Thursday, 23 February 2012

What does Greece’s future hold? Ask the Argentinians

By Mathew Partridge, UK Money week.

What does Greece’s future hold? Ask the Argentinians

The Greek crisis is on every front page. Behind many of the headlines is an assumption that a default and exit from the euro would be an unprecedented, unthinkable disaster.

However, Athens’ problems are hardly unique. Little more than a decade ago, Argentina went through a similar process.

Like Greece, Argentina fixed its currency to that of a larger, more powerful neighbour, while running a chronic deficit. And like Greece, Argentina attempted to use cuts, International Monetary Fund bail-outs, and talks with bondholders to solve the problem.

Like Greece, unfortunately, this only led to a bitter recession and riots. And when the country finally devalued, the economic and political pain was huge.

Here’s what happened – and why history could repeat itself.

When did Argentina’s problems begin?

In 1991, Argentina adopted a currency board that fixed the peso to the dollar at a convertible one-to-one rate. This meant that anyone could swap the peso for an equal number of dollars. For all intents and purposes the dollar became the national currency – just as the euro replaced the drachma in 2002.

Initially, this worked well. The tighter monetary policy helped bring inflation under control. However, from 1995 onwards the US dollar began to strengthen in real terms. This meant that the peso followed suit. In turn, Argentina’s exports became more expensive for its customers, while it began to import more from its local trading partners. This meant that the gap between its exports and imports grew larger.

At the same time, government spending, especially by regions and towns, grew faster than revenues. Corruption was also a major problem. This led to public debts mounting up – just as they did in Greece.

What caused the crisis?

The Russian default in late 1998 led to investors panicking, as the assumption that emerging-market sovereign debt was risk-free collapsed. Brazil’s currency fell sharply. As a result, the 30% of Argentinian exports that went there became even less competitive.

At the same time, the US Federal Reserve began to hike interest rates from 4.75% in the summer of 1999 to 6.50% in May 2000. This caused Argentinian monetary growth (M3) to collapse – indeed, the monetary base started to shrink by the end of 2000 – driving the economy from strong growth into recession.

What did Argentina do?

Faced with its high debt levels and faltering economy, Argentina should have let its currency float freely and focused its efforts on converting any foreign debts denominated in other currencies into pesos. This would have helped exports, boosted demand, and also would have meant that a fall in the value of the peso would not have increased the nation’s debt burden.

Instead, it decided to stick with the currency board. It tried to solve its debt problems by slashing spending. It also sought aid from the IMF. In December 2000, the first of several bail-out packages was announced – contingent on austerity.

Did this work?

The strategy failed badly. Even after the US started cutting interest rates, the peso was simply far too expensive. By the summer of 2001, the government began to change course. The currency board was broadened to include the euro – making the currency slightly cheaper. It also started talking to creditors about a debt swap.

However, the new measures were too little, too late. Later in the year, the money supply plunged further, shrinking at an annual rate of 21%. Unemployment rose to 18%, while the economy shrunk by 5%. This economic collapse, combined with the austerity measures, led to widespread riots, strikes and looting. People started taking cash out of banks. There was political chaos with the country going through four different presidents in eleven days.

On Boxing Day 2001 Argentina’s government threw in the towel, ending the currency peg and defaulting on its debt. The peso halved in value against the dollar. Dollar bank accounts and foreign loans were forcibly converted at a rate that favoured debtors.

What happened afterwards?

Cheaper exports and looser monetary policy saw strong growth return by the end of 2002, with the economy expanding at an annual rate of 9% in both 2003 and 2004. While creditors only got a fraction of their money back, the IMF was repaid in full in 2006 (although it did not get all its interest payments).

However, the chaos caused by the delay in breaking with the dollar peg has created serious long-term problems. At the worst point of the crisis, many business owners shut their firms. Many of these firms were later taken over by complete strangers – with the government backing this theft when the original owners tried to reclaim their property.

What are the lessons for Greece?

