Mon | Dec 5, 2016

Argentina and Newton's Third Law

Published:Friday | August 22, 2014 | 12:00 AM
President of Argentina, Cristina Fernández de Kirchner. - File
Argentina's Economy Minister Axel Kicillof. - File
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Walter Molano, Guest Columnist

Isaac Newton's three laws of physics are part of the core curriculum for most high-school students. Although the subject matter is tucked away in the science department, it has special relevance for the social sciences.

The Third Law states: 'For every action, there is an equal and opposite reaction'. Not only is this applicable to the design of jet turbines and rocket engines, it is very useful in understanding Argentine policymaking.

For the last three months, the Argentine government has undergone several complete reversals, taking everyone by surprise. At first, the government vowed to respect Judge Griesa's decisions.

President Cristina Kirchner promised that default was not an option. Economy Minister Axel Kicillof scheduled and cancelled visits to New York several times a day.

The government then proceeded to break all of its assurances, by defaulting on the debt and refusing to abide by the court's verdict. Moreover, it moved aggressively to infuriate all of the parties that were sympathetic to its cause. It pulled the rug from underneath the local Argentine banks and business leaders when they tried to buy out NML's claim. It turned a deaf ear to an overture from large international banks to do the same, and it alienated the Obama administration by trying to bring the matter to the International Court of Justice in The Hague.

Such actions only led to catcalls, accusations of amateurism and ad hoc policymaking.

A simple explanation

Commentators tried to justify the government's actions by examining the limitations put in place by the 'Rights Upon Future Offers' (RUFO) clause, but the explanation was much simpler. In the end, ever since the emergence of the Peronist movement in the 1940s, Argentine politics has been driven by populism.

Ideology may be an important motivator for the Kirchner administration, particularly with Kicillof, an avowed communist, at the helm of the economy. However, the true basis of power is the teeming masses of poor urban dwellers that surround the city of Buenos Aires.

President Kirchner's decision to settle with the Paris Club and Repsol demonstrated a true desire to regain access to the international capital markets. The government saw the ease with which other frontier market economies, such as Paraguay, Bolivia and a range of sub-Saharan countries, were able to raise capital at low single-digit rates.

With international reserves dwindling and the most important sources of domestic savings already tapped out, Buenos Aires had little choice but to settle with the holdouts. Plus, the terms that they were willing to accept were not so bad. They would take a partial payment in cash and the rest in bonds. Therefore, the cash flow impact was going to be minimal.

Moreover, the memories of the 2001 default were clear in the president's mind. The destruction of the financial system, the massive devaluation of the peso and the collapse of the De la Rua administration were the chain of events that led to the rise of the Kirchners.

For more than a decade, the political power of the Kirchners grew as the economy recovered. It was logical for her to think that the opposite would happen if the economy collapsed. Yet, it didn't - at least, not yet.

July 1, 2014, was a normal day in Buenos Aires. The ATMs worked. The banks were open for business and vendors accepted Argentine credit cards. At the same time, President Kirchner's standing in the polls shot up, as she stood down the greedy international cabal that was holding the country hostage.

The polls shot up, as she stood down the greedy
international cabal that was holding the country
hostage.

Up to that moment, the president thought that
a default would trigger a political crisis. However, when it led to a
boost in her support, it only emboldened her actions. She blew through
the grace period and pushed the country into a full default - marking
the seventh time that the country failed to live up to its international
obligations.

Five of the last seven occurrences
happened during the last eight decades. Yet, as the Argentine populist
political machine stochastically bounces down the corridor of history,
we may soon see another reversal.

International
reserves continue to fall, and the central bank is adding more
restrictions. The economic slowdown is deepening. Unemployment is on the
rise. Shortages are appearing and prices continue to
soar.

It is only a matter of time until the applause
turns to the sound of clanging pots and pans as the people turn to the
streets. Let's hope that happens before the hedge fund community returns
from its summer holidays and accelerates the Argentine stand-off, which
will turn the default into an outright horror movie. In the meantime,
we must remember Newton's Third Law whenever we try to understand
Argentine policymaking.

Dr Walter T. Molano is a
managing partner and the head of research at BCP Securities
LLC.wmolano@bcpsecurities.com