1 July 2015

Greece: beware the Argentine precedent

By Federico N. Fernández

Alexis Tsipras has repeatedly praised the way Argentina handled its 2001 economic crisis. The current events in Greece, unfortunately, seem to be a déjà vu of the Argentinian collapse. Now that the Syriza administration has imposed capital controls and flirts with default and Grexit, a calm assessment of the Argentinian crisis might be needed more than ever.

To defeat hyperinflation, in 1991 the government applied a fixed exchange rate system which demanded that for every peso in circulation there would be a dollar stored at the Central Bank. This single measure ended an inflation cycle of more than five decades. However, such a strict monetary should have been accompanied by a set of measures to balance the budget. The latter never arrived.

And old habits die hard. Like Greece today, Argentina was for a very long time living beyond its means. In particular, its public sector was oversized and in perennial deficit (in the late 1990s, Argentina’s public sector was running a deficit of around 10 billion dollars a year). With the option of printing money off the table due to the convertibility regime the government turned to foreign debt as a way to make ends meet.

This irresponsible behavior continued until 2001, when the bond markets showed serious doubts regarding the sustainability of the sovereign debt. The Argentinian political elite back then was as incompetent and suicidal as the Greek today. But in the second half of 2001 they tried some desperate attempts to put things right (including an across-the-board pay cut in July of up to 13% to all civil servants and an equivalent cut to government pension benefits).

Too little, too late. By the end of 2001, the collapse finally happened and Argentina devalued its currency and defaulted on its sovereign debt. On top of this, all bank deposits were frozen.

Leaving the convertibility regime was one of the most traumatic events in the country’s recent history. Since the peso had a parity with the dollar and Argentinians, for obvious reasons, tend to distrust their own currency the economy had been de facto dollarized. Politicians knew this and they also knew that it would be too hard to honor people’s contracts and savings in dollars. So the must have cried “Eureka” when somebody came with the concept of asymmetrical devaluation – which in practice meant the destruction of all existing contracts.

Savers were heavily penalized by this economic atrocity. For instance, if you had 10,000 dollars in your bank account the government transformed them into pesos at a 1.4 exchange rate. So, where is the trick? After devaluation, the real exchange rate was 3 pesos per dollar. Thus, in one magic act more than half of your actual savings were lost. What is more, your new bank balance would be given back to you in installments or in government bonds due in five to ten years. By 2002, the peso had fallen by 80% against the dollar.

There followed a major transfer of wealth. The losers were savers, people living on salaries, creditors of private dollarized contracts like mortgages, and many more. All of them saw their income and savings liquefied by an imposed exchange rate and the eroding power of inflation.

Many people lost their life savings. Some people lost a lot more. There were cases in which individuals could not even get their money to pay for medical procedures. The only possibility way was to go to a judge. But justice was slow and, in many cases, unfair. A renowned sports journalist requested his savings to pay for surgery abroad. A judge ruled that he was not ill enough… A few months later the journalist died. We will never know how many died because of situations like this.

The political system was utterly destroyed by the crisis. Only one party remained standing – and it took a populist turn following the steps of Hugo Chávez’s “Bolivarian” Venezuela. Led by Peronist administrations since 2002, the country has declined. This decay is perhaps best portrayed by the 2015 edition of the Heritage Foundation / Wall Street Journal Index of Economic Freedom, Argentina ranks 169th… out of 179 countries.

Yes, the economy did grow rapidly from 2003, averaging a 9% growth rate for the next few years. But it was neither the devaluation, nor the political genius of the Peronists, which caused the economic growth of the 2003 – 2010 period. Argentina benefitted of an extremely benevolent economic environment started in 2002 with the rise of commodity prices. The 21st century has been so far a century of a weak dollar and an easy monetary policy by the Federal Reserve. Historically, there is a correlation between commodity prices and the US dollar cycle. This windfall was of such a magnitude that it even allowed the Argentinian government to heavily tax its own commodity exports.

Even in this favorable scenario Argentina has not been able to fully restructure its national debt. What is more, due to the demagoguery and irrationality of its leaders, it has been declared in contempt by an American Court in an unresolved dispute with defaulted bondholders.

The prestigious economist Carlos Rodríguez Braun says that if devaluations were the way to economic success, Argentina would be rich and Switzerland would be poor. Leaving the common currency will definitely bring to the Greek population most, if not all, of the problems that leaving convertibility brought to Argentinian citizens. As to the advantages, they remain to be found.

Federico N. Fernández is a Senior Fellow of the Austrian Economics Center (Vienna, Austria) and Founder of Fundación Bases (Rosario, Argentina)