The dangers of government spending


Hi Cullen,

People always seem to bring up the 1998-2002 Argentinian and more recently the Venezuelan hyperinflation crises as primary examples of the inevitable failures of high government spending and public debt.

Both these countries, have their own sovereign currencies, were strongly export oriented, but were hurt when their respective currencies weakened with respect to the dollar.

So what exactly went wrong? How did they default on their debt if they are sovereign currency issuers?

Why couldn’t they have just adjusted the maturity of their debt to reduce interest rate costs as you have mentioned what the Fed in the US normally does/is doing?

Marked as spam
Posted by (Questions: 42, Responses: 53)
Posted on 06/08/2017 6:41 AM
Private answer

Good questions – I hope Cullen chimes in. I’ve read Cullen’s paper “Hyperinflation – It’s More Than Just a Monetary Phenomenon” – and if you have not read it, I think you’d find it interesting.

Cullen has said that in post 1900 hyperinflations there has typically been some other exogenous event occurring, not just high government debt. The events list: losing a war, regime change, rampant corruption, or foreign denominated debt.

Marked as spam
Posted by (Questions: 23, Responses: 68)
Answered on 06/08/2017 9:46 AM
Private answer

Argentina is comparable to Greece. They’re a small economy in a competitive region with a small non-tradables domestic economy. As a result of this they’re not really that “sovereign”. In my paper on Understanding the Monetary System you’ll find a chart towards the end that shows how a nation is sovereign to varying degrees. Argentina would not rank well on that scale. The basic story is that they don’t have a very robust or significant private sector economy. So they’re more susceptible to exogenous events than a really diverse economy like the USA. In this specific case you’ve had a series of oil crises, currency pegs, govt mismanagement, etc. Of particular importance here I’d argue that the govt has done a very poor job managing their pegs and deficit. They’ve been largely procyclical in the sense that the govt tends to spend with the economic cycle rather than spending against it. This has created a series of booms and busts that left them exposed to exogenous events. So, every time the global economy weakens or oil weakens, you get huge shocks to the economy. Combined with the weakness of the currency and the many competitive options (mainly the use of USD in the domestic economy) and you get a situation ripe for high inflation and economic turmoil.

Argentina needs a more diverse and probably a smaller economy. Which is not really politically palatable for obvious reasons. So they keep exacerbating the impact and we keep getting a series of revolving crises in Argentina.

Marked as spam
Cullen Roche Posted by (Questions: 10, Responses: 1858)
Answered on 06/09/2017 4:06 PM
Private answer

Hi Cullen,

Thanks for your explanation. I understand what you mean that Argentina and Venezuela are not diversified economies to be able to withstand exogenous shocks. However I do not understand why the Government of these countries can’t just ask their banks to increase credit in the economy to get things running? Isn’t that technically what Japan and Germany did post World War 2 after their economies were practically decimated? Their bank credit creation policies led to near full employment and high economic growth for a good few decades.

So surely in countries like Argentina and Venezuela, their private sectors are BEGGING for more government investment and people are BEGGING for job creation so that they can spend and save? So why on earth do these countries keep making things worse by requesting loans from the World Bank and IMF, which are all dollar denominated debt; something which they can never realistically pay back, as the working population is already shackled by high unemployment and depreciated consumer spending power?

I still don’t understand how countries like Japan can have a government debt of over 200% their GDP, a slowing economy due to an ageing population and practically no immigration, and STILL be able to comfortably control the maturity on their debt to lower their interest costs like there’s no tomorrow…Like seriously, WTF is going on here?! Why can’t Argentina and Venezuela do the same thing despite having a Central Bank and sovereign currency?

You also mention that Argentina needs a more diverse and a “smaller” economy. A “smaller” economy is not possible unless you plan on half the population leaving the country as refugees (or dying due to famine)!

Marked as spam
Posted by (Questions: 42, Responses: 53)
Answered on 06/09/2017 5:53 PM
Private answer

Look at the affect of imports Vs exports. The government can not lower the price of imports with government debt. Japan and Germany import alot but it also export a lot.

Marked as spam
Posted by (Questions: 22, Responses: 345)
Answered on 06/10/2017 7:22 AM
Private answer

If you want to understand Japan Bill Mitchell covers it beautifully.

More Fun in Japanese bond markets


Rgarding Argentina and Venezula think of them in terms of what Skills and resources they have available to absorb increased government spending. There’s no point in the monopoly of the currency creating currency at will if they don’t have the skills and resources to absorb it. Otherwise you get a zimbabwe type of situation.

