Economic Performance and Trends

Does Argentina’s 2002 Debt Default Provide an Option for Greece?

Does history offer Greece any help in determining how to handle its massive debt, or is it simply a condemned man’s choice between being shot or hanged? Argentina’s experience with linking the peso to the U.S. dollar two decades ago provides some useful insights into this difficult issue.

In 1991, after decades of hyperinflation, Argentina established something close to a currency union with the United States when it tied the peso to the greenback. The discipline imposed on monetary authorities by the fixed link between dollar and peso brought inflation under control, and the economy expanded. However, the Argentine government failed to bring its fiscal house into order as deficits soared.

Throughout the 1990s, the dollar and peso appreciated sharply—a development that slowly hurt Argentina’s export competitiveness. As the economy continued to deteriorate, the government eventually severed the link to the dollar to try to restore external competitiveness. Weak economic growth also made it difficult for Argentina to make payments on its foreign debt, forcing the government to default on international obligations in early 2002.

The peso depreciated sharply without the link to the dollar, and the price of imports soared. However, the weaker peso, combined with booming demand for agricultural commodities, eventually turned the economy around.

A default could shut Greece out of global financial markets for years. But, as the situation in Argentina revealed, this need not be fatal to the Greek economy if it also exits the euro.

The events in Greece since it adopted the euro in 2001 are eerily similar. Like Argentina, Greece linked its currency to that of stronger economies by joining the eurozone. Similarly, Greece allowed its public and current account deficits to soar and experienced a loss in international competitiveness. When the global recession hit in 2008, Greece found it increasingly difficult to pay its mounting international obligations.1

Now Greece faces many of the same choices Argentina did. Should it default on its international obligations, quit the euro, or do both? A default could shut Greece out of global financial markets for years. But, as the situation in Argentina revealed, this need not be fatal to the Greek economy if it also exits the euro. If Greece started using the drachma again, the currency would likely depreciate sharply and help restore Greece’s international competitiveness. Greece would face the same problems Argentina faced after it broke with the greenback, since capital controls such as withdrawal limits on bank accounts would be required. Yet if Greece experienced the almost double-digit growth Argentina experienced after 2002, it might be worth some of the added costs of currency depreciation.

Alas, this is where Greece and Argentina’s plights will likely diverge. After Argentina permitted the peso to depreciate in the early 2000s, the price of commodities started to increase sharply. Argentina is a major commodity exporter, and the combination of a weak peso and strong demand helped the economy achieve strong growth. Greece would not have this advantage, because it is not a major exporter of commodities.

A protracted slump in Europe, as a result of Greece’s departure from the euro, could wipe out the positive benefits for Greece of currency depreciation. In fact, the deep integration of the EU makes predicting the endgame in this crisis extremely difficult and makes the problem even harder to solve.

1  The Economist, "After the Fall," (September, 2011).

Kip Beckman Principal Research Associate Economic Services

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