Looking at Greece in the Argentinean mirror

Domingo Cavallo 15 July 2011



The Greece 2011-Argentina 2001 comparison has been worked hard since the Greek crisis emerged. The analogy is particularly popular with those who think Greece should abandon the euro as Argentina abandoned the dollar in January 2002. They argue that by transforming all existing contracts from euros into New Drachmas, Greece would recover monetary “sovereignty” and exchange-rate flexibility.

The probability that this ‘opinion’ becomes a self-fulfilling prophesy is increasing rapidly – and this despite the fact that it is completely undesirable for the Greek people and very dangerous for the rest of Europe.

The Greek crisis is more difficult to manage

Greece’s crisis is much more difficult to manage than the 2001 Argentinean crisis.

  • Greece is much more indebted that Argentina was; Greece has 3 times the public debt-to-GDP ratio that Argentina had.
  • Greece’s current-account deficit is 5 times larger than Argentina’s was at the time.
  • Greece’s competitiveness problem is much deeper as it is due to high unit labour costs rather than external shocks as in Argentina’s case (the devaluation of the Brazilian real, the depreciation of the euro since the beginning of 1999 and the lowest level of commodity prices during many decades).

By contrast, Argentina’s unit labour costs had decreased thanks to the structural reforms during the 1990s that produced a very rapid increase in labour productivity. Argentinean exports had been expanding and continued expanding at a rapid pace back then, even though exports prices had been declining during the three previous years. The case for a peso devaluation to stimulate growth was even harder to make than it is nowadays for Greece.

Was Argentina’s case more desperate?

It is frequently argued that the situation in Greece is not as desperate as it was for Argentina because Greece has the ECB as a lender of last resort while Argentina did not. However, that argument misses that fact that the IMF back then had been acting - in practice - as lender of last resort for emerging economies.

For example, Argentina in 1995 overcame, in just one year, a sudden stop of capital inflows that followed the Tequila Crisis thanks to the fast support of the IMF (and the Argentinean decision to deepen the structural reforms, particularly to privatise provincial banks that had been financing budgetary deficits of the provinces).

The IMF helped in the same way at the beginning of the 2001 crisis. The first symptom of the 2001 crisis came in November 2000 with a sharp increase in the yields of public bonds and the first spurt of bank deposits withdrawals. That initial stage of the crisis was overcome by an IMF program. The IMF program included some “private sector involvement” as requested by the then Managing Director of the IMF, Horst Kohler.

Private sector involvement in the Argentinean crisis

At that stage, the private participation took the form of a commitment of a bank rollover. That is, the banks that had been creating markets for Argentinean bonds helped to roll over Argentinean debt, particularly the bonds that became due during the implementation of the rescue program.

This program – which carried the suggestive name of “Blindaje” (“shield” in English) – was announced by December 2000. It included fiscal targets for the first quarter of 2001; by March, it was clear that Argentina was not going to meet these. Early hints that the program was unrealistic provoked a second spurt of deposits withdrawals from the local banks, and another sharp increase in interest-rate spreads. As a consequence, two finance ministers came and went within 3 weeks.

Greece-Argentina parallels

  • The April 2010 European decision to provide financing to Greece is akin to the December 2000 Argentinean Program.

The big difference was that the European decision took several months rather than the few weeks it took in Argentina.

  • Later European finance ministers finally accepted IMF involvement, and approve a larger program subject to clearer and stricter fiscal and structural conditionality.
  • As in the Argentinean case, it took a short period of time for it to become evident that Greece would not comply with the fiscal targets.

The events in Greece looked just as those in Argentina, but in slow motion, because creditors for some time expected that, at the end, Europe would not let Greece go under.

In Argentina, when I accepted to become the new Finance Minister and Congress used an urgent procedure to vote a law that gave the President strong powers to implement fiscal and other structural reforms, the situation seemed to stabilise again. The IMF program could be rehabilitated with fiscal commitments similar to those of the “Blindaje”. The IMF granted a waiver for the first quarter targets that had not been fulfilled.

The default option is mooted

While this ‘rehabilitation of the program’ was being negotiated, Allan Meltzer and Charles Calomiris proposed that Argentina default on its debt and the IMF announce a repurchase program of Argentinean debt at 60 % of its face value. They made this proposal in an article entitled “Argentina cannot pay what it owes”. I immediately asked the IMF if the Meltzer-Calomiris idea was feasible and whether it would count as the private sector involvement that Kohler was asking for. (Kohler went on to be Germany’s President during 2004-2010.) The IMF’s answer was as negative as rotund – this is not what Managing Director Kohler was requesting as a private sector involvement.

Instead, to rehabilitate the program, the IMF accepted the view that the private participation would take the form of a voluntary bond exchange. This was to clear the next few years of large debt-servicing burdens by extending maturities and capitalising interest payments. Even though this “mega swap”, as it was then called, succeeded in rolling over around half the dollar bonds that Argentina had issued since the mid 90s, the markets remained calm only for around one more month.