Venezula suffers from Dutch disease and as soon as the neoliberals are in charge in Argentina the first thing they do is borrow in $’s which is crazy. A political decision in order to control the nation. Then asset strip it.

Argentina versus the Vultures – simple solution but leave morality out of it


There is a difference – obviously. But the similarities and their consequences dwarf these difference. Argentina had lost control of its currency by pegging and running up debt (public and private) in US dollars. They were continually reliant on export income to remain solvent. Once their export markets became recessed they were unable to pay their foreign-currency debts.

Further, by abandoning the peg, they effectively created the same dilemma as Greece would do if it abandoned the Euro. They had massive liabilities in a foreign currency and had to take their chances on default.

And, once they abandoned the peg (because they could not longer gain the foreign exchange reserves to maintain it), Argentina’s currency went into freefall for a while, with all the negative short-term consequences that come with that dynamic. Greece would face the same future.

In April 1991, Argentina adopted a rigid peg of the peso to the dollar and guaranteed convertibility under this arrangement. That is, the central bank stood by to convert pesos into dollars at the hard peg.

This decision was totally unsuited to the nation’s trade and production structure. In the same way that most of the EMU countries do not share anything like the characteristics that would suggest an optimal currency area, Argentina never looked like a member of an optimal US-dollar area.

It faced quite different external shocks to those that the US had to deal with. The US predominantly traded with countries whose own currencies fluctuated in line with the US dollar. Given its relative closedness and a large non-traded goods sector, the US economy could thus benefit from nominal exchange rate swings and use them to balance the relative price of tradables and non-tradables.

Argentina was a very open economy with a small non-tradables domestic sector. So it took the brunt of terms of trade swings that made domestic policy management very difficult.

Convertibility was also the idea of the major international organisations such as the IMF as a way of disciplining domestic policy. While Argentina had suffered from high inflation in the 1970s and 1980s, the correct solution was not to impose a quasi-currency board arrangement.

Both monetary and fiscal policy were constrained by the arrangement. The central bank could only issue pesos if they were backed by US dollars (with a tiny, meaningless tolerance range allowed). So dollars had to be earned through net exports which would then allow the domestic policy to expand.

After the peg was introduced, the neo-liberals made matters worse with wide scale privatisation, cuts to social security, and deregulation of the financial sector, the latter which burdened the economy with massive amounts of foreign-currency denominated debt.

Things started to come unstuck in the late 1990s as export markets started to decline and the peso became seriously over-valued (as the US dollar strengthened) with subsequent loss of competitiveness in the export markets.

Lumbered with so much foreign-currency sovereign debt the decline in the real exchange rate (competitiveness) was lethal and the domestic economy in the late 1990s was mired in recession and high unemployment. The unemployment rate was around 16 per cent in 1999.

The bond markets then introduced the “Greek scenario” – they realised the nation would become insolvent as exports collapsed and so yields on sovereign debt rose.

In 2000, under direct orders from the IMF (with the threat of refusal to maintain financial assistance), the government tried to implement a fiscal austerity plan (tax increases) to appease the bond markets – imposing this on an already decimated domestic economy.

The government believed the rhetoric from the IMF and others that this would reinvigorate capital inflow and ease the external imbalance. But at the time it was obvious that it was only a matter of time before the convertibility system would collapse. They couldn’t hold back the flood waters.

Why would anyone want to invest in a place mired in recession and unlikely to be able to pay back loans in US dollars anyway? Think about this in terms of the UK Guardian writer’s assertion about the future of Greece with a new currency (above quote).

In December 2000, an IMF bailout package was negotiated but further austerity was imposed. No capital inflow increase was observed. That was also an obvious prediction apparently not in the IMF forecasting model’s capacity to provide.

The government was also pushed into announcing that it would peg against both the US dollar and the Euro once the two achieved parity – that is, they would guarantee convertibility in both currencies. That was an impossible ask.

Economic growth continued to decline and the foreign debts piled up. The government (April 2001) forced local banks to buy bonds (they changed prudential regulation rules to allow them to use the bonds to satisfy liquidity rules). This further exposed the local banks to the foreign-debt problem.

The bank run started in late 2001 – with the oil bank deposits being the first which led to the freeze on cash withdrawals in December 2001 and the collapse of the payments system.

The riots in December 2001 brought home to the Government the folly of their strategy. In early 2002, they defaulted on government debt and trashed the currency board. US dollar-denominated financial contracts were forceably converted in into peso-denominated contracts and terms renegotiated with respect to maturities etc.

