Which brings us to Argentina. Now, on the one hand, it almost doesn't seem worth mentioning that its currency is collapsing. It has been doing that for the better part of a century. But, on the other hand, this does deserve attention, because this time really was supposed to be different. Center-right President Mauricio Macri, you see, had promised that he'd make Argentina a "normal country" by once and for all rejecting what he accurately described as the kind of "magical" thinking that said they could have their cake, eat it, too, and then print money to buy more cake. Despite that, though, Macri has, much like his predecessors, now been reduced to asking the International Monetary Fund for a $30 billion line of credit to try to stabilize the situation.
What happened? Well, a few things. Macri has rather sensibly attempted to only gradually cut the country's budget deficit, while much more rapidly reducing what was Argentina's 40 percent inflation rate. As a result, the currency, as much as it's weakened, has still been a bit stronger than you might have expected. That's made both its exports less competitive, and the country as a whole more dependent on borrowing from abroad.
In this, Argentina is hardly unique among emerging markets, but it is uniquely bad. That's because, as the Council on Foreign Relation's Benn Steil and Benjamin Della Rocca point out, the "taper tantrum," a period when emerging market stocks, bonds and currencies sold off five years ago in response to then-Fed Chair Ben Bernanke's suggestion that the Federal Reserve might start printing less money, was enough to scare a lot of them into shoring up what had been pretty vulnerable borrowing positions. So now that the Fed is, in fact, increasing interest rates, and U.S. Treasury bond yields are starting to rise, as well — attracting money that had previously been pouring into emerging markets where it could earn a better return — they're in a strong-enough spot to withstand the whipsaw of these financial flows going into reverse. But Argentina, which the IMF estimates borrowed the equivalent of 4.8 percent of its gross domestic product from overseas last year, is not.
The rest of it is a pretty familiar story, at least for Argentines. It started last December when Macri seemed to become so concerned that the central bank's efforts to, if not quash, at least bring inflation down to a more manageable level were not only unrealistic but would also hurt the economy (and his own reelection chances) so much in the short-term that his government increased the inflation target for the next year from a range of 8 to 12 percent up to 15 percent. Right on cue, of course, the central bank started cutting rates a month later, despite the fact that inflation was still sitting at 25 percent. It's no surprise, then, that, notwithstanding what Macri has said, markets began to wonder whether the central bank really was independent when it looked as if the same old story was going on: Argentine monetary policy being driven by political more than economic concerns.
That was the economic fuse that rising interest rates in the United States set off in the last month. Argentina's peso, as you can see below, has dropped about 10.4 percent the past two weeks.
The government's response has followed the classic pattern. First, it tried to spend the problem away by using $5 billion of its reserves to prop up the peso in international currency markets. This worked for a few minutes. Then, when it had no other choice, it did what it hadn't wanted to at the start of the year, and increased interest rates; first from 27.25 to 30.25 percent; then, when that didn't work, from 30.25 to 33.25 percent a week later; and finally up to 40 percent a few days after that. The idea is simply to raise rates so much that the returns investors get can entice them to move their money back into the country, in the process, push the peso back up. And, just to make sure markets got the message, it even announced that it would cut its deficit more than it had already planned to.
This worked for a little while — the Financial Times even had a headline last night proclaiming that "Argentina's 'shock and awe' appears to pay off" — before it didn't. The peso resumed its slide on Tuesday, prompting the government to ultimately turn to the IMF for help. The problem is that currencies don't tend to just fall to whatever their fair market value is but, rather, to go even further than that so that investors can expect to make money as it rises back to wherever it "should" be. In the interim, though, Argentina is left with interest rates that are far too high for its economy to grow in any kind of way. It's a Catch-22: The only way to save its economy from a panic over the peso is to destroy it with punishingly high interest rates.
It's a reminder that what's good for the United States isn't always good for the world, especially if they've borrowed a lot of dollars and have a central bank that looks a little less than independent.