Readers Question: With talk of a Greek exit from the Euro, the situation is almost always compared to Argentina in the 1980s and 90s. Can you explain what happened there and how it was resolved.

In the 1980s, Argentina built up substantial debt and also suffered from periods of very high inflation. To stabilise inflation, Argentina set a peg of the Argentina Peso against the dollar – the peg was one Peso to one dollar (this was enshrined in law).

The aim of this fixed exchange rate was to give people greater confidence in the Argentinian currency after periods of inflation.

• The fixed exchange rate meant that inflation was stabilised and encouraged capital flows into Argentina. These capital flows led to a rise in wages and living standards
• It also made imports cheaper, so the value of imports increased,
• Exports became less competitive, leading to lower demand for exports.
• This fall in exports and rise in imports lead to a current account deficit which was initially financed by these international capital flows.
• However, the over-valuation of the currency contributed to a fall in domestic demand, and from 1998, Argentina experienced fall in GDP.
• Also from 2001, international capital flows to Argentina dried up as investors were worried about the state of the global economy and the state of Argentina finances.

In particular, Argentina was adversely affected when the dollar rose against the Brazilian Real in 1999. This meant that the Argentina currency experienced a strong appreciation against its main trading partner – Brazil. This appreciation led to rapid fall in exports.

This appreciation in the Argentina currency was a key factor in pushing Argentina economy into a deep recession. Domestic demand fell. Unemployment rose to a socially crippling level of over 15%.

Government Debt

During 1999-2002, the Argentina government debt became unmanageable. This was because:

• Legacy of debt from 1980s
• Poor tax collection and corruption
• Rise in government spending
• Fall in tax revenues from recession.

International investors lost confidence in Argentinian bonds and interest rates rose to over 30%. Argentina relied on loans from the IMF to meet its shortfall.

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In 2012, the Pound has strengthened against the Euro – reaching a level not seen since 2008. However, the value of the Euro to Pound is still  less than the peak of late 2007, when £1 reached €1.4.

In June 14th, 2012 £1 = €1.24 Euros. An increase since the start of the year when £1 = 1.18 Euros.

This appreciation in the Pound makes it cheaper to buy goods from Europe, but makes UK exporters less competitive.

Why Has the Pound Appreciated against the Euro?

The Pound’s appreciation against the Euro reflects the growing concern over the future of the Euro.

• • Rising Euro bond yields. Bond yields on major economies, Spain and Italy have continued to rise. There is fear over prospect of possible default in not just Greece, but also bigger economies like Spain and Italy.
  • Lack of Effective Political Will to Deal with Eurozone’s problems. There appears to be a reluctance to embrace a form of fiscal union. The main approach is to rely on fiscal austerity to deal with budget deficits in the peripheral countries. But, these austerity measures have failed to stop bond yields rising.

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