This default has been largely successful. Initially, FDI dried up completely when the default was announced. However, the Argentine government could not service the debt as its foreign currency reserves were gone and realised, to their credit, that borrowing from the International Monetary Fund (IMF) would have required an austerity package that would have precipitated revolution. As it was riots broke out as citizens struggled to feed their children.

Despite stringent criticism from the World’s financial power brokers (including the International Monetary Fund), the Argentine government refused to back down and in 2005 completed a deal whereby around 75 per cent of the defaulted bonds were swapped for others of much lower value with longer maturities.

The crisis was engendered by faulty (neo-liberal policy) in the 1990s – the peg and convertibility. This faulty policy decision ultimately led to a social and economic crisis that could not be resolved while it maintained the currency board.

What happened after the nation abandoned the peg and restored full currency sovereignty?

As soon as Argentina abandoned the peg/convertibility, it met the first conditions for gaining policy independence: its exchange rate was no longer tied to the dollar’s performance; its fiscal policy was no longer held hostage to the quantity of dollars the government could accumulate; and its domestic interest rate came under control of its central bank.

At the time of the 2001 crisis, the government realised it had to adopt a domestically-oriented growth strategy. One of the first policy initiatives taken by newly elected President Kirchner was a massive job creation program that guaranteed employment for poor heads of households. Within four months, the Plan Jefes y Jefas de Hogar (Head of Households Plan) had created jobs for 2 million participants which was around 13 per cent of the labour force. This not only helped to quell social unrest by providing income to Argentina’s poorest families, but it also put the economy on the road to recovery.

Conservative estimates of the multiplier effect of the increased spending by Jefes workers are that it added a boost of more than 2.5 per cent of GDP. In addition, the program provided needed services and new public infrastructure that encouraged additional private sector spending. Without the flexibility provided by a sovereign, floating, currency, the government would not have been able to promise such a job guarantee.

Argentina demonstrated something that the World’s financial masters didn’t want anyone to know about. That a country with huge foreign debt obligations can default successfully and enjoy renewed fortune based on domestic employment growth strategies and more inclusive welfare policies without an IMF austerity program being needed.

The clear lesson is that sovereign governments are not necessarily at the hostage of global financial markets. They can steer a strong recovery path based on domestically-orientated policies – such as the introduction of a Job Guarantee, which directly benefit the population by insulating the most disadvantaged workers from the devastation that recession brings.

The following graph shows the REER for Argentina from January 1994 to October 2012.

It peaked in October 2001, just before the crisis really began and by January 2002 it had fallen to 62.1 (Indexed at 100 as at October 2001). The low point came in June 2002 (index number was 34.8), after which it rose and stabilised around 45. It certainly depreciated but with it came a massive boost to international competitiveness.


The nominal depreciation created a major change in the trade sector. Argentine exports became much cheaper and demand grew rapidly at the same time as import demand fell because of the rise in prices in the newly restored local currency.

It also turned out that the rise in China helped Argentina via soya bean exports which helped stabilise the currency. In general agriculture started booming.

The Government also sought to take advantage of the massive shift in relative prices (terms of trade) by providing incentives for import substitution. The tourism industry also grew rapidly as a result of the currency depreciation.

Before too long, the peso started appreciating again but by then the economy was on a solid growth footing with strong social welfare spending to maintain domestically-sourced growth and a booming export sector.

In the mid-2000s the Government actually had to take measures to stop the peso appreciating further given the size of its trade surplus. The central bank acquired huge stockpiles of foreign reserves (USDs mainly) by selling pesos in the foreign exchange market. The exchange rate is now relative stable at the higher value.

The foreign exchange intervention of the central bank (selling pesos) is sterilised by issuing government debt which is a quite different operation to the current ECB claims that it is sterilising its SMP. But that is another issue again.

So is any of that applicable to Greece? Of-course it is. Greece would suffer the same short-term collapse in its currency. But in Argentina’s case it is clear that people still wanted to buy the currency on foreign exchange markets even with the massive default and the plunging value.

In this report from the Banco Central de la Republica Argentina (BCRA) – Report on the foreign exchange market performance. First quarter of 2007 – you see that international buyers of the depreciating currency were many.

Here is a sequence of graphs taken from that Report that highlight the massive changes that occured once the peg was abandoned and the exchange rate liberated.

The first shows the swing in the Current Account. I know there are readers of my blog who vehemently deny that exchange rate depreciation improves competitiveness and claim that it is a neo-classical position to take to suggest such a thing. Neither is true.

