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The currency that fell apart

Kathleen Brooks, director of research
Argentinian pesos (AP Photo/Alan Diaz)

Emerging markets have taken a battering in recent weeks; the Turkish lira has been propped up with emergency rate hikes, the Russian rouble is at historic lows and the South African rand has seen a sell-off. But at no stage has it looked like we are returning to 1997 territory, when the emerging world imploded in a giant debt bubble.

Except for one country: Argentina.

The Argentine peso has fallen 18.68% since the start of this year; nearly triple the losses in the Turkish lira, Russian ruble and South African rand. To put this in context, a 22% loss in a month is usually considered currency crisis territory, so not far off. At the weekend the Argentinian government took the radical step to devalue the currency by 15% and to limit currency controls.

Then on Tuesday the central bank hiked interest rates to their highest level in a decade to shore-up the peso further after the central bank said it would no longer intervene in the markets to support the currency.

Bigger problems
Even before the recent bout of turmoil in emerging markets, Argentina was ticking the boxes of crisis territory: Inflation at 28% in 2013, tick; regular blackouts caused by underinvestment in the electricity grid, tick; government spending running out of control leading to unsustainable public sector wage growth, tick.

But why did the panic happen now? Everybody knows not to trust the government data, that the economy is in much worse shape than the government admits, that President Christina Fernandez has a woeful grip on power and riots and lootings are commonplace some 13 years after Argentina requested a $95 billion bailout.

The currency has been falling for most of the last 5 years; however, it was last week’s pace of decline that spooked the wider financial markets. But why now, if the problems have been  mounting for years?  This comes down to market psychology.

Panic spreads fast
Crises don’t happen in a linear fashion, they take place in waves. You go through the eye of the storm then you have some calm before the wind picks up again.

You could say that Argentina is at the extreme end of the spectrum when it comes to market confidence, because the market is loath to forgive a defaulter especially one with weak leadership.  It costs more than double to buy insurance for Argentina than for Greece and Pakistan, which highlights just how lowly Argentina is held by the international investment community.

Since emerging markets tend to fall in unison, and Argentina is deemed the “worst” in the emerging markets space, then the peso was always going to be in the firing line if traders went into panic mode. 

Making a bad situation worse
While Argentina has had to adapt to hardships and inflation over the years, the latest crisis has pushed Argentina even further away from recovery. The ways things are going the situation could still be bad in 50 or even 60 years time.

For the man or woman on the street this means even more inflation (which could top 30% this year), making it harder to set up a home and even to eat. There is even a risk of hyperinflation now that the currency has been devalued. As we saw in Germany at the end of the Second World War and Zimbabwe more recently, hyperinflation ruins the fabric of a community and the scars can run deep.

There is the risk of a run on deposits held in banks now that currency restrictions have been lifted, which could see savers transfer their cash into US dollars to preserve its value. While it is fully understandable why people would want to do this, it could exacerbate the currency crisis even more.

Ultimately, though, another crisis in Argentina will lead to soaring poverty rates, a rapid drop in living standards and the potential for even worse social unrest. The tragedy is that for such a beautiful country, Argentina cannot offer a good quality of life any more.

That never used to be the case, Argentina is the second largest economy in South America and used to have standing in the financial markets.

If Argentina can fall could the same happen to us?
We continue to have one of the largest deficits in the western world, we have had our own share of rioting through the years and our currency can fluctuate wildly, remember 2008?

However, right now we have the investment community’s confidence; they trust us that we will pay our debts, which is why we can still borrow so cheaply. That doesn’t mean that will always be the case – if we don’t sort out our debt problems or we experience some major economic mismanagement in future years then we can expect the same punishment.

For now though, our leaders look angelic compared to Fernandez. However, Argentina is a good example for all debt-bloated western economies of how far the mighty can fall.

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Kathleen Brooks is author of Kathleen Brooks on Forex, published by Harriman House.