The US Dollar Is Going Down The Path Of Argentina

Something I’ve touched on before but have not elaborated too much on is the similarities between Argentina in 2001 and 2002 and the US now. Here is a fantastic analysis of this subject. Below is a breakdown of the key events:

1. In 1997, Argentina experienced a recession. The government response was to ease credit — i.e. lower interest rates — and increase government spending, which for Argentina, would mean increasing deficit spending (i.e. borrowing and spending rather than taxing and spending). The US followed the same path in the semi-bursting of the 2002 and 2003 NASDAQ bubble.

2. The excessive easing of credit leads to inflation. For Argentina this occurred in 1998 and 1999; in the US, this peaked in the summer of 2008. During these episodes of inflation, both countries receive warnings from the IMF that their monetary policies are unstable.

3. Both countries than revert back into a recession. This time, however, they are both saddled with greater debt.

4. The recession, coupled with the increased debt burden, leads to a credit crunch, defaults on borrowed funds, and bank failures. For both countries, this results in a decrease in the money supply.

This is where the similarities end, as we don’t know how the US will get out of this situation. Will it continue to follow Argentina? Let’s see:

1. During its debt ridden recession of 2000, Argentina responded by continuing deficit spending. Likewise, Barack Obama has already stated that deficit spending is not a concern, and that deficits to stimulate the economy is needed.

2. Eventually, Argentina was having trouble finding borrowers to lend it money. To make its debt more attractive, it increased its yield — what it was willing to pay to borrow money. In the United States, we are seeing bond prices rally, and many are pointing out similiarities to other bubbles. If this is a bubble, and if it starts deflating, interest rates will need to rise to make the bonds appealing. Interestingly, Paul Volcker, the Federal Reserve Chairman who raised rates in the ’70s to help curb inflation and tighten the money supply, has been brought on to head a new economic advisory board. Are they looking to Volcker for assistance in raising rates?

3. For Argentina, the rate hikes were not sufficient. Eventually, the diminishing tax base, bank failures, and higher interest rates made Argentina unable to make debt repayments. The result was a run on the currency. If the US cannot find buyers for its debt, the same scenario would play out here, which would result in currency devaluation.

Disclosure: I am short US dollar against the Japanese yen.

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