Here are the facts for Argentina between 1995 to 2007:


So no-one would want a currency in free fall? The second graph shows the movement in USD reserves held by the BCRA between 1999 and 2007. They nearly ran out in 2002. The question you need to ask yourselves: where did they get these dollars from?


The final graph in this sequence shows the volumes of foreign exchange transactions for Argentina between 2003 to 2007. It is hardly descriptive of a necrotic foreign exchange sector.


It is true that the Greeks do not have large quantities of natural resources like Argentina did when it defaulted and floated in 2001-02 but it is equally untrue to say it has no desirable assets that are exchange rate sensitive. I noted its tourism capacity and its ship-building industry among others.

But the other point the Guardian author ignores is that Argentina also created new export capacity given the shift in its competitiveness. Greece would do the same.

But, initially, I predict that there would be a boom in tourism virtually immediately and investment funds would flow into it. I know the argument that the tourist industry has been rundown and would not be attractive. With a currency say 30 per cent below the Euro (in real terms compared to now) thousands would be flooding into the islands no matter how rustic the experience was.

And just like Argentina, the change in the current account would put a floor into the currency fall.

Further, in the same way that Argentina had to bear a major inflation impulse as its currency depreciated, which eroded real living standards, the reversal in standards was just as swift as the currency appreciated again on the back of renewed growth.

Greece would experience the same dynamic as the Germans flooded into the sunny Greek islands to escape the Berlin winter.

The UK Guardian article fails to address any of these issues. He just asserts no-one would want to buy anything Greece has to offer. I don’t believe that at all. Capitalism chases growth. Greece would grow almost immmediately it defaulted and restored its currency. Life would be tough for a while but no worse than it is going to be for years into the future under the current plan with no growth dynamic in sight.

He also raises another “more obvious difference between the eurozone and Argentina””

The government of Buenos Aires chose to unpeg its currency from the currency of a foreign nation. In the case of eurozone, the single currency is the most crucial part of an immensely complicated structure of unified decision-making we came to call the European Union. Like the euro, the EU is also a unique construct in modern history and all analogies drawn between it and other cases of economic crises are unfounded. The EU is based on the premise of an “ever closer union”. Sure, you can slow down the whole process and even bring it to a halt, as the British government demands. But if you put it in reverse gear by dissolving the euro, this will trigger a chain reaction of “renationalising” that will bring the EU to an end. And that is only the best-case scenario. In fact, the most likely scenario is that the chaos that would ensue immediately after the dissolution of the euro would lead to the sudden death of the EU. It doesn’t take a genius to understand that the economic, political and geostrategic stakes are immensely higher for the eurozone member states than they were for Argentina in 2001. I am not arguing that such an eventuality is impossible, but it will be like nothing we have seen before, just as the EU is like nothing we have seen before.

The argument has validity. But the facts are that Greek resources – its labour, capital, and land – can be deployed productively by a national currency even if the institutional surrounds collapse.

If the EU structures have become so burdensome and damaging then why hang on to them? I actually support the political ambitions of the European Project. But trying to extend that project to a common currency has been a disaster and provides no scope under current circumstances for enduring prosperity.

I haven’t the time to discuss his second point about the “United States of Europe”.

But consider the following two graphs. The first shows real GDP per capita indexed at 100 at the peak before the crisis, which in Argentina’s case was 1998 and for Greece 2007.

Argentina’s trough was reached in 2002 (index value 78.5) whereas in the five-year period since Greece plunged into its Depression the index has dropped to 78.5 and has still some way to go yet.

You can see the sustained growth that Argentina enjoyed in real per capita income once its recovery took hold.

Is anyone actually imagining that Greece will turn its current situation around as quickly as that.


The second graph shows the employment rate indexed at 108 slow point before the respective crises. So for Argentina the year was 1998 and as you can see the unemployment rate increased by more than 50 percent.

But once growth resumed in 2002 the employment rate fell rather quickly and the economy has sustained that performance since.


Compare that to Greece’s labour market. Its unemployment rate is now three times higher than it was in 2008 and there’s no end to the spiral in sight.


The reality is that Argentina, in part, provides a model for all nations that have surrendered their currency sovereignty courtesy – either via a peg of some sort of outright use of foreign currencies (as in the Euro case).

That is why the elites are working hard to disabuse us of the notion that Argentina is broadly applicable. They know that the nation effectively got away with a major default, enjoyed renewed FDI and have been growing more or less continuously ever since.

Marked as spam
Posted by (Questions: 6, Responses: 100)
Answered on 06/13/2017 6:49 AM