Life after the Euro? What can Greece learn from Argentina?
The 'No' vote in the recent bailout referendum has pushed Greece closer to an exit from the Eurozone. Although Davy believes some agreement will be reached with creditors, the Greek government would be wise to consider Argentina's experience before deciding whether to go it alone.
Argentina, like Greece, has an unenviable track record of not paying their bills and, much like Greece today, its fortune at the start of this century was linked to the success of others, through a pegged currency (fixed exchange rate) with the US dollar.
The combination of rigid currency, a poor track record of tax collection and successive spendthrift governments contributed to heavy debt burdens in both nations.
In 1992 the Argentinian government established a currency peg between the peso and the US dollar which lasted for ten years with some success before being abandoned with painful consequences for Argentina's economy. Although we can't discount the immediate benefits that a 'devaluation dividend' would give Greece, thirteen years on, Argentina is still dealing with the consequences.
As the US dollar rose with the booming American economy, Argentina's borrowing costs began to skyrocket and competitiveness fell during the late 1990s. Like Greece, several loans were provided by the International Monetary Fund (IMF), but by January 2002 Argentina was forced to abandon its peg with the dollar. Within six months the currency and any residual wealth had plummeted by nearly 75pc.
To stop a run on the banks the Argentine authorities introduced "Corralito", or capital controls limiting withdrawals to 250 pesos a week. Intended to last just 90 days "Corralito" lasted until December 2002, causing the economy to collapse.
As a result Argentina had little or no chance of paying its debt, most of which had to be restructured through write downs and maturity extensions. Thirteen years later there are still legal actions being taken in US courts today for a resolution on some residual private sector debt that had not been re-paid or restructured.
In the six months leading up to the default government borrowing costs exploded, peaking at 51pc, with debt soaring from a manageable 45pc of GDP to 135pc. Even when borrowing costs steadied, they remained at extraordinarily high levels for the next five years reflecting residual market distrust. The overall impact on the economy was devastating. Consumer and business spending tanked as hyperinflation kicked in; unemployment jumped to 22pc and poverty soared. By the end of the year it is estimated that up to 50pc of Argentinians fell below the poverty line with 25pc becoming indigent.
Despite these challenges, the weaker peso also improved competiveness and in the four years after the devaluation exports grew on average by 24pc. As confidence began to rise consumers and businesses began to spend and unemployment dropped from a peak of 22pc in 2002 to below 10pc by 2007. These upsides have caused some to ask whether Greece should follow suit.
For Greece, the 'devaluation' benefits of re-introducing the drachma to help provide a similar boost to economic growth should not be dismissed. Competitiveness would improve, exports would rise (mainly tourism) and in time unemployment would fall.
Yet despite the medium term 'devaluation dividend', the Argentinian experience points to very harsh outcomes. Failure to reach an agreement would see Greece default on its debt, abandon the euro and the economy would enter a sharp depression. Capital controls would persist, wealth would be decimated, inflation and unemployment would soar and Greece would not be able to access international debt markets for a very long time.
Longer term few would argue that Argentina's experience has been a good one. If Greece 'goes it alone' it's difficult to see how the outcome would be any different.
Brian O'Reilly is Head of Global Investment Strategy at Davy Private Clients