What Argentina can tell us about Greece
0The plight that Greece, and the rest of Euroland’s periphery for that matter, can be compared with the experience of Argentina from 1999 to 2002, which like the Euroland periphery, reached its debt limits, was pegged to a currency that it could not print (the US dollar) and began to de-leverage.
Looking back, Argentina was initially committed to engaging in austerity and maintaining its dollar currency peg, but eventually the cycle of weak growth, capital flight and rising interest rates overcame the desire to maintain monetary continuity. As a result, after a 20% contraction in GDP (only a bit more than the contraction that Greece has experienced to date), the Argentinean people overturned the existing government and the currency peg was abandoned.
In terms of the details of Argentina’s experience, when Argentina reached its debt limits, the government initially reacted with austerity and then sought IMF assistance. When it became clear that Argentina was missing its budget targets and the need for official lending was greater than estimated, the IMF and foreign governments increased their bailout package in exchange for further austerity. Then when it then became clear that its debt burden was too great, Argentina created a couple of ‘voluntary’ debt swaps to extend maturities and lower interest burdens. However, without devaluation, this did little to resolve the underlying competitiveness issues, and as the magnitude of the problems became clear to private sector creditors, bank runs occurred, driving up Argentina’s funding needs. The government subsequently made it illegal to move money out of the country, but these capital controls were both difficult to enforce practically and caused material damage to economic activity, and so were unsuccessful. In late 2001, the Argentinean president was voted out and a few days later the new administration broke the peg.
One of the key differences between the positions of Greece and Argentina has been the role that the ECB has played, and unlike private creditors, the ECB has continued to provide liquidity to Greece despite its deteriorating creditworthiness and lack of collateral. This liquidity has allowed Greece to continue to run current account and capital account deficits that would not otherwise have been possible. Without such support, Argentina was forced to enact capital controls and make more rapid economic adjustments. Yet the decline in Greek output is now close to the 20% collapse experienced by Argentina before the peg broke. Importantly the break of the currency board and the associated monetary easing marked the bottom for Argentina’s economy and it’s interesting that the pace of economic deterioration in late 2001 in Argentina was faster than that experienced in Greece today because the ECB’s actions have slowed the deleveraging, although the current account imbalance in Greece is much worse than that experienced by Argentina. Even with the improvement of the past few years , driven mostly by the destruction of Greek domestic demand, Greece still has a current account deficit of close to 10% of GDP, far worse than Argentina’s ever was, and Argentina’s current account was in balance by the time it abandoned the peg. However by that time capital flight was the larger problem. Both Greece and Argentina experienced material capital outflows as their economies deteriorated, with the difference of course being that the ECB replaced the outflows from Greece.
Looking at bank deposits, with nearly 25% of deposits fleeing the country, Greece has already experienced a greater bank run than seen with Argentina. Argentina also experienced a large run on deposits before capital controls were put in place and the peso was eventually devalued and after Argentina’s devaluation, deposits continued to leave the country. The spike in deposits after the devaluation was a function of deposits being redenominated at 1.4 times the previous level, and only after a 75% decline in its currency and high interest rates did deposits stabilize and credit and economic growth resume.
The ECB has printed money to back fill what the private sector withdrew and thereby kept Greece going, but the pursuit of austerity without the prospect of currency devaluation may explain why the collapse in Greek equities has been far worse than that experienced in Argentina. Devaluation marked the bottom for equities in Argentina, and the market almost doubled in the year after the peg was broken. Indeed stocks actually rallied in advance of the currency break, likely because markets increasingly expected the currency devaluation and the associated easing of monetary policy. As we know, like Argentina in the early years of the crisis, Greece has experienced basically no improvement in the level of its currency.
The combination of fixed currency and austerity measures means that Greece remains in a destructive de-leveraging phase. The policy mix for dealing with this de-leveraging has not yet been sufficient to alleviate the self-reinforcing deflationary depression. The elections, which largely voted out the parties that agreed to more austerity, highlight the political and economic limitations of austerity when dealing with extreme de-leveraging.
Over the next few months, Greece will be increasingly unlikely to deliver on the austerity commitments it made for its second bailout package and how both the EU and Greece deal with this limitation will likely influence what policy mix the EU utilizes to manage the de-leveraging requirements for other peripheral Euroland countries.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
