Don’t cry for me Argentina, and Japan, too.

By Ichiro Suzuki Simon Kuznets, the 1971 winner of Nobel prize in economics once said “There are four kinds of countries: developed country, underdeveloped country, Japan and Argentina.” To be more specific he reportedly said “Nobody knows why Japan grows and nobody knows why Argentina doesn’t.” Argentina always struggled to grow on a long-term basis at the time he said this, and has not been growing meaningfully since then. At the turn of the 20th century, Argentina was one of the wealthiest countries on earth, along with the U.K., Germany, France, Austria-Hungary and the U.S. Argentina has been a great agricultural power that thrived on grain exports, and then it failed to move up from that position, missing the boat of industrialization. After WWII, populist policies of fiscal spending without productivity growth has been hurting the economy. Its currency, the Argentina peso was almost always under pressure amid high inflation. In sharp contrast, Japan went through an era of supernormal growth after WWII. Japan registered dazzling growth rates in the 1950s and the 1960s that were repeated by China in the early years of the 21st century. Japan stood at the polar opposite position of where Argentina was. In the 21st century, Argentina still remains the same old Argentina. The 1990s witnessed a brief revival period of the economy under supply side reform called “the Convertibility Plan”. The cornerstone of this policy by finance minister Domingo Cavallo was ‘currency board’ that pegged the Argentina peso to the U.S. dollar. The peg immediately enhanced the credibility of the peso. A stable currency crushed rampant inflation, enabling the economy to grow strongly. A consumption boom sucked in imports but greater trade deficits were financed by flight capital’s return to the country. Foreign capital also flowed into Argentina in the form of both direct and portfolio investments. So external accounts did not have a problem. Argentina’s economy looked fantastic after decades of dismal performances, at least for a while. Here was a catch, however. Though it came down to single digit rates from near hyperinflation, inflation in Argentina was still running considerably higher than that of the United States. As the ARS was pegged against the USD at 1 for 1, higher inflation rates in Argentina eroded real (after inflation) value of the peso. At 1 for 1, the ARS became too expensive. An overvalued currency weighed on the economy, exerting deflationary pressure. The Central Bank of Argentina, however, was not able to do anything about it since it had to abandon monetary policy of its own under currency board. The Fed’s action fully dictated the Argentine economy. As speculators tried to attack the overvalued ARS, the central bank defended the currency by selling the USD and buying the ARS in the market, causing outflows of the USD out of Argentina’s foreign exchange reserves. Since currency board requires the peso circulated in Argentina’s economy be fully backed by the USD in the central bank’s vault, outflows exacerbated downward pressure on the ARS. Private capital that once flowed into Argentina began to leave the country. Under an overvalued ARS, deflationary pressure became intense at the end of the 20th century. In late 2001, the Central Bank of Argentina came to a point that it could no longer hold the ARS on par with the USD, and then the Convertibility Plan was scrapped. The decision opened a floodgate, sending the ARS into a tailspin, and the country’s external liability translated in the ARS had ballooned, forcing the Argentina government to default on its sovereign debt. The rest is history. Today, a dollar buys 100 Argentine pesos. Japan stopped growing in the 1990s after the burst of the bubble, and then precipitated into a banking crisis. The Bank of Japan did not loosen its monetary policy sufficiently, and relatively tight money drove the yen to surge in the mid-1990s, and again in the ensuing years of the 2007-09 global financial crisis. Unlike Argentina back then, the JPY is not pegged against the USD and the Bank of Japan has its own monetary policy. It has no currency board to defend.

In contrast to Argentina, inflation in Japan has always been lower than that of the U.S. Other things equal, it is quite natural for the JPY to rise against the USD. A stronger currency causes downward pressure on an economy where demand is naturally weak due to decreasing population, especially that of working age population. Low inflation in Japan has been at least in part attributed to demography since it suppresses demand and hence inflation. A currency rises because of low inflation and inflation is low because of weak demand. Something is wrong in this logic. Low inflation rate was often cited as a cause of a stronger JPY in the old days when the Japanese economy boasted of strong growth rates. Those days are gone forever, and this logic probably no longer holds. Weak demand should not drive up value of a currency indefinitely. Having lost a glitter, Japan that once stood in a polar opposite position to Argentina has moved 180 degrees to the camp of not being able to grow. Ever-growing public sector debt is weighing on the yen. At least for now, the JPY is immune to disorderly sell-offs that are often witnessed among developing countries, due to Japan’s robust external positions. Nonetheless, quiet capital flight from Japan is in progress, pressing down the currency. The Bank of Japan says that the value of the JPY is lowest since 1973, the year the Japanese currency went free-float, in terms of real effective exchange rate (REER) that takes inflation effects into consideration. As the ARS experienced at the turn of the 21st century, the JPY is sinking in a deflationary/ low inflation environment. Half a century after Professor Kuznets’ Nobel prize, Argentina and Japan continue to set themselves apart from the rest of the world, albeit this time sharing a bizarre similarity.


About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.