May 01, 2011
Paul Krugman is on target, as usual, in his Friday post on Argentina’s experience and the Euro zone. However, there are some details worth adding.? ?
First, Argentina’s remarkable expansion, in which it grew 63 percent over six years, was only export-led for the first six months. It also got a boost from the devaluation in the form of billions of dollars of capital that had fled during the 1998-2002 recession, coming back into the country because the peso was now worth about a third of its previous level against the dollar. So this is also a benefit of devaluation, but not in the current account.?
Most importantly, the vast majority of the benefits that Argentina got from the collapse of the currency and accompanying events did not come from net exports. It came from other policy changes, including macroeconomic policy, that were not possible while the fixed peso/dollar exchange rate was being maintained. This is particularly relevant for Europe because the same is true for the trapped Euro zone countries (and Latvia and Estonia, with currencies pegged to the Euro) currently suffering through the Argentine (pre-2002) –style “internal devaluation.” Much worse than the effect of an overvalued exchange rate on the net exports of Spain, Greece, Ireland, Portugal, or Latvia are the pro-cyclical fiscal and monetary policies that they are tied to by the European authorities. ? ?
Returning to Krugman’s table for a moment, most of the adjustment of the current account in Argentina took place the hard way, through one of the worst recessions in the 20th century. In 2002, which registers a GDP decline of 10.8 percent year-over-year (although recovery began in the second quarter), it is worth noting that the size of the 8.5 percent of GDP current account surplus is mostly the result of measurement associated with the devaluation (i.e. Argentina’s GDP measured in dollars had fallen by more than two thirds). The world-record sovereign debt default ($95 billion) also boosted the current account by cutting foreign debt service, and this too – Greece take notice – was essential for the recovery.? ?
Argentina also instituted some other important heterodox policies that helped restore fiscal balance, including a windfall profits tax on exporters who benefited from the devaluation. ? ?
All this does not take away from Krugman’s main point, that devaluation was a necessary and important part of Argentina’s recovery, and that there are important lessons in this for the European periphery. But there is one point on which I would disagree. Krugman writes:?
“There may be no easy alternative given the way the euro is set up: no country can even think about exiting without triggering a huge bank run.”
No European bank run triggered by a country exiting from the Euro could be anywhere near as bad as the collapse of the banking system in Argentina that followed their abandonment of the fixed exchange rate and default. If it is going to take Greece, as projected by the IMF, more than 10 years to reach their pre-crisis level of output (it took Argentina 3 years), then exiting the Euro may very well be a better option. Perhaps even more importantly, the European authorities have enough money to help all of the peripheral countries recover through counter-cyclical, rather then pro-cyclical policies. Although all of their situations are different, I would think that a responsible leader in Greece, Ireland, Portugal or Spain would use the threat of exit (and default) to force the European authorities to help them, instead of punishing them.
