Tag Archives: Argentina

Argentine Peso crisis: An inevitable response to unresolved issues

Argentina historically has been in a rather unique position .  They were not really in the spectrum of third world countries, given their rich mineral deposits and sufficient development from numerous groups of settlers. But at the same time they aren’t being talked about as a serious emerging market because they have never exhibited the growth rates minus inflation.  They are in fact one of the two South American members of the G-20, the other one being Brazil.

However, Argentina has also faced a bit of a currency crisis over the past couple of years, and credit rating agencies have definitely taken notice.  The Wall Street Journal reported that Moody’s downgraded Argentina’s credit into junk territory (Caa1 on their several step credit rating, US is triple AAA).  They cited serious problems with net capital outflows and a lack of access to international financial markets due to other fiscal policies.

The reason the current situation is problematic, and the reason why Moody’s downgraded Argentina is better explained by the lack of access to international financial markets.  This was a measure put in place after Argentina went into a near-depression back in 2001 and defaulted on their debts in early 2002 to effectively end the cycle of borrowing and further contractions.  The result was an extremely painful contraction of 11% in GDP and a soaring unemployment rate of 20%.  Naturally there was a lot of pressure on political leaders at the time due to rising debts but perpetual economic contraction beforehand and the situation would have deteriorated to where Greece is now.  Argentina did agree to make payments on some of their foreign-debt obligations during the crisis after their economy stabilized in 2005; however, they have done so almost exclusively through reserve currency.  The Argentine government has basically restricted itself to using dollars.  With the high inflation that is currently ravaging the country, reserves were declining rapidly, so the government devalued the Peso by 19% in January to increase net capital outflows in the short-run.  However, with very limited options to reverse the capital outflow trend, Moody’s analysts believe that Argentina would have to devalue again which would only be a temporary fix until their debt essentially becomes worthless or unsustainable.  In which case, Argentina would have to default.

This crisis is not new, and in fact many of the problems that Argentina are facing now, led to a massive and largely isolated depression in the country.   The Washington Post chronicled the Argentine collapse that unfolded back in the late 90s/early 2000s and the causes sound eerily similar to what is occurring today.  Argentina introduced a dollar peg which brought about high growth for about a decade and an influx of capital; however, the rate of growth was unsustainable and Argentina entered a recession with escalating levels of debt that were unresolved after the government defaulted in 2002.  Since then monetary and fiscal policy have taken to the other extreme in terms of financing and are in danger of heavy inflation and internal economic damage. The best solution would be to stimulate domestic investment. This will not be possible, however, unless the government encourages its citizens to start borrowing and lending with domestic currency while opening itself to some international borrowing.

Revised – Inflation Scare in Argentina

Earlier this month Argentina’s currency experienced its largest devaluation since 2002. This substantial devaluation caused a rise in inflation and increased uncertainty within the economy. Argentina’s currency devaluation is not only a result of US tapering and weak manufacturing numbers from China, but also long-term domestic policies that have created a large distrust in the Argentinian government.

According to the Wall Street journal many economists believe that the inflation is a result of “heavy state intervention, price controls and corporate nationalization that have underpinned [Argentina’s] policy making for more than a decade.” (WSJ – Inflation Fuels Crisis in Two Latin Nations) To further this distrust in the central government, the state released inflation index for 2013 was reported at 10.9%, while an independent figure measured by an independent group of economists came in at 27%. (WSJ – Dispute Leads to Revise Index) As a result many local businesses are struggling to price their products and are being forced to close shop. One local coffin maker in Argentina said, “I have to tell customers that I can give you a coffin today, but you’ll have to pay for it later, at who-knows-what-price.” This confusion in pricing has resulted in decreased consumer spending and investments in Argentina. Bank of America Merrill Lynch recently forecasted that the decrease in investments and spending as a result of higher interest rates and inflation will lead to a 3% contraction in GDP this year. (WSJ – Inflation Fuels Crisis in Two Latin Nations)

Argentina has reacted to the inflation scare by issuing strict warning to business owners to not increase prices. The government warned that fines would be placed on businesses that continued to raise prices. If Argentina continues to mandate pricing, they may be able to temporarily curb inflation but businesses that rely on imported goods will be unable to sell products for profit. This will inevitably lead to further economic contractions.

