The Price of Argentina's Default

Dean Baker is tut-tutting at Planet Money for their segment on the 2001-2 Argentinian default:

NPR's Planet Money made its entry in the Stake Your Claim game show with a segment on Friday that claimed that Argentina is suffering horribly as a result of its decision to default at the end of 2001. It turns out that Argentina has actually been doing quite well since its 2001 default as the most recent data from the IMF show.


Source: International Monetary Fund.

As can be seen, Argentina was already in a severe recession prior to default. It had tied its currency to the dollar, which went through the roof following the East Asian financial crisis in 1997. While the United States could support the trade deficit that resulted from the over-valued dollar, Argentina could not. It eventually had no choice but to break its peg with the dollar and default on its debt in December of 2001. Its economy fell sharply in the next quarter, but had stabilized by the summer of 2002. It then began to grow rapidly and was above its pre-recession level by the end of 2004.

Paul Krugman piles on:

This isn't the only case where news organizations consistently report as truth something that didn't happen, while failing to report what did. Another one that comes to mind is the California electricity crisis of 2001-2002. As some readers may recall, that crisis was caused by market manipulation -- and that's not a hypothesis, Enron traders were caught on tape telling plants to shut down to create artificial shortages. Yet "news analyses" published after the whole thing was revealed would often tell readers that excessive environmental regulation and Nimbyism caused the crisis, with nary a mention of the deliberate creation of shortages.

And as you'll notice, in both cases the imaginary history just happened to be one more comfortable to status quo interests.

As it happens, I had just listened to that podcast when I saw that piece. And I can't believe that Dean Baker and Paul Krugman listened to the same podcast that I did. In fact, I find it hard to believe that they listened to it at all.

Let me start by saying two things: I agree with what I presume is the Baker/Krugman position, which is that Argentina needed to devalue and default.  However, I think the story is a bit more complicated than Baker makes out.  For starters, I'm not sure why Dean Baker chose to index to 1998, which makes it look as if Argentina's default were the key to stratospheric growth rates.  But if you index to 1980--the first year of the IMF data series--default and devaluation don't look quite so miraculous:
Thumbnail image for Argentina3.png

As you can see, the dollar peg was very bad for Argentina. When Argentina left the peg and defaulted on its debt, they ended a multi-year recession, and rebounded to nearly the GDP levels they'd enjoyed before the peg.  [Editor's note: tragic excel mistake now fixed] (The figures are based on real GDP in Argentine pesos).  But they didn't discover some miracle economic elixir; it's more like they stopped banging themselves in the head with a sledgehammer. They also got an enormous boost from a commodity boom driven by rising Chinese demand; Argentina produces a lot of agricultural exports, and when those prices rise, so does the Argentine economy.

However, even this obvious (in retrospect) step was not cost-free: GDP growth doesn't tell the whole story. Defaulting and breaking the peg wiped out a lot of domestic savings, further tanked the economy and the banking system in the short run, and cut off Argentina from the capital markets.  This was exacerbated by the way Argentina chose to default: they demanded extremely stiff "haircuts" from their creditors.  And since the bond agreements stipulated that the bonds were payable in dollars, and that disputes would be adjudicated in foreign courts (mostly, I believe, the US), Argentina had no way to force creditors to accept those terms.  Many of them didn't.

Of course, the creditors had no way to force Argentina to pay, either.  So there's a sort of standoff . . . except that those creditors still have legal claims on Argentine assets, and if any of those assets are found on foreign soil, the creditors can seize them.  Which in turn means that Argentina has a very hard time raising money abroad, since their creditors can legally seize the proceeds.  (Also, people don't like lending money to governments who refuse to pay more than 35 cents on the dollar to foreign creditors.)  Argentina has, I believe, been able to borrow some money, but nothing like what it was able to access before the crisis.

So who cares?  The Argentine government, that's who; that inability to finance deficits has pinched.  Devaluation raised the peso value of their debt, so rather than building up reserves, Argentina used the proceeds of its commodity boom to pay down debt and stimulate consumer demand.  When the global financial crisis drove commodities into a temporary slump, the government was caught out, unable to borrow the money they needed.  They turned to their equivalent of America's 401(k) system, seizing the money on the pretext of protecting the elderly.  They've also used central bank reserves to pay their debts. Their capital markets remain shallow and prone to capital flight at the first sign of trouble.  If there's more trouble in the global economy, what does the government do for an encore?  There's not much left to nationalize, and I don't think there's going to be a big appetite for their debt in the near future.

The shallowness of their capital markets has also made it hard to diversify beyond those booming commodities.  The other sectors of their economy have not, as I understand it, been developing as you'd like to see.  They remain vulnerable to falling prices in their key export sectors or appreciation in their currency.

All of which is not to say that devaluation and default were bad ideas (though you can, I think, make a strong argument that they would have been better off taking a more conciliatory approach towards their bondholders).  Argentina was in a very bad spot; I think that leaving the peg and forcing its creditors to take a haircut was the best of the terrible choices open to its governments.

Remarkably, this is exactly the point that the Planet Money podcast makes--if you listen to the whole thing.  I mean, sure, the host says something like "If you can believe it", but they explain very clearly that post-default, the Argentine economy boomed.  I don't understand why Krugman and Baker believe that they "claimed that Argentina is suffering horribly as a result of its decision to default at the end of 2001".  Here's the end of the podcast, with highlights added by the justifiably protesting Planet Money team:

Robert Smith: It has been a tough decade for Argentina, but a lot of people think that the default was the best thing to happen to them.

Zoe Chace: After the money was devalued, banks opened up again. Pesos weren't worth as much, sure, but Argentinian products suddenly looked cheap on the world market. And that's been really good for Argentina's economy. Exports of staple products like soybeans and wheat went up. And eventually, some investors started to lend Argentina money again...

Robert Smith: This whole thing is something of a happy ending, after a long nightmare of a story

Which is not surprising, because when it comes to Argentina, as far as I know, the "status quo" view is that default and devaluation were pretty much inevitable. I haven't spoken to anyone who thinks that with the economy stuck in a four-year recession, riots in the streets, and the government changing leaders every few days, Argentina could have held onto the peg much longer.  And once it left the peg, default was inevitable, because there was no way they could pay that much dollar-denominated debt while collecting taxes in radically devalued pesos.  The only question is whether the transition could have been handled better--a question that neither Krugman nor Baker address.

But as you'll notice, the imaginary history is more comfortable to the interests of a quick blog post.

Updated to correct an error in the chart, to add the relevant section of the podcast, and to clarify my points of disagreement with Krugman and Baker.