Writing’s on the Wall for Argentina

Step into a discount department store in New York or Miami these days, and you’re likely to hear Spanish in the aisles. Not just any Spanish, though — Argentine Spanish. The distinctive accent, where "y" becomes "zh" and the final "s" sometimes disappears entirely, has lately become the sound of a massive transfer of wealth. Ringing through American checkout lines, it is also the sound of another economic crisis on the way.

Argentina has become much more important to the global economy in the decade following its last crisis, which began in 2001. Back then, its exports were only worth about $31 billion, or 11 percent of its gross domestic product. Today, Argentina’s exports have almost doubled, even after accounting for inflation, and it is a central player in commodity markets ranging from lithium to soy. Yet its trading regime is notoriously fickle, and another crisis — economic, political, or more likely both — could cause severe disruption.

Argentines have been talking about the imminence of their next crisis for about two years now, and their economy is showing plenty of worrying signs. Private economists estimate that inflation is running between 20 and 30 percent, while the government has doctored economic statistics to such an extent that the International Monetary Fund may censure it. The peso trades at more than six to the dollar in the street, though the official exchange rate is 4.7. The central bank maintains the artificially high value of the currency by buying pesos with its reserves, while the government limits the purchase of dollars by ordinary Argentines.

The combination of high inflation in wages — as well as prices — and an artificially strong peso has been a boon to Argentine consumers, especially the upper-middle class. Foreign goods are cheaper than ever, as is tourism. Visitors to Argentina, on the other hand, will find prices for clothing, electronics, and other manufactures in Buenos Aires on a par with New York, London, or Tokyo. The question for many well-to-do Argentines is not whether they will go abroad to shop, but how they will sneak their purchases through customs on the way back.

Almost inevitably, the cost of this government-backed spending spree will be another sharp economic adjustment. When the central bank can no longer prop up the peso, a selling frenzy will push the peso down to, and probably below, its black-market rate. This is essentially what happened in 2002, when the Argentine government had to abandon the peso’s peg to the dollar and default on its debts. Within a few months, the peso-dollar exchange rate went from 1-to-1 to about 4-to-1, and Argentines lost a huge chunk of their savings as bank deposits were forcibly converted from dollars to pesos.

Now as then, a sudden devaluation will make it tougher for Argentine companies to pay debts in foreign currencies. But the bigger losers will be average Argentines who didn’t convert their savings from pesos into other currencies or assets, either because they lacked access to securities trading, didn’t have bank accounts abroad, or couldn’t afford to buy dollars on the black market. They will lose perhaps a third of their wealth overnight. And all Argentines will suddenly face much higher prices for products with imported components, as well as for fuel and energy. These last items have been subsidized in the past, but subsidies may be too costly for Argentina’s cash-poor government once the crisis hits. Naturally, the higher prices will hit the poorest Argentines hardest.

In other words, wealthier Argentines are benefiting today at the cost of poorer Argentines tomorrow. And when the crisis finally arrives, the rich will benefit again. After the Argentine markets crash, they’ll be able to snap up property at bargain prices — often from less-well-off people who need cash — just as they did a decade ago. The profits they later earn will exacerbate inequality in a country whose middle class was finally regaining the strength it had in the mid-1990s.

For the moment, however, Argentina is still a country with sky-high prices and per capita income at $11,000. Its success in exporting crops and raw materials, along with a more limited ability to attract foreign investment, has allowed this bizarre reality to last until now. With enough cash flowing into the country, the central bank has been able to replenish its reserves and keep buying pesos… just as the government has kept printing them.

But the central bank’s capacity to support the peso may finally be running out. For the first time since 2009, its reserves have fallen below $45 billion, or about 9 percent of Argentina’s gross domestic product. (Back in 2009, $45 billion would have been about 15 percent of the economy.) Moreover, the government continues to use the reserves to pay its debts and fund its treasury. And though the IMF estimates that Argentina’s current account balance — the net income from trade and other incoming payments from the rest of the world — might well stay in surplus this year, it forecasts deficits for the next five years. There simply won’t be any more hard currency coming in to buy pesos.

At the same time, the government continues to run structural deficits, meaning it isn’t balancing its books over the economic cycle. The revelation that thousands of public employees are paid under the table has not helped to foster confidence in its ability to collect taxes, either. Together with its reliance on the central bank for financing, these factors strongly suggest that the Argentine government’s debt would not be sustainable in the event of a currency crisis.

The writing is on the wall. Already, the province of Chaco has had to make payments in pesos on a dollar-denominated bond. If that occurred at the national level, it would signal default and devaluation. Global investors can see the writing, too, and some are recommending a complete exit from Argentine assets.

All of this is happening in a country that has yet to close the book on its last crisis. This month, owners of debt left over from the default in 2002 seized an Argentine frigate in port in Ghana, in an effort to force repayment. It would be comical, if it weren’t so tragic.