Don’t Be Baffled by Argentina’s Crisis

(The Bloomberg View) -- The collapse in Argentina’s currency underlines two facts about global finance that are well understood yet far too easily forgotten. First, the effort to normalize U.S. monetary policy after a decade of extraordinary monetary stimulus has put many other economies, especially those at risk for domestic reasons, under greater financial pressure. Second, once a crisis of confidence gets going, it can be impossible to control.

Few would say that the recent monetary tightening in the U.S. has been hasty. With the economy at full employment and growing well (more than 4 percent in annual terms in the second quarter) interest rates remain low and the central bank’s balance sheet is still engorged with bonds purchased under the Fed’s enormous bond-buying program. Even so, gentle tightening has pushed up the dollar, making it harder for countries such as Argentina to sell or service dollar-denominated debt.

Combine that with underlying vulnerability, errors of judgment, and political uncertainty, and the stage is set for a self-reinforcing economic meltdown.

In Argentina, the cycle can seem baffling. A popular pro-business government had earlier come to terms with the International Monetary Fund, secured seemingly adequate official financing (the biggest credit line in the fund’s history), and adopted a program of fiscal responsibility. A course correction had been needed, and was underway.

But to no avail. Downward pressure on the peso pushed inflation higher and sowed doubt about the country’s financial position — raising questions about the need for further fiscal austerity and, in turn, threatening the defeat of President Mauricio Macri’s government in elections next year. Those doubts put further downward pressure on the peso, tightening the loop of collapsing confidence.

The government’s response on Thursday was to raise interest rates to 60 percent. Far from stemming the cycle, this fueled it.

As always, it’s easy to be wise after the event, whereas wisdom before the event is apparently impossible. But the lesson is worth emphasizing nonetheless. Financial sustainability needs to be tested not against a central case of business as usual but against a vicious circle of mounting stress and collapsing confidence. Stability demands a degree of financial sobriety — especially when it comes to borrowing in foreign currency — which might seem excessively and even absurdly cautious in good times.

Argentina’s travails, especially if they spread panic more widely across emerging-market economies, will raise questions about how far the Fed should weigh conditions in other countries while trying to steer demand in the U.S., about the international financial architecture and the IMF’s place in it, and about the proper role of the dollar in international finance. Those are all good questions — but even the smartest answers won’t be as useful as remembering that financial confidence is always more fragile than it looks, and that worst-case scenarios have an infuriating habit of coming true. 

Editorials are written by the Bloomberg View editorial board.

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