By the beginning of July it was clear that Argentina had fulfilled the cumulative fiscal targets agreed upon in the IMF program. Problems, however, emerged from a different direction.

New, unexpected problems

Spooked by rumours that the provinces might stop servicing their debts, Argentinean depositors started withdrawing their money from the banks which had made large loans to the provinces. In order to cope with this new spurt of the banking crisis I approached again the IMF. The goal was to get additional funding to replenish the Central Bank reserves.

In exchange, the IMF requested additional fiscal measures. The Federal Government succeeded in getting support from governors and Congress to approve the “Zero Deficit Law”. This Law empowered the government to cut public-sector salaries and pensions to whatever extent was necessary to balance the budget. The opposition, and even those governors and congressmen that had voted the “Zero Deficit Law” started to campaign against the Federal Government. They argued that extreme austerity only served the purpose of funding debt servicing – the paying of extremely high interest rates to bankers and other creditors.

The debt restructuring idea takes hold

  • While this was unfolding, the US Secretary of the treasury, Paul O’Neal, became persuaded by Allan Meltzer and other advisors that “Argentina could not pay what it owed”. He started consulting with Wall Street bankers on the possibility of “a restructuring of Argentinean debt”.

Many in Argentina and abroad started to speak of “a debt restructuring” that would benefit Argentina with an undefined debt haircut, but nobody in the Argentine government, in the IMF, or in the American Treasury knew what the restructuring process would look like.

  • Uncertainty increased and spreads exploded.

Under the pressure of the markets, The Secretary of Treasury asked the IMF to approve an $8 billion additional financial support to facilitate the restructuring of Argentinean debt. That program was approved by the end of August and $5 billion were disbursed immediately. The remaining $3 billion, as the undisbursed instalments of the “Blindaje”, would be used to feed a escrow account to enhance the new debt, with lower interest rates and extended terms, that would be issued to replace the existing more expensive debt.

Greece in 2011 as Argentina in 2001, only in slow-motion

Since the approval of the Greek Program a similar but much lengthier process has been taking place in Greece.

  • Many voices say that Greece will not be able to pay what it owes,
  • The German Government demands private sector involvement.

Government officials of Germany and France are discussing with private bankers how to reduce the Greek debt overhang on a voluntary basis.

  • Rating agencies downgrade Greek Debt, uncertainty is increasing and spreads are exploding.

These spreads are already higher than the week before the Argentinean Government fell in December 2001.

  • In Greece the Indignant and the opposition, including some members of the PASOK, blame the Government for imposing austerity measures to save the banks.
  • No government official is ready to explain how the “Greek Orderly Debt Restructuring Process”, which still does not even have a name, will proceed.

So today’s Greece is a mirror image of Argentina in October 2001.

How it ended in Argentina

In October 2001, immediately after a midterm election in which the party of the Government was defeated in most provinces, the President decided to finally lunch the “Argentinean Debt Restructuring Process” that I had proposed. The US Treasury and the New York Federal Reserve were fairly supportive but the IMF decided a “hands off approach” because it felt it did not have the authority to get involved in such a debt restructuring process. Actually, part of the staff of the IMF, under the leadership of Anne Krueger, started to work on the design of a future “Sovereign Debt Restructuring Mechanism” that in the best of the case would have required not less than 2 years of multilateral negotiations to be approved.

The first of November I announced our debt restructuring program on behalf of the Argentinean Government. It included two stages:

  • Stage one was to restructure debt of creditors that would accept new debt under Argentinean law, and
  • Stage two second was to restructure the rest of the debt once the Security and Exchange Commission of the US had cleared the way for a swap to be offered to bondholders that only accepted bonds issued under US law.

By November 30, the first stage of the restructuring process had concluded with significant success. More than 50% of the debt ($54 billion) held by non-official institutions and individuals was transformed into a loan to the State collateralised by the revenue of the financial transaction tax that would accrue directly to an escrow account in the Central Bank. This loan charged a maximum annual interest rate of 7% and involved a 3-year maturity extension. This awarded the Federal Government and the provinces a $4 billion reduction on the annual interest bill that in 2001 had amounted to $12 billion. (It took the form of a loan and not of new bonds because cross default clauses prevented the issue of new bonds with inferior conditions to the existing ones.)

The second stage was being prepared with the advice of leading bankers Bill Rhodes, Joe Ackerman, and Jacob Frenkel. It was expected to generate another $3 billon reduction in the annual interest bill. The new bonds would offer 5% interest instead of the 9% on the old debt. The new bonds would be enhanced by the money the IMF had committed to disburse, and revenue from import taxes collected in dollars. With this reduction in the interest bill and the adjustment in the primary expenditure of the Federal and provincial budgets, the target of the “Zero Deficit Law” could have been achieved in 2002.