The lessons for Greece - and other troubled countries - are simple. Firstly, an ill-considered currency union can cause serious damage to the economy by making exports expensive.

A fixed (or single) currency also prevents a government from using monetary policy to boost growth. The Greek money supply fell at an annual rate of 14.6% in December. This means that action is urgently needed to rescue the economy.

Another lesson is that the longer it takes for Greece to quit the euro, the more extensive the damage to its economy will be. Already the situation is getting worse, with the passage of the debt deal leading to riots, which are hardly good for business. Miserable though it may be in the short term, Greece’s best bet would be to get out of the euro now.

As for the investment lessons - they might surprise you. As James Mackintosh noted in a recent column for the Financial Times, “if a devalued drachma appears, investors should pile in.” Why? Research by Elroy Dimson, Paul Marsh and Mike Staunton of London Business School suggests that “investing in the weakest currencies of the previous five years boosted equity and bond returns significantly since 1972.” So “Greece warrants attention: not for a bet on it sticking with the euro, but to be ready to buy in once it exits.”

New York Times describes Greek awareness that its a classic asset strip:
Growing Air of Concern in Greece Over New Bailout

Ms. Katseli, an economist who was labor minister in the government of George Papandreou until she left in a cabinet reshuffle last June, was also upset that Greece’s lenders will have the right to seize the gold reserves in the Bank of Greece under the terms of the new deal, and that future bonds issued will be governed by English law and in Luxembourg courts, conditions more favorable to creditors. 

While their country’s fate is being decided in abstract, high-level negotiations in Brussels, Berlin and Paris as much as in Athens, many Greeks said they had begun to feel that the debt writedown and new loan is aimed at saving the banks more than the country and its citizens.

The gold reserves? In Greece that accounts for 111 Tonnes and is 81% of the countries foreign exchange reserves. If Greece agrees to this they are mad (and bankrupt). At the current spot price of $1774oz, 1 Tonne is $57,035,423; 111 Tonnes is $6.33B.

What did Greece do in 1930s?

The Great Depression

As the reverberations of the Great Depression hit Greece in 1932. The Bank of Greece tried to adopt deflationary policies to stave off the crises that were going on in other countries, but these largely failed. For a brief period the drachma was pegged to the US dollar, but this was unsustainable given the country’s large trade deficit and the only long term effects of this were Greece’s foreign exchange reserves being almost totally wiped out in 1932. Remittances from abroad declined sharply and the value of the drachma began to plummet from 77 drachmas to the dollar in March 1931 to 111 drachmas to the dollar in April, 1931. This was especially harmful to Greece as the country relied on imports from the UK, France and the Middle East for many necessities. Greece went off the gold standard in April, 1932 and declared a moratorium on all interest payments. The country also adopted protectionist policies such as import quotas, which a number of European countries did during the time period. Protectionist policies coupled with a weak drachma, stifling imports, allowed Greek industry to expand during the Great Depression. In 1939 Greek Industrial output was 179% that of 1928.[16] These industries were for the most part “built on sand” as one report of the Bank of Greece put it, as without massive protection they would not have been able to survive. Despite the global depression, Greece managed to suffer comparatively little, averaging an average growth rate of 3.5% from 1932-1939. The fascist regime of Yannis Metaxas took over the Greek government in 1936, and economic growth was strong in the years leading up to the Second World War.
 The path is quite clear. Exit the Euro, adopt the Drachma at a low exchange rate and tell the Germans, French and the banks to fuck off. Or, face decades of depression and servitude.


  1. There are indeed many parallels between past defaults, of which there have been very many, like Argentina's recently, as pointed out and today's situation in Greece.

    However, what is being overlooked is the fundamentally systemic nature of the crisis which engulfs us. A failed ideology of infinite growth in a finite world is now being dashed on the rocks of peak finance, peak resources and peak energy. Poor Greece is merely the canary in the coal mine.


  2. Spot on John. Austerity to trigger growth and mainly and trying to lend more when everyone has a debt problem is bizarro.

    Thanks for commenting.