As government discontent and uprising continues, one alternative plan for Argentinean citizens would be the adoption of Bitcoin or another cryptocurrency for payment. Cryptocurrencies are essentially independently created digital currencies that are not regulated by central banks and governments. An adoption of one of these cryptocurrencies would free businesses from the political constraints and corruptness of the central government and would provide them with better pricing transparency, as well as the ability to purchase exports.

The one downside of cryptocurrencies is the volatility of the currency. These currencies can experience drastic intraday changes that would directly affect the wealth of those using them. For citizens in Argentina, the high level of inflation is nearly as volatile and has the real potentially of becoming more volatile if price mandates continue.

For small business owners that are at the mercy of price ceilings emplaced by the Argentinian government, cryptocurrencies could be the only solution for these business owners. With the current restrictions emplaced by the government many small business owners cannot break even with the pricing ceilings.

As inflation continues to rise and reach levels believed to be unstable by economists (about 50%), inflation will likely rise exponentially. If this occurs and the price ceilings are enforced there will be no way for businesses to continue selling goods at the ceiling price and they will be forced to either close shop or adopt a new method of payment.

I have argued previously that the volatility of cryptocurrencies will likely be the downfall of their ability to become a legitimate form of transaction, but Argentina is a different case. The price controls and the potential for hyperinflation make cryptocurrencies a reasonable alternative for many in Argentina. For this reason, it will be interesting to see what happens in Argentina in 2014.

 

Inflation Scare in Argentina

This past week Argentina’s currency experienced its largest devaluation since 2002. This substantial devaluation has a caused a rise in inflation and uncertainty to grow within the economy. Argentina’s currency devaluation is not only a result of US tapering and weak numbers from China, but also long-term domestic policies that have created a large distrust in the Argentinian government.

According to the Wall Street journal many economists believe that the inflation is a result of “heavy state intervention, price controls and corporate nationalization that have underpinned their policy making for more than a decade.” (WSJ – Inflation Fuels Crisis in Two Latin Nations) To further the distrust in the central government, the state released inflation index for 2013 was reported at 10.9%, while an independent figure measured by an independent group of economists came in at 27%. (WSJ – Dispute Leads to Revise Index) As a result many local businesses are struggling to price their products and are being forced to close shop. One local coffin maker in Argentina said, “I have to tell customers that I can give you a coffin today, but you’ll have to pay for it later, at who-knows-what-price.” This confusion in pricing has resulted in decreased consumer spending and investments in Argentina. Bank of America Merrill Lynch recently forecasted that the decrease in investments and spending as a result of higher interest rates and inflation will lead to a 3% contraction in GDP this year. (WSJ – Inflation Fuels Crisis in Two Latin Nations)

Argentina has reacted to the inflation scare by issuing strict warning to business owners to not increase prices. The government warned that fines would be placed on businesses that continued to raise prices. If Argentina continues to mandate pricing, they may be able to temporarily curb inflation but businesses that rely on imports will be unable to sell products for profit. This will inevitably lead to further economic contractions.

As government discontent and uprising continues, one alternative plan for Argentinean citizens would be the adoption of Bitcoin or another cryptocurrency for payment. This would free businesses from the political constraints and corruptness of the central government and would provide them with better pricing transparency. Even though cryptocurrencies are known for being volatile, a large scale adoption from a country like Argentina could give the chosen cryptocurrency stability. Regardless, the high level of inflation currently present in Argentina is just as volatile, if not more volatile, as those of the cyrpotcurrencies. For small business owners that are at the mercy of pricing ceilings cryptocurrencies could be the only solution for these business owners. As inflation continues to rise and reach levels believed to be unstable by economists (about 50%), inflation will likely rise exponentially. When this occurs watch for Argentina to move towards cryptocurrencies.

Black markets break Argentina’s currency controls (Revised)

Imagine prices increasing 44% in 6 hours.  This weekend’s Wall Street Journal reports just that is happening in Argentina.  Friday ended a week of chaos for the Argentinean Peso that saw it devalued to the point that it started to fail as a medium of exchange.  After new currency control policies where created and others relaxed, the only thing that is certain is that Argentina is in real economic trouble.  In order to avoid repeating past mistakes, Argentina needs to take drastic action.

