece: Between Dire and Disastrous.
Thus far, however, I'm not seeing any evidence of such urgency or intelligence. Up until now, it's looking like a repeat of the same old story.
James Kostohryz has accumulated almost two decades of investment and trading experience that has spanned a variety of asset classes across the entire globe. He is a contributor to Minyanville.com .
- AmericanPatriot | 1:04 a.m. Today1:04 a.m. Feb. 20, 2010
Poll shows Americans want bank reform at a faster pace than Congress is delivering.
12:20 p.m. Feb. 19, 2010 | Comments: 51
Second Opinion
The mobile-phone paradigm shift
Vancouver stock-picker gets the gold
Media Web
New York Times learns yet another lesson
On the Markets
Parsing reaction to Fed's surprise move
Ways and Means
How well is your 401(k) plan serving you?
Read Full Article »