Accidents happen

Unfortunately, rumours started that the IMF would not disburse the tranche that had been budgeted for November. Fear was further stoked by statements from the IMF team that was working on the Sovereign Debt Restructuring Mechanism. They suggested that a country going through a process of debt restructuring had to impose capital controls to put off capital flight. Together these generated fears that sparked the fourth run against local banks.

As neither the banks nor the Central Bank had the dollar liquidity to finance the withdrawals, exchange controls were imposed. That was the so called “corralito”, implemented on December 1st as the only way to impose exchange control in a dollarised economy.

The self-fulfilling prophecy came full circle when the IMF – whose own officials had made imprudent statement about capital controls just a few days before – used the imposition of exchange controls to announce that no disbursement should be expected as the Argentinean program had been suspended.

Political chaos and disorderly default

At this point, events unfolded in a chaotic manner.

  • The Argentine opposition used the social unrest that was aggravated by the “corralito” to promote riots that forced the resignation of the President.
  • During a week of political chaos an interim President formally declared default on the debt that had not been restructured,
  • Then the former Governor of Buenos Aires that had lost the presidential elections in 1999 was appointed President by Congress.
  • The new President cut the peso-dollar link, forcing all contracts signed in dollars to be transformed into pesos 1-to-1, and allowing the peso to float.
  • The peso’s dollar value – which had been pegged 1-to-1 with the dollar for a decade – fell to 4-to-1 in just a few months.

Debtors were very happy because their debts in dollars were reduced to one fourth. But depositors lost three fourths of their financial wealth.

  • Inflation jumped up to 40 % in 2002 and is still around 25 % per annum in 2011, despite the peso’s real value being back to its 2001 level.
  • The devaluation reduced all wages and pensions in real terms to a third of their pre-crisis level.

The devaluation also aggravated the recession.

  • GDP fell an additional 5% in just one semester;
  • Unemployment jumped to 24% from 18% at the end of 2001.

Growth restarts due to external factors, not the devaluation

Growth restarted and unemployment begun to fall in 2003. But this was not due to the devaluation. The key factors were the depreciation of the dollar and good luck on the commodity prices. The price of soy – which is a price set in international markets – jumped from less than $120 a ton in 2001 to more than $500 a ton by the late 2000s. It is absolutely erroneous and misleading to attribute the rapid growth of Argentina during the last 8 years to the “pesofication” and devaluation of 2002.

What Greece should do now

Greece should, as soon as possible, attempt to undertake what Argentina tried to do in November 2001. But it should do this with clear commitments from Europe and the IMF that the “Greek Orderly Debt Restructuring Process” will not be interrupted mid- course. Decisions like those that the IMF adopted on Argentina in December 2001 should be ruled out in advance.

  • The easiest way to conduct a Greek restructuring would be to offer a swap between non-official Greek debts with these valued at the market rate of the day before to the announcement of the restructuring.

This would allow Greece and Europe to capture the debt haircut that the markets have already conceded. The loss for the bond holders would not be larger than that that is already reflected in the market value of the Greek bonds.

  • To allow the banks to continue with the current procedure of delaying the registration of their losses, the regulatory authorities could authorise the amortisation of those losses in various years.

The situation would be no different than what it is today, when the financial institutions are not reflecting the market value of their bond holdings in their balance sheets.

  • The European bonds that Greece would use to conduct the massive repurchase operation should be lent to Greece by the European Stabilisation Fund which would take as collateral Greek property that is available for privatisation.

But the selling of the assets should be done at an adequate gradual pace as to avoid fire sells.

  • Greece should stay committed to introducing all the necessary fiscal and structural reforms needed to regain competitiveness and renewed growth.

But it will be much easier to find the political and economic support once the debt overhang disappears. Nobody would be able to argue that austerity measures have the only purpose of meeting creditors’ demands and the argument that Greece has to follow the Argentinean way of inflating its debt away by abandoning the euro would become obsolete.

  • Greek and European authorities should be prepared to fund the banks that will inevitably suffer runs against their deposits while Greece conducts its debt restructuring program.

If the depositors fear that the lender of last resort may finally abandon those banks, the run will prove hard to stop and that may by itself precipitate the collapse not only of Greece but of many Greek and European Banks with severe contagious effects on other European economies.

Greece in the Argentinean mirror: Euro-exit is not the solution

When one looks at Greece in the Argentinean mirror all these recommendations and preventive steps become crystal clear. The Argentinean mirror does not project the misleading image that some economists are suggesting. For sure it does not encourage Greece to solve its crisis by leaving the euro like Argentina left the dollar in January 2002.



Topics:  Europe's nations and regions Financial markets

Tags:  greek crisis, orderly restructuring, Argentine crisis

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