The Default is a Minor Problem – Argentina's Real Problem is Something Else Entirely

By now it is well known that Argentina has been declared in default by the major credit rating agencies. This has happened in spite of the Argentine government actually depositing the interest payment intended for those creditors who have grudgingly accepted the post 2001 default restructuring because they thought they had no other choice. After all, they couldn't very well invade Argentina and sell its government assets. That is the problem with lending to governments: they not only assuredly waste the money they borrow, but when push comes to shove, creditors often find themselves left out in the cold.

However, the so-called “hold-outs” –  a group of investors that didn't accept the terms of the debt restructuring – have continued to fight the Argentine government in court to get restitution, and have won several cases. At one point, they even had an Argentinian warship confiscated in a Ghanaian port.  The latest court case won by the hold-outs has led to the current impasse and subsequent default.


“Standard & Poor’s declared Argentina in default after the government missed a deadline for paying interest on $13 billion of restructured bonds.

The South American country failed to get the $539 million payment to bondholders after a U.S. judge ruled that the money couldn’t be distributed unless a group of hedge funds holding defaulted debt also got paid. Argentina, in default for the second time in 13 years, has about $200 billion in foreign-currency debt, including $30 billion of restructured bonds, according to S&P.

Argentina and the hedge funds, led by billionaire Paul Singer’s Elliott Management Corp., failed to reach agreement in talks today in New York, according to the court-appointed mediator in the case, Daniel Pollack. In a press conference after the talks ended, Argentine Economy Minister Axel Kicillof described the group of creditors as “vulture funds” and said the country wouldn’t sign an accord under “extortion.”

“The full consequences of default are not predictable, but they certainly are not positive,” Pollack wrote in an e-mailed statement. “Default is not a mere ‘technical’ condition, but rather a real and painful event that will hurt real people.”

Kicillof, speaking at the Argentine consulate in New York, told reporters that the holdouts rebuffed all settlement offers and refused requests for a stay of the court ruling. He said Argentina couldn’t pay the $1.5 billion owed to the hedge funds because doing so would trigger clauses requiring the country to offer similar terms to other bondholders.”


(emphasis added)

Given the nature of the current government of Argentina (financial repression is its bread and butter), we love to see its neo-Marxist “economy minister” Axel Kiciloff squirm. On the other hand, creditors to governments occasionally deserve to be taught a lesson about lending to governments, and one must fear the ultimate victims of the tussle will be the people of Argentina (of course, they could have voted for someone else, but it is not certain that it would have made any difference).

Be that as it may, the default is really a sideshow to Argentina's real problem, which is a profligate government financing its spending increasingly via the printing press, while publishing severely falsified “inflation” data in order to mask this fact.

The Merval Index has exploded higher in recent years, and just as is the case with stock market rally in Venezuela, it is not a sign of a healthy economy at all – on the contrary, it is actually a sign that a hyper-inflationary crack-up boom is anticipated by its captive audience (captive due to exchange controls that include “dollar sniffing dogs” being deployed at border crossings).


Merval(Monthly)20140804100056The Merval Index (monthly) is anticipating a hyper-inflationary crack-up boom as the printing presses are doing overtime in Argentina. Back in 2001, this index traded at 200 points. Its surge has nothing to do with the economy's health, as any visitor to Argentina can easily confirm first hand – click to enlarge.

The official exchange rate of the peso looks bad enough as it is, but it doesn't tell the whole story:


USDARS(Weekly)20140804095852The official exchange rate of the peso to the US dollar, weekly – click to enlarge.


The Sobering Reality

Professor Steve Hanke from John Hopkins University runs the “troubled currencies” project at the Cato Institute.  One of the things he is doing is to look at the black market exchange rate in countries that have currency controls in place to determine the “implied inflation rate” of its consumer price index. Even though one must acknowledge that such measurements are inherently difficult, as it is not truly possible to measure the purchasing power of money in the first place, the method gives us a rough idea how far removed from reality the official data are. In this particular case, very far indeed.


exchange-rates-and-inflationOfficial and black market currency exchange rates of Argentina and Venezuela, as well as official vs. implied inflation rates as of July 24 – click to enlarge.


Obviously there is a rather big gap between the officially admitted annual CPI rate of change of 15.01% and the implied rate of 51%. Given the action in the Merval, we can state with some confidence that the 'implied rate' is probably a lot closer to the truth. Here is a chart comparing the peso's official to its black market rate (inverted). This chart has been last updated in early July, so the most recent swoon in the currency is not yet shown on it:


argentine-pesoThe official vs. the “blue” (black market) peso-dollar rate – click to enlarge.


