A Dangerous Sign That Argentina's Economy Is Going Off The Rails

Cristina Fernandez de Kirchner argentinaREUTERS/Marcos BrindicciDemonstrators look up next to an image of Argentina’s President Cristina Fernandez de Kirchner during a demonstration in support of Argentina’s government outside Buenos Aires’ Historical Cabildo, July 30, 2014. Argentina was in a race against time on Wednesday to cut a deal by the end of the day with holdout investors suing it and avert a default, as a surge in the country’s bond prices fed optimism that an agreement was possible.

The exchange rate for Argentina’s black market dollar, the ‘dolar blue’, has hit its highest rate in history at 15.10 dolar blue to one U.S. dollar.

The official rate, fixed by the government, has been set at 12 pesos to the U.S. dollar since the country devalued its currency in January.

Axel Kicillof, the country’s Economy Minister, responded to the rate on an Argentine radio program. He blamed a group of hedge fund holdout creditors suing the country for over $US1.3 billion of sovereign debt.

He said the rate was all part of their plan to speculate the country into ruin, and dismissed the size of the underground market.

“This attack on our money was all a part of the vultures’ plan,” said Kicillof. “The United States representative spoke of default, and that wasn’t casual… The dolar blue is a small market that is illegal… It’s easy for it move quickly… There are no economic reasons for the dollar to equal 15 pesos [15 dolar blue]. This is simply an attempt to generate panic. Do not be alarmed…”

Argentina was ruled in default of its debt in July after it defied a U.S. court order and refused to pay a group of hedge fund creditors.

That, however, is only a small part of Argentina’s problems. The “economic reasons” for the underground peso’s historic jump that Kicillof dismissed are very, very real. And the dolar blue market rate is no tiny market in the country. Regular Argentines use it every day, underground blue dolar exchanges aren’t hard to find, and it’s estimated that $US10 million U.S. dollars are exchanged on the black market daily.

In a country where memories of hoarding dollars during the 2001 economic crash are vivid and horrifying; Where there are tough restrictions on hoarding U.S. dollars for fear of capital fight; this is a sign that things are falling apart.

“I would say by the end of the year, or the beginning of next year — that’s the most they can have in terms of margin,” said Dr. Claudio Loser, a former International Monetary Fund economist and founding member of Centennial Group Latin America.

“Maybe sooner.”

The list of economic problems with Argentina is long. Economic activity is in recession, the inflation rate is at almost 40%, and the country’s Central Bank dollar levels are at a 4 and a half month low of $US28.2 billion.

Additionally, the prices of Argentina’s commodity exports, like the soy bean, have gone down this year resulting in a balance of payments issue. Swiss bank UBS expects GDP growth to come in completely flat for 2014.

“All these things are together with a fiscal policy that is very irresponsible,” said Loser. “All the signals… are wrong, in my view, in therms of trying to draw foreign investment.”

Of those policies Loser said simply: “I won’t give it the honour of calling it Marxist because that’s too sophisticated,” he mused.

Kicillof also said in his radio appearance that the holdouts are waiting for the country’s Presidential election at the end of 2015. It is likely that a new, more market friendly government would be more willing to pay them back.

If that’s the case, then they’re not the only ones. Ordinary Argentines are bracing themselves for a lost year as President Cristina Fernandez de Kirchner finishes out her term.

“I do not know whats gonna happen,” said Federico Zaldua an Argentina-based trader on Itau BBA’s Latin America bond desk. He spoke with Business Insider shortly before the country defaulted.

“We are all looking into 2015 already,” he said.

But a new administration is not the cure for what ails Argentina. It’s just a teeny tiny step on the way to a recovery. Unfortunately, paying the holdouts wouldn’t immediately help the country either.

“[If they pay the holdouts] they will still have pneumonia but at least the fat man sitting on their toes will get off,” Loser said.

What he means is that this isn’t even close to over, especially since economists believe that another currency devaluation is on the way, given the country’s economic malaise.

This is going to get worse before it gets better.

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