Currencies across the developing world have been sliding recently, but none more so than Argentina. The Argentine peso slid a whopping 16 percent against the dollar this week.
"Fear, uncertainty, abandonment, and confusion," are the reigning sentiments in the country right now, according to Augustino Fontevecchia, a reporter for Forbes and a native Argentinean who travels there regularly. "There’s been problems finding basic supplies from food to electronics. Inflation has led to police going on strike in several provinces, which has in turn, caused crime waves." The government, he says, has done little to substantially address the problems.
A TRAIN WRECK
"It’s been a slow motion trainwreck," says Win Thin, global head of emerging markets strategy at Brown Brothers Harriman. "Many analysts, including myself, have been predicting a crisis for several years."
2001 DEFAULT SETS THE STAGE
In 2001, Argentina defaulted on its sovereign debt. It did so in an aggressive way that left many investors displeased, says Thin. Since then, the country has been locked out of global credit markets. In other words: It can't borrrow.
That hasn’t stopped the Argentinian government from spending, however.
Peter Hakim, president emeritus of the Inter-American Dialogue, says the government, fueled by revenue from commodity exports, embarked on massive subsidy programs: "Huge expenditures on social programs, subsidies to the airlines, energy subsidies."
During all this time, investment and productivity growth were essentially stagnant. Eventually, when the export boom slowed, “the party ended,” as Thin puts it.
INFLATION, CURRENCY, AND ECONOMIC WHACK-A-MOLE
The spending contributed to intense inflation, reaching nearly 30 percent. When the government tried to impose price caps, that led to shortages – already exacerbated by subsidies.
"They tried to use policies that have largely failed in other places," says Inter American Dialogue’s Hakim. Each time, it created another problem.
Inflation pushed Argentinians (and investors) to convert their pesos to dollars (or other foreign currencies) to prevent their value from eroding. That caused depreciation of the currency.
"What’s happening is a flood of capital out of Argentina," says Hakim.
The government tried to prevent more currency from leaving the country, using dollars it had earned from exports to buy its own currency in an effort to prop up its value. That was expensive, and drained the central bank’s reserve of dollars. It finally had to relax its pressure yesterday, and the currency devalued quickly.
That made people who hold Argentine pesos even more anxious, and even more desperate to sell, which made the currency problem even worse.
All of the policies Argentinians have tried come with "some short term benefits," says Hakim. "But over the long run, they make everybody very nervous about the economy," or have unintended consequences.
TOUGH CHOICES, NO GOOD ANSWERS
"It’s a classic situation of what happens to emerging markets when policy is ineptly followed," says Keith Savard, senior economist at the Milken Institute.
"We’ve seen this play out. When people lose confidence, you have a run on the exchange rate, they try to impose capital controls to ameliorate it, and it’s an impasse,” says Savard. "Governments don’t do what needs to be done."
Unfortunately, what Savard says needs to be done – higher interest rates, less government spending, including on subsidies - would reduce standards of living and employment for Argentinians already badly afflicted with a broken economy.
"The state of denial of policy makers in Argentina is just huge," says Hakim. "They have this unwillingness to recognize how serious this is."