Argentinians do not seem to have great faith in their currency. Most of the people have been through this before.  Major transactions are done in US dollars.  This aversion the peso puts a constant downward pressure on the currency’s value relative to the US dollar.  When current President Cristina Fernandez de Kirchner was elected in 2007, she pledged to keep the value of their currency stable, but as this graph shows, the government has not been able to keep the currency from depreciating. This failure has an adverse effect on an economy that has increasing become dependent on imports.  The more their currency moves, the more dollars people will want to hold to protect against inflation and uncertainty.  It can be seen in the previous graph that the government’s 2011 restriction on the purchase of dollars only made the problem worse.  It also fueled a black market for US dollars that could work against any controls they try to implement.

Unfortunately, the results of this policy are coming to fruition.  Reported in the economist on January 22nd, in a bid to keep money in the country, the government put a limit on the number of transaction that could be done online, as well as increased taxes on items that where typically bought in dollars like cars.  This touched off a massive collapse in the value of the peso, shedding 15% of its value over the next two days.  It only ended when the government intervened through policy change two days later.  On Friday, the government made an unexpected decision and relaxed the restrictions on exchanging pesos for dollars, effectively deflating their own currency. The government was possibly hoping that by allowing more dollars out into the economy would have a stabilizing effect (It didn’t, as reported on Monday).  The policy of deflating the peso with out regard for inflation may have only increased demand for dollars. With the established black market, wealth will continue to leak out of the country, and the government will receive less and less revenue. This could see Argentina default on its debt again.

Argentina’s erratic and heavy-handed currency controls may have doomed it to repeat history.  But they don’t have to.  There may be way for Argentina to take out the black markets, get its citizens holding its own currency, and capture the world’s attention all in one action.  Argentina should be the first country to implement a digital currency. By doing this, it could address two of the main causes of the crisis, the black market for dollars and the lack of foreign investment.

The black market for US dollars would go out of business if the digital peso were implemented.  It would be all too easy to make such a transaction impossible to make.  In China, so called crypto currencies were used to avoid capital controls, but by making the currency the official currency and allowing/mandating that transactions are done in the new currency, they will make capital controls almost unavoidable, cutting out the black market.  This could lessen the flight from the peso, easing the devaluation.  It could even make any policy the government implemented more effective, as there wouldn’t be a black market to work against.  Such stability could see the return of badly needed foreign investment, which when paired with the extinction of the black market would signal recovery.  A digital currency could reverse the flow of wealth into the county, and it might even make Argentineans excited to hold their own currency again.  It certainly would captivate the world, as it would be the first country to attempt a digital currency, and that alone could drive investment, if not in the currency itself.

The monetary system in Argentina has been a mess for years.  The economy seems to stumble from crisis to crisis.  It has come to the point where commerce has stopped altogether.  It that’s not a failed currency, I don’t know what is.  Everything they have tried up to now has failed.  In order to take control of its money and its future, Argentina should implement a digital currency. It may be the most unlikely of countries to pioneer new monetary policy, but they certainly are in need of it most.

 

 

 

Emerging Market Trouble

Last week, markets across the globe were rocked by the sharpest decline in over a year. The S&P 500 dropped 3% on the week. Despite relatively positive signs at home, it appeared that trouble in emerging markets was the source of the sell off. Argentina is one of the more interesting and dangerous stories in this EM sell off.

Last week, Argentina’s central bank devalued the peso from 6.92 dollars per peso to 7.88, a twelve percent decline, according to Bloomberg. The country’s foreign-exchange reserves, which the country uses to support this currency peg, have dropped to dangerous levels, forcing the central banks hand. According to the Economist’s Free Exchange blog, foreign-exchange reserves reached a seven year low of $25 billion at the end of 2013. The decline in foreign reserves is a symptom of several structural problems in Argentina, which are posing a threat to its economic stability and putting it at risk of another crisis, like it faced in the 1990s when the country defaulted. The key problems are:

