“We are witnessing the First World – which at one point had been painted as a Mecca we should strive to reach – popping like a bubble.”
Argentine President Cristina Fernández de Kirchner didn’t hold back on her evaluation of the financial crisis gripping the US during a speech in front of the UN in September.
In the last month, the world’s largest economy has been rocked by the collapse of several major banks and financial institutions. Stock markets, which had already been heading downwards, went into freefall as the entire financial system creaked. In an attempt to restore stability, the US government passed into law a massive US$700 billion bailout plan at the start of October. This form of intervention was unprecedented in its scale and ambition, and did not go unnoticed by Kirchner or other critical South American leaders.
“They told us South Americans that the market would solve everything, that the State wasn’t necessary, that interventionism was mere nostalgia. Nonetheless, we’re now seeing the most formidable act of state intervention in living memory, in precisely the place where they’d been telling us that the State was unnecessary,” said the Argentine president
Experienced In Disaster
Of course, Argentina is no stranger to economic crises. Seven years ago, the country went through the biggest sovereign debt default in history, plunging the economy into a devastating recession.
Perversely, this catastrophe may protect Argentina from the worst of the fallout in the current crisis. The domestic banking sector was left in tatters after the 2001 crash, and even today, public trust in banks is fragile. The limited use of credit in local markets prevented local banks from the reckless lending of US and European banks over the past few years.
Argentina’s exposure to the crisis is also limited by the country’s financial ‘quarantine’ over the past seven years. In 2005, around 75% of those still holding defaulted debt accepted a ‘take it or leave it’ settlement by then-President Nestor Kirchner. However, as long as outstanding claims against the government existed, the threat of legal action prevented Argentina from accessing international financial markets.
So while countries like Brazil – which was one of the biggest beneficiaries of the boom in global credit – are feeling the strain as bank lending dries up, the impact here is barely noticeable.
“We with our own model, based on building with our own means, are here weathering the storm, firmly, recovered, and ready to face the present and the future.” declared Kirchner triumphantly.
Kirchner’s confidence in the resilience of the Argentine economy may not be shared by all. Money has already begun to flow out of the country at an alarming rate, as nervous investors sell off assets in high-risk locations. In the last week of September alone, Argentina’s Merval stock index tumbled almost 10%.
Argentina’s turbulent economic history, combined with the unorthodox policies of the Kirchner presidents, makes it unsafe in the minds of many investors. JP Morgan’s EMBI+ Index, which measures risk in emerging markets, showed a surge in Argentine risk to over 1,100 points at the start of October. Alongside Ecuador, this is the highest level in the whole of South America.
This image has already taken its toll on the country’s economic development. According to the UN Department for Trade and Development, foreign direct investment (FDI) in Argentina slumped by 37% in 2007. This was during a year when soaring commodity prices were spurring rapid growth, and FDI for the wider Latin American region jumped 50%.
Facing Up To The Real Problems
It is figures like these that have investors running scared from Argentina now that the external climate is considerably bleaker. Up until now the crisis has been contained in the financial markets, while the impact on the wider economy has been limited. But there are clear signs that the US is entering into a painful recession, with profound implications for the rest of the world.
Academics, economists and journalists have called this the worst crisis since The Great Depression of the 1930s. During that period, the US led the world into a severe downturn that lasted the best part of a decade, ending with the start of World War II. Back then, Argentina was heavily exposed to tumbling commodity prices. Farmers and exporters were hit hard, the gold standard currency peg was abandoned, and the economy slid into recession.
Eighty years on, and though outright recession is unlikely, the parallels are plain to see. The collapse in demand of Argentina’s key exports remains one of the biggest threats to the economy. The country is a major producer of soy, wheat, corn and cattle, and tumbling prices of these products since July is causing alarm in the agricultural sector. The fall in global demand and prices has also arrived at the same time as Argentina’s worst drought for four decades. The tensions are clear to see as producers declared a six-day strike at the beginning of October.
It is not only the farmers that are affected by falling crop prices. The Kirchner administration has become increasingly reliant on agricultural taxes to fund its lavish social spending programmes. It was a proposal to raise taxes on soy exports to 45% – the third hike in less than a year – that triggered a nationwide farming strike in March this year.
Twin trade and budget surpluses have been the cornerstone of economic policy under the Kirchners. Both presidents quoted them regularly to boast about the stability of the Argentine economy. But as exports and tax revenues fall, they will eat away at these two insulators against external shocks.
Faced with this prospect, the government is preparing measures to shore up the state budget, including cutting back on transport and utilities subsidies. It also eyeing up a possible return to international markets: President Kirchner recently announced a surprise new deal for the outstanding holders of defaulted debt, with similar terms to the 2005 deal. These are important steps, though it remains to be seen whether they are too late to prevent a severe downturn in the economy.
A Blessing in Disguise?
For some, one of the silver linings of the Great Depression in Argentina was the creation of a Central Bank, with an independent monetary policy, in 1935. Today too, some see an opportunity for change as external complications force the hand of the Kirchner administration. “The shift in the focus of economic policy goes beyond financial normalisation,” says economist Miguel Bein, writing in national daily ‘Clarín’, “it even reaches [the issue of] inflation, and how to control it.”
The pressures of inflation should ease as demand subsides. But expectations of inflation over the coming year remain above 30%, according to a monthly index published by the University Torcuato di Tella. So far, the government has refused to acknowledge that inflation is running above the official rate of 9%, despite substantial evidence to the contrary. Restoring credibility to government data and addressing the threat of inflation is seen by many as the main priority for the Kirchner cabinet. As Bein concludes, “[these are] changes that come better late than never.”