Day of Reckoning

The marathon is in its last stages, and the only question is whether the runner will make it to the finish line or collapse a few miles short. With two years left before she must leave office, Cristina Fernández de Kirchner has brought the Argentine economy to the brink of a currency crisis. Can the peso survive until a new president arrives?

Back in October, I outlined the worsening problems with Argentina’s economic policy. Fernández’s government has been spending oodles of money with the side effect of annual inflation in excess of 20 percent, which it has repeatedly denied in almost comical fashion. As if to prove that inflation could not possibly be so high, the central bank has defended the peso at an artificially strong exchange rate with the dollar. This policy has required the central bank to deplete its reserves, selling dollars to prop up the peso, while Fernández’s government has strictly limited Argentines’ ability to buy dollars at the favorable rate and take them out of the country.

Inevitably, a black market has arisen for dollars in Argentina. As I write this column, the official exchange rate is about 5.7 pesos to the dollar; the black market rate, which is sufficiently out in the open to be quoted in newspapers, has the peso at about 9.2 to the dollar. The gap is enormous, suggesting that an end to the central bank’s interventions would lead to a massive devaluation.

In the past few years, the central bank has relied on trade surpluses to prop up its reserves. But those surpluses, which ran as high as 2.5 percent of gross domestic product in 2009, have essentially disappeared. In fact, the International Monetary Fund predicts that Argentina will see trade deficits every year from 2013 through 2018.

These deficits will continue to chip away at the reserves, as will the interest payments on Argentina’s still unsettled debts, for which the government has lately relied on the central bank. Foreign investment in Argentina would help to bring in more hard currency, but the country has consistently lagged behind its neighbors Chile and Uruguay in attracting money from abroad.

As things stand now, the safety net for the peso is rapidly fraying, a fact made obvious by a comparison of the central bank’s reserves with the size of the money supply. In the spring of 2009, the reserves were worth about 1.8 times as much as the monetary base at the official exchange rate. Since then the ratio has dipped steadily, settling at around 0.65 this month.

Perhaps ironically, this value is just below the level of 0.67 that the central bank was required to maintain before the disastrous crisis that began in 2001. In fact, the ratio never slipped below 0.82 that year, but a huge devaluation still occurred when the government finally abandoned the peso’s one-to-one peg to the dollar. The peso fell by 25 percent in two weeks and more than 70 percent in six months.

Clearly, the current exchange rate is also unsustainable in the long term. But is it sustainable until 2015?

If the central bank can hang in there, Argentina could achieve a rare soft landing. All of the likely candidates for president — Mauricio Macri, Sergio Massa, Daniel Scioli, and Elisa Carrio (or one of her allies) — have condemned the rampant inflation that is destroying the peso’s value. To varying degrees, they are all committed to converting the economy from a mad scientist’s laboratory into a more transparent and integrated part of the global financial system.

As a result, a successful election is likely to bring a flood of foreign capital and a reinvigoration of the economy, bolstering the central bank’s reserves and the peso. Government spending would fall, the printing of money would slow, and inflation would ease. Share prices and asset values would rise. Only a gradual devaluation of the peso, if any, would be necessary.

But Argentine governments don’t always survive until elections, especially when the economy runs into trouble. If the gap between the official and black market exchange rates continues to grow over the next few months, so will the flight of capital that the government has tried so doggedly to restrain. Eventually, the loss of liquidity could lead to runs on banks and chaos in the streets.

A trigger might come much sooner, however. On September 30, the U.S. Supreme Court will decide whether to hear Argentina’s appeal in a case brought by bondholders who have yet to settle claims from the last crisis. According to a brief filed by Argentina’s lawyers, the current ruling could cost the country another $15 billion in reserves. If the court refuses or rules against Argentina, default and devaluation could occur virtually overnight.

In this situation, not only the soft landing but also the transition to an economically saner regime could come under threat. The last post-crisis transition featured a string of five presidents in two weeks, and the time would be ripe for less scrupulous hands to grab control of the ship of state. With a bad political outcome, the promise of an improved business climate might disappear, and along with it any chance of an influx of foreign capital.

It has been suggested that Fernández de Kirchner dreams of a constitutional reform and a third term in office, much as her predecessor Carlos Menem did in 1999. In truth, she’ll be lucky to finish her second. Yet if she moderates her doomed economic policy now, she may still be able to protect the economic future of her compatriots, as well as her own legacy.