  1. Leadership. President Cristina Fernández de Kirchner has done little to inspire confidence. Her administration has been criticized with corruption and deliberate falsification of inflation data, according to a 2011 Economist post. More recently, she has been absent for nearly a month over the holiday as her countries foreign-exchange reserves dropped precipitously and bond rates spiked as Bloomberg reports.
  2. Protectionism. Argentina has increasingly become more protectionist. The country has taxed agricultural and commodity exports in an attempt to boost domestic manufacturing. Additionally, they impose limits on imports, which are done through delaying specific import items for long periods of time. All of this has served to close Argentina off from international markets and has hurt consumers domestically, who demand superior quality foreign goods. Most recently, the country has imposed restrictions on online purchases abroad (according to the BBC).
  3. Currency controls. More a consequence of the previous two problems, currency controls showcase the lengths to which Argentina must go to preserve its current economic regime. The country has forbidden its citizens from buying foreign currency. In response, a black market in currency trading has sprung up on the streets, where the market exchange rate is over 12 pesos per dollar – nearly 70% higher than the official exchange rate according to Bloomberg.

The problems in Argentina run deep but they do not stop there. Emerging market countries across the globe are now under scrutiny and have seen also their currencies slide over the last several weeks, as the Economist illustrates in the graph below:

This may indicate a troublesome start for the markets this year if EM contagion spreads and threatens developed markets. The Financial Times Alphaville blog, however, points out a more optimistic view point from Capital Economics, a research firm:

In the past, financial crises have indeed tended to sweep from one EM to another, primarily because they shared many of the same vulnerabilities. The financial crisis that began in Thailand in 1997 swept through the rest of Asia, hit Russia and also caused a wobble in parts of Latin America. Today, the emerging world is a very different place.

Capital Economics goes on to bucket different EM countries into different categories with differing levels of risk. They believe that the risk of contagion between these categories is small. Let us hope that this is the case.

Argentina: An Emerging Market Squandering its Potential

As Latin America’s third largest economy behind only Brazil and Mexico with an abundance of natural resources and a diversified manufacturing sector, it is tough to understand why Argentina’s economy has been so unstable. Throughout the 21st century, Argentina has not been able to maintain a steady level of growth, frequently falling into severe recessions after short-lived spurts of rapid economic expansion.

A recent WSJ op-ed by Mary O’Grady, “Argentina’s Crumbling Economy,” paints a grim picture of the months ahead for the emerging market.  Some of the main causes the article presented for the degradation of the Argentine economy are (1) a high and underestimated inflation rate, (2) socio-political instability, and (3) the inevitable negative effect these factors have on the value of the Argentine peso.

(1) High and Underestimated Inflation Rate

The fundamental problem Argentina is currently facing is a high inflation rate combined with a government that refuses to admit it. The article states:

According to the Foundation for Latin American Economic Research (FIEL), based in Buenos Aires, inflation for December was 3%, driving the total for 2013 to 26.4%… The government claims annual inflation is 10.5%. But there is widespread distrust of official figures… Even the International Monetary Fund took note. In February 2013 it censured Argentina for its failure to divulge accurate inflation data to the public.

This spells trouble for the Argentine Economy on two fronts. First off and most obviously, an inflation rate of 25% will push up interest rates and decrease domestic investment, halting growth tremendously. Notice the recent spike in interest rates:

Argentine Interest Rate: Jan 2011 - Jan 2014

Argentine Interest Rate: Jan 2011 – Jan 2014

Secondly, the inflation shading the Argentine government is apparently performing hurts investor confidence. Not many investors would be willing to take the risk of investing in an economy whose government does not give accurate information about the inflation rate. It is likely that foreign direct investment will decline and capital will flow out of Argentina as a result.

(2) Socio-Political Instability

Another factor is social unrest. In December, police officers in Cordoba went on strike to protest low salaries, inviting thieves to loot more than 1,000 stores across the city. The governor of Cordoba was caught between a rock and a hard place after the national government refused to respond, forcing Gov. Jose Manuel de la Sota to increase the police officer’s salaries by 33%. This, in turn, sparked police protests in 20 other provinces across the nation. This type of thing can ruin an economy, not to mention a country. Political and social stability are prerequisites for economic growth. Forget high inflation rates. If daily transactions across the nation cannot be carried out due to the threat of looting and other crime, there is no telling how severe the recession could be.