And finally, here is Professor Hanke's chart of Argentina's implied annual inflation rate over time (note that due to the calculation method, implied rates below 25% are considered unreliable):

argentina-inflation-ratesThe implied inflation rate is highly volatile, but has been far higher than the official one for an extended time period. Since this is a year-on-year measure, the effect is compounding over time, hence the growing flight into 'real values' in Argentina. People are not only buying stocks, but also real estate and other hard assets – click to enlarge.


Such inflation rates represent an unmitigated economic disaster. Not only for the obvious reason that they make economic calculation practically impossible and rob savers of their hard-earned money, but because they also undermine people's productivity and their morals. Once a nation's entire population is forced to spend a lot of effort on a daily basis looking for ways to escape the ravages of inflation, its economic productivity is invariably sapped.

By robbing savers, government moreover undermines the moral fabric of society at large, while creating a new underclass – comprising all those who rely in some way on fixed incomes.

As Hans Sennholtz once wrote (and although this was written in the context of the Federal Reserve's inflationary policies, it is readily applicable to such policies everywhere):


“[…] many victims readily conclude that thrift and self-reliance are useless and even injurious and that spending and debt are preferable by far. They may join the multitudes of spenders who prefer to consume today and pay tomorrow, and they may call on government demanding compensation, aid, and care in many forms. Surely, the hurt and harm inflicted by inflation are a mighty driving force for government programs and benefits.

In their discussions and analyses of various problems, economists usually avoid the use of moral terms dealing with ultimate principles that should govern human conduct. Ever fearful of being embroiled in ethical controversies they seek to remain neutral and “value-free.”  They do counsel legislators and regulators on the cost-efficiency of a policy but not on its moral implications. They may offer professional advice on the efficiency of money management but not on the morality or immorality of inflationary policies. They dare not state that inflation is a pernicious form of taxation which most people do not recognize as such.”


The biggest debtor also is the biggest inflation profiteer.


The primary beneficiaries of the new order are its own managers: legislators, regulators, and a huge army of civil servants. They are first in power, prestige, and benefits.


Evil acts tend to breed more evil acts. Inflationary policies conducted for long periods of time not only foster the growth of government but also depress economic activity. Standards of living may stagnate or even decline as growing budget deficits thwart capital accumulation and investment that are sustaining the standards.


(emphasis added)



Inflationary policy is and always will be extremely destructive. In the developed world, a situation like that observed in Argentina has so far been avoided, but that doesn't exactly mean that central banks in the industrialized nations are slouches in the money printing department.

Their actions buy us what appear to be “good times” by diverting scarce resources into various bubble activities, but in reality they impoverish us. In this respect, there is no difference with Argentina. The latter has merely gone a step further, attempting to keep its government flush and the boom going by going completely overboard with its inflationary policy. The end result in either case is economic devastation, there are merely differences in degree, but not in substance.


Charts and tables by, Cato Institute/Steve Hanke



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One Response to “Argentina – the Economic Backdrop to the Default”

  • wrldtrst:

    Personally I wouldn’t rush into concluding “The Sobering Reality”, is “the” reality because it is not the reality either.
    From my experience with Argentina, it is somewhere in between. The high volatility in the implied rate is a screaming warning to be careful with the data. There is clearly a volatile “basis like” spread in blue/official rates as you can see in Apr ’13 and Dec ’13. And having been many times in countries while they were undergoing currency problems, one thing always struck me as strange. I remember first reading about PPP and thinking, “ah, of course, it makes complete sense”. In reality I have never seen it hold. Which is why I have often found myself in places saying “wow, everything here is so cheap”. I have always just assumed this had something to do with export restrictions and the amount of domestically produced product.
    Argentina is one of those “cheap” places right now.
    Also to explain the blue rate, it is only for dollars. US GREEN DOLLARS!! and those dollars better not be crumbled, too worn, or have even the slightest tear in them. So if I go to Argentina with friends from outside of the US. If they do not bring dollars with them, they have NO benefit of a black market rate!!!! Things are expensive for them, whereas for me everything feels like it has a 35% discount and cheap, cheap, cheap…Much cheaper than it “felt” a year ago, and if PPP held that would not be true.
    Therefore i’d cuff inflation as somewhere between the 2 rates you are showing.

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