argentinian peso currency money banknotes

Economics

Decoding Currency Crises

Sep 3, 2018 Andrés Velasco

Brazil invests little and is running a fiscal deficit of 9% of GDP, whereas Argentina invests more and is gradually consolidating its public finances. So why is Argentina the one that's in trouble with the currency markets?

SANTIAGO – Imagine two countries. Country A has a fiscal deficit of slightly over 5% of GDP, while country B shows a gaping hole of nearly 9%. Moreover, until recently A’s public debt barely exceeded 50% of GDP, while B’s public debt has been shooting up and will soon reach 90% of domestic output.

Of the two, B is more likely to suffer a currency crisis, right?

Not quite. A is Argentina, and B is Brazil. Since the beginning of 2018, the Argentine peso has lost half of its value. Nearly out of foreign exchange, Argentina had to adopt austerity measures to secure a $50 billion bailout from the International Monetary Fund – and not even that has calmed investors. Meanwhile, the Brazilian real has weakened, mostly in response to the uncertain outcome of the October presidential election, but no obvious financial crunch looms.

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Andrés Velasco

Writing for PS since 2001
136 Commentaries

Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.

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0 Comments on this paragraph, 9 Comments on this article

camilla alves Sep 5, 2018

I'm afraid the author is missing a very important point: Argentinean politics and institutions are way more instable and not committed to macroeconomic stability than their Brazilian counterparts. Throughout the last century there were several coups and contra-coups in the country, deindustrialization, poor economic policies, a deep populist inheritance that has Perón as its champion until nowadays, as a result, two first ladies became president as heiress of their late husbands, and they even started a war against Britain(!). Although this may not be explicitly priced, it cannot be ignored, and is clear that this sentiment exists when you confront the lack of credibility of the country. Although Macri is serious and very well intentioned, Argentina is much more likely to be trapped in caudillo’s populist politics.
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Turgay Sanac Sep 4, 2018

Additionally, a rightful key-question nowadays: How big is the (deliberately negative; sometimes/somewhat manipulative) impact of "The pretty honoured/privileged international credit rating agencies", i.e. so-called "Big Tree Trustees, exclusively from USA", on the currencies/economics of the emerging/poor countries (and especially in crisis situations) actually?
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Robin Yoshimura Sep 4, 2018

I think the author misses a big difference between A and B. According to Reuters, nearly 70 percent of Argentina's debt is in foreign currency vs. Brazil just 5 percent of debt is foreign denominated.
- Peter Schaeffer Sep 4, 2018
  
  Robin Yoshimura, Good comment. Good observation. Borrowing in a foreign currency is dangerous. This point has been recognized for a long time. There is actually a term for this, "original sin". There is also a substantial literature on the subject (of "original sin").
  
  The dire problems of Southern Europe are a direct consequence of borrowing in a foreign currency (the Euro). The situation in Southern Europe is actually worse because the countries in question don't even have a domestic currency to devalue.
  
  I would add that history (in this context) favors Brazil over Argentina. Argentina is a well known, serial defaulter. Loaning money to Argentina has been a disaster for a long, long time. As a consequence, markets don't trust Argentina (for good reason). Brazil doesn't have the same (bad) reputation.
  
  Of course, the author (Andrés Velasco) knows all of this far better than I do. His failure to mention these salient points is both surprising and revealing.
  - Peter Schaeffer Sep 4, 2018
    
    I would add one more point. If Brazil is really running a deficit of 9% of GDP, then Brazil is in trouble. Not immediately to be sure. However, no country can sustain deficits of that magnitude. Of course, Brazil is not at war with anyone these days and the global economic environment is moderate (not great, not terrible). Brazil should be much closer to fiscal balance, but is not.
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Jose Antonio Vanderhorst Silverio Sep 3, 2018

When I read that "... given well-functioning financial markets and a strong legal system, the dairy plant could also be quickly mortgaged and turned into cash," and thought something else was coming for a moment. Are those markets really well-functioning?

I say no. They are what I suggest is the Dark Globalization where regulations are unsustainable (or legalized corruption), when we need the Bright Globalization, where regulations are sustainable. Having said that, as country A has less judicial capacity to deal with corruption than country B, the market risk is a lot larger in country A than in country B.

All the EcoNoMic analysis is done without mentioning that the market is globalized. So it is very difficult to understand what's happening without introducing the EcoIsOurs profession that has the necessary heuristic and learning power needed. I would love that the analysts consider country DR - the Dominican Republic - which recently is loved by investors as it is a good payer, but with very little judicial capacity to deal with corruption. Public debt has been increasing non linearly, for example, from US$6,587 in 2004 to US$30,585 in 2018.
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Nicolas Cornejo Sep 3, 2018

I was hoping Velasco would apologize for his previous comments on Argentina. But some people never learn.
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jrstevens90 Sep 3, 2018

It feels like this article is basically making excuses for why Argentina is having this crisis when it's been enacting exactly the neoliberal policy platform the author advocates.
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Decoding Currency Crises

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