Posts Tagged ‘Argentina’
The Argentine model
Today’s floating exchange rate regime has created a vicious form of economic intervention that is getting more popular by the day. In the last couple of years we have seen many countries abandoning their currency pegs. Argentine abandoned their fixed exchange rate in 2002, devaluing the peso, and at the same time defaulting on their foreign debt. China cut their peg to the dollar in 2005 at the same time also devaluating their currency against the dollar. Next in line stands the Gulf coast countries which are planning to cut their peg to the dollar in the up coming years.
Fixed exchange rate regimes create serious problems as the country with the pegged currency are forced to import the monetary policy of the other country. Fixed exchange rates are nothing else than a price regulation, causing disruption of the supply and demand relationship in the currency market. More importantly it causes havoc in the economy, as the production process is altered.
The type of intervention that initially was referred to, is the exchange rate policy often adopted after a country has abandoned their fixed exchange rate. This is the policy of a weak currency regime where central banks literally drain the domestic market of foreign currencies, putting an upper lid on rates.
The logic of such a policy is flawed from the beginning as it artificially boosts goods exporting business and creates inflation, resulting in the business cycle. A good example of this ignorance is Argentine. Since they devaluated their currency, the peso has weakened against the dollar despite resent attempts of US to join the band wagon of weaker currencies. As the peso has lost international purchasing power, monetary inflation and price inflation has skyrocketed with official CPI close to double digits.
Supposedly, this has resulted in a GDP growth of about 9 % per year. Although GDP numbers have been adjusted for inflation, the misalignments of the Argentine economy is severe, and will eventually act as a downward force on growth. As exports are heavily subsidized, economic activity centers on this alleged profitable business, leaving the rest of the economy with lesser goods available to higher prices.
Real growth requires real investments. Only savings can produce future economic wealth. When a country is artificially holding exchange rates low they not only cause economic misalignment but also destroys incentives for foreign direct investments. Compared to Brazil who has followed a more conservative exchange rater policy since 2002, the percentage change in foreign direct investments in Argentine is estimated to only 12 % in 2007 compared to 84 % in Brazil.
The popularity of the “Argentine model” is undisputable as United States stand next in line to adopt the model, as deliberate actions are taken to devaluate the dollar with high inflation, money supply growth, and low interest rates, they’re lured by the fallacious logic of short term gain over long term pain.