(3) The Weakening Exchange Rate

The combination of high inflation and political instability has caused the value of the Argentine peso to plummet. As can be seen by the graph below, the peso has been steadily losing value, but has spiked recently jumping from 6.52 pesos/$ to 8.01 pesos/$:

Argentine Exchange Rate

USDARS spot exchange rate 2010-2014: shows how much the USD is worth in terms of the Argentine peso (ARS)

Argentines are selling their currency to whomever they can, causing a massive surplus in the market and bringing down its value.

It is sad to see a country with so much capacity for growth fall into what appears to be a serious potential recession. I do think, though, that even given the multitude of problems Argentina is currently facing, it is possible for it to avoid a fall from grace. It starts with an immediate and firm response by the national government to stop social unrest. After social and political stability are restored by whatever means necessary (whether it be increasing police officers’ salaries or temporarily replacing their positions with soldiers from the Argentine army), Argentina can begin to sort out its inflation problems. Perhaps a combination of short-term exchange rate policy and long-term supply-side policy could do the trick. What do you guys think are some potential strategies for Argentina to curb its high inflation?

Impact of Biggest Economies on Developing Countries

In the past decade, there has been much talk about emerging markets and their immense growth. Developing economies have been receiving a great deal of attention from investors, speculators, and wealthy governments. However, it is rarely discussed how much these economies depend on the actions of the biggest players in the global economy. Recently, shifts in China’s and the United States’ economies have greatly impacted emerging markets. Notably, Turkey and Argentina have been hit hard. An article in the New York Times (Economic Shifts in the US and China Batter Markets) states that “the ascent of developing countries over the last decade has been fueled by two global trends: the steady rise of China and the willingness of the Federal Reserve to stimulate the economy.”

This week saw the first sustained drop in the United States stock indexes in 2014 (Standard & Poor’s 500-stock index dropped 2.1% Friday) – resulting in the worst week since June of 2012. More importantly, developing economies are most affected by the Fed’s decision to start pulling back on the bond-buying stimulus programs. These have helped to keep interest rates low around the world – on which many countries relied for low borrowing costs. Now they may face an increase in borrowing costs and a difficult period to readjust. Also, this may cause investors to pull their money out of emerging economies and into the recovering economies in the US and Europe, which may yield higher returns.

Turkey will be especially affected by the Fed’s decision. The country had used the Fed’s low interest rates to pay for a building boom. If interest rates increase, it is unclear whether Turkish businesses will be able to repay loans. Besides this, the country is facing a difficult political situation – which is also hurting business confidence. The fate of Turkey largely depends on the Fed’s future decision on whether to pull back on its bond-buying programs.

Though the Fed’s actions play a huge role in the world, the biggest impact is expected to be seen in places that rely heavily on the demand for raw resources in China. Chinese economic growth is slowing, and the second-largest manufacturing sector has been contracting for the first time in six months. Brazil’s soybean industry and Mozambique’s nickel production will be a few of those heavily impacted.

Argentina’s current situation has much to do with the US dollar. Another article in the New York Times (Erosion of Argentine Peso Sends a Shudder Through Latin America) explains that the Argentine government had previously tried to restrict access to foreign currency after nationalizing YPF (the country’s biggest oil company) and seeing the people wanted to take their money out of the country. This week, though, the government decided to ease access to buy US dollars. The result was a 20% drop in the value of the Argentine peso. Much of the drop in the value of their currency has to do with the speculation and distrust of their government. People are fed up with power-outages during extreme heat waves, rampant inflation, and a seemingly-incompetent government.

Thus it is evident that the emerging economies over the past decade rely heavily on the actions of the biggest global economies. This is strikingly obvious, really. But I don’t think we realize the extent to which they are affected. The fact that Turkey’s growth may slow down because of the Fed’s decision on bond-buying programs, is pretty crazy to think about. And the fact that a shift in China’s economy (slightly away from manufacturing) can impact economies around the world, who provide raw materials. Finally, the impact of the US dollar everywhere – it is bought and sold all over the world and is often a point of contention in other countries (like Argentina).