Argentina has (apparently) defaulted again. This is the seventh time in its history, but no tears are warranted. For more than a half-century, its government has been a chronic fount of fiscal profligacy and statist economic schemes that have destroyed its once fabulous national wealth.
Perhaps now it will face that historic day of reckoning that has been for so long deferred. Hopefully, its long suffering citizens will finally come to realize that they have been governed by charlatans and crooks, and demand a clean break with the kind of destructive Peronist policies which have plagued the nation for most of the last 70 years. In this context, the short-run pain that the hedge fund “holdoutsâ€Â are inflicting on the nation’s 41 million citizens is regrettable, but in pursuing their contractual rights and speculative gain they are, in fact, doing the work of the economic gods.
Yet there is an important back story in this saga that should not go unremarked. Argentina’s most recent plunge into national bankruptcy actually originated in the financial repression policies of the Greenspan Fed back in the 1990s. At that time, Argentina’s government under Carlos Menem attempted to cure the nation’s historic addiction to central bank money printing and periodic bouts of virulent hyper-inflation by enacting the so-called Convertibility Law. This effectively put the Argentine central bank out of business and shackled its printing presses in favor of a de facto dollar standard. In effect, Argentina’s peso money supply could not expand by even one dollar equivalent unless a new US dollar was added to its reserves.
Needless to say, switching to a dollar standard and what amounted to an old fashioned fixed exchange rate in the external financial markets swiftly quashed the peso hyper-inflation that had brought its economy to ruins in the 1980s. Indeed, in theory it established a sound monetary foundation that would allow the labor and enterprise of the Argentine people to once again earn a higher standard of living.
Unfortunately, there was a huge fiscal chink in Menem’s armor. Once on the dollar standard, the days were numbered for the government’s historic fiscal profligacy. Large government deficits financed in the local peso market would swiftly crowd-out private investment, send interest rates soaring and the domestic economy into a tailspin.
And that’s as it should be. Under a system of honest money, there is no fiscal free lunch—no painless “monetization†of the public debt. Instead of being put off onto future generations, increases in the public debt dispense penalties and pain to current citizens and taxpayers, thereby providing the basis for politicians to exercise budgetary discipline and prioritize spending from the tax revenue actually available.
At the end of the day, Argentina’s chance for fiscal salvation broke down not due to the Convertibility Law and its quest for honest money at home, but owing to the temptations provided by dishonest money up north in New York. Specifically, Argentina began to finance billions of its public debt in the Wall Street bond market under New York law. The latter feature was crucial because bond fund managers were attracted by the extra yield on Argentina bonds versus US treasuries, but wanted their rights protected under a legal regime that could not be manipulated or corrupted by a future government in Buenos Aires.
So far, so good. Unfortunately, there was a huge problem in the New York bond market—-namely, Alan Greenspan and his merry band of money printers at the Fed. As shown below, the revolt of the bond vigilantes in 1994 sent 10-year treasury yields soaring to north of 8%. Owing to still large US budget deficits and the gathering collapse of the domestic savings rate, long-term interest rates in an honest market would have remained high—in the 7-9 percent range shown in the graph—- until the demand for borrowing and the supply of savings were rebalanced.
