Argentina’s Shock Therapy: Devaluing the Peso and Its Consequences
Introduction
Argentina’s new president recently announced a shock therapy to address the country’s economic challenges. One of the most significant changes was the devaluation of the official peso exchange rate by 54 percent. While this move aimed to align the official price with the true market price, it may not have a meaningful impact on those who prefer to use U.S. Dollars instead of ARS. This article explores the implications of currency devaluation and the macroeconomic fundamentals that contribute to such measures.
The Difference Between Central Bank Devaluation and Market Forces Depreciation
There are two distinct types of currency devaluation: one driven by the central bank and the other influenced by market forces. Central bank devaluation is often used as a beggar-thy-neighbor policy to restore a country’s competitiveness by lowering the aggregate price level abroad. This approach assumes that there is no significant exchange rate misalignment and that depreciation can be managed in an orderly manner. On the other hand, market forces depreciation occurs when macroeconomic fundamentals are already weak or deteriorating rapidly, leading to a significant misalignment. In such cases, the central bank usually intervenes through foreign exchange purchases using reserves like U.S. Dollars or gold.
Macroeconomic Fundamentals and Indicators
Macroeconomic fundamentals play a crucial role in determining a country’s currency stability. These fundamentals can be assessed at both the governmental and national levels. At the governmental level, fiscal balance measures the flow of revenue minus expenditure, while governmental reserves less debt reflects the stock. On a national level, the current account balance, which measures net exports, indicates the flow, while assessing a country’s net assets is more complex. These indicators are often presented as a percentage of GDP, which is the ultimate variable governing the overall health of an economy.
Argentina’s Deteriorating Fundamentals
Unfortunately, Argentina has not fared well in terms of these macroeconomic indicators. The severity of the resulting crisis remains unknown, similar to how the impact of a bad habit can be unpredictable. However, a persistent deterioration of fundamentals leads to continuous depreciation pressure. As shown in the attached chart, peso devaluation has been a recurring issue since World War II. While sharp depreciation may seem like a solution, implementing effective tightening measures is easier said than done, as it requires the cooperation of citizens.
The Way Forward
Addressing Argentina’s economic challenges requires a comprehensive approach that goes beyond currency devaluation. Increasing savings may lead to lower consumption and prosperity in the short term, but it can also contribute to long-term stability. Breaking the vicious circle of declining savings and consumption requires practical solutions that are yet to be determined.
Related Stories
For more information on Argentina’s economic situation and recent developments, you may find the following articles helpful:
- Argentine Peso Crashes As Leftist Populist Candidate Takes the Lead in Primary Election Results
- Argentina Sharply Devalues Its Currency and Cuts Subsidies as Part of Shock Economic Measures
Image Source: The Epoch Times
Author: KC Law, Ka Chung
