Greece 2011 vs Argentina 2001

Unless you have been living in a cave for the last year, you would know that there is quite a significant debt crisis festering in Europe. It is not just worrying for European nations, but other markets know that contagion is likely to reach their shores if action is not swiftly taken. The inter-connected nature of European finance is a contributing factor to the obvious challenge of dealing with this situation; no action can be made independently because of the inevitable repercussions on other countries.

European debt

European debt

So what to do? The present European captains (France and Germany) have done little to assuage concern, and are at loggerheads on the best way forward, much to the annoyance of key institutions and other countries. This post should hopefully give you some food for thought on what could potentially happen by using the Argentinian economic crisis as a case study.

In 1999, Argentina was feeling the brunt on several fronts: GDP was falling; the US-Peso currency peg had made exports uncompetitive; and the Country was haemorrhaging capital as a consequence of the Asian financial crisis in 1998.

In financial strife, Argentina arranged a contingency loan from the IMF worth US$7.4million, but not even this could save the country from its huge budget deficit and public debt. All these factors just fuelled market uncertainty, and things began spiralling out of control.

The government enacted Corralito, which froze a substantial number of bank accounts held by the Argentinean people. This resulted in bloody riots, and some Argentinians are still chasing the money they saved over 10 years ago. In 2002, the artificial currency peg was scrapped and Argentina floated the Peso. This resulted in a swift devaluation, and a loss of 70% in total value of local funds, as well as a steep increase in consumer prices.

How is this relevant to the situation now? Well you may be able to see some similarities in this story with our current predicament, but another comparison can be seen in government bond rates. Bond rates are a good indication of the level of confidence in the entity issuing the bond, and clearly represented the angst being felt in Argentina during the crisis. Could our current bond rates predict the same fate?

Bonds are basically IOU’s. The yield of a bond (the % ‘coupon’ rate the buyer is quoted) is the interest you are paid for holding the bond, and this rate is also inversely related to the bond’s current price. This means that higher the % quoted, i.e. the coupon rate, the riskier the investment. Bonds are like most investments, at the outset there is a price quoted, but markets fluctuate and so can your investment.

Greek and Argentinian bonds

Greek and Argentinian bonds (via Hiddenlever.com)

The graphs above show some worrying similarities. Furthermore, Italian and Spanish government bonds are also experiencing turbulence, and it is likely this will continue until the Euro zone begins calm market fears.

So what happened in Argentina? Well the country partly defaulted on its external debt in 2002 (about US$93million). Since then, the government has made significant attempts to bring itself back to health. According to figures supplied by the Argentine government, the country has seen strong economic growth over the last several years, but there are some criticisms of the figures provided. So can we foresee what will happen in Europe based on this previous experience?

Like Mark Twain once said: history does not repeat itself but it does rhyme.

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