The U.S. Dollar Is Following Argentina's Path

Something I've touched on before but have not elaborated too much on is the similarities between Argentina in 2001 and 2002 and the US now. Here is a fantastic analysis of this subject. Below is a breakdown of the key events:

1. In 1997, Argentina experienced a recession. The government response was to ease credit -- i.e. lower interest rates -- and increase government spending, which for Argentina, would mean increasing deficit spending (i.e. borrowing and spending rather than taxing and spending). The US followed the same path in the semi-bursting of the 2002 and 2003 NASDAQ bubble.
2. The excessive easing of credit leads to inflation. For Argentina this occurred in 1998 and 1999; in the US, this peaked in the summer of 2008. During these episodes of inflation, both countries receive warnings from the IMF that their monetary policies are unstable.
3. Both countries then revert back into a recession. This time, however, they are both saddled with greater debt.
4. The recession, coupled with the increased debt burden, leads to a credit crunch, defaults on borrowed funds, and bank failures. For both countries, this results in a decrease in the money supply.

This is where the similarities end, as we don't know how the US will get out of this situation. Will it continue to follow Argentina? Let's see:

1. During its debt ridden recession of 2000, Argentina responded by continuing deficit spending. Likewise, Barack Obama has already stated that deficit spending is not a concern, and that deficits to stimulate the economy is needed.
2. Eventually, Argentina was having trouble finding investors to lend it money. To make its debt more attractive, it increased its yield -- what it was willing to pay to borrow money. In the United States, we are seeing bond prices rally, and many are pointing out similarities to other bubbles. If this is a bubble, and if it starts deflating, interest rates will need to rise to make the bonds appealing. Interestingly, Paul Volcker, the Federal Reserve Chairman who raised rates in the '70s to help curb inflation and tighten the money supply, has been brought on to head a new economic advisory board. Are they looking to Volcker for assistance in raising rates?
3. For Argentina, the rate hikes were not sufficient. Eventually, the diminishing tax base, bank failures, and higher interest rates made Argentina unable to make debt repayments. The result was a run on the currency. If the US cannot find buyers for its debt, the same scenario would play out here, which would result in currency devaluation.

Disclosure: I am short the US dollar against the Japanese Yen.

Comments

[Balderdash:]

The only missing piece here is the dollar status as the world reserve currency. Not that there won't be a run on the dollar -- there will -- but that it will need to surmount a greater hurdle than Argentina to kill it.

China and Japan and OPEC have to get sufficiently angry in unison.

2008 Dec 03 06:43 AM

[Long Silver...:]

When the Fed starts buying long term Treasury Bonds, how does this "Round Robin" perpetual motion machine get any real traction? (i.e., does it come out somewhere as inflation?). I'm having trouble following it through to the ultimate endgame... Any thoughts?

2008 Dec 03 10:24 AM

[Willten08:]

Just finished watching video of Peter Schiff's November 2006 speech at the Mortgage Bankers Association Meeting in Las Vegas. He made these same points very forcefully and clearly, plus a wide-ranging discussion of the state of our economy and where we were headed. The guy is phenomenal - too bad people, especially our leaders and experts, did not heed his warnings.

2008 Dec 03 11:36 AM

[William Samedy:]

There are structural differences between those two economies. But the most important one is that before the 2001 crisis, in Argentina we had a fixed exchange rate regime.ç
Practically there were no possibility for monetary policy and the peso couldn’t adjust freely to market forces.

2008 Dec 03 12:01 PM

[wallyjm:]

all fiat money only pieces of paper with their value based on faith alone have all gone the way of the dodo from the roman empire to the present.

2008 Dec 03 01:05 PM

[Smarty_Pants:]

Good choice for a comparitive analysis. As Balderdash noted, our foreign creditors hold our fate in their hands. How they choose to utilize that power remains to be seen.

2008 Dec 03 02:22 PM

[VintonCounty:]

To Armageddon Baby:
Each dollar the Fed creates by buying government bonds adds to the money supply (M1) and so is currency inflation. Each dollar is subsequently loaned numerous times (the multiplier effect), and those credit dollars are money just like the original dollar the Fed created. The credit dollars also add to currency inflation. People's insouciance about inflationary effects from huge federal deficits presumably derives from the theory that, due to scarcity of credit, the number of credit dollars is currently reduced; so currency inflation will not occur. Even if that theory is correct now, the money supply will increase when credit availability returns to normal.

2008 Dec 05 10:15 PM

[Chris B:]

Here's a follow-up question: In hindsight, what should the citizens of Argentina have done? Set up a forex account? Shorted their own currency? Hoarded PM's or foreign currencies such as the USD, Euro, or Yen? Emigrated?

2008 Dec 09 12:48 PM