Edward Lotterman
Economic news was incongruous this past week as three economists got Nobel prizes for their research on factors that determine how well economies grow over the long term just as President Donald Trump throws money to bail Argentina out of a short-run crisis very familiar to that nation.
Start with the Nobels. The three laureates’ work returns us to economics pioneer Adam Smith’s focus on “the nature and causes” of why some economies become more prosperous than others.
Joel Mokyr, a Dutch-born Israeli-American, got half the prize for exploring why technological innovation takes place and how cultures foster or retard this process. He sees modern science as key.
Prior to the scientific method, meeting challenges to new technology was piecemeal. An example would be that 200 years ago, the new, efficient Bessemer converter to make steel did not work with many iron ores. Modern chemistry found the problem was phosphorus content and that a different firebrick to line the converters solved the problem.
The other laureates, French economist Philippe Aghion and Canadian-American Peter Howitt, also took up the earlier work of renowned Austrian-American economist Joseph Schumpeter, from the first half of the 20th century, 150 years after Smith.
Smith had argued that leaving resource allocation to market forces fostered efficient resource use. But why and how did this cause growth? Schumpeter found it was because free markets fostered “creative destruction” — the natural eroding away of obsolete businesses and technologies as newer, more productive ones take over. Efficiency and convenience drive market forces, market forces drive out less-efficient, less-convenient technology. Think automobiles replacing horse-drawn buggies and electric lights supplanting kerosine lamps.
Why, however, was such creative destruction more prominent in some countries than in others, say Japan or the United States versus Peru or Argentina? Did culture play a role in such activities? If so, which aspects? Aghion and Howitt used sophisticated mathematical models to tease out answers.
Thus, the work of this year’s laureates helps us understand differences in longer run trends for nations that perform better or worse than others.
Now, let’s relate this work to news of Trump offering a potential $40 billion rescue package to help Argentina. First, let’s note that Argentina’s problem is acute rather than its traditional chronic ones that have hindered the creative destruction needed to foster growth.
President Javier Milei, Argentina’s charismatic but mercurial leader, had been lauded until recent weeks for turning his nation’s economy around after 2023. He is much beloved by the even more mercurial Trump. Yet again Argentina is in deep financial trouble, and Trump sees an opening. Not only is Trump proposing a currency swap that is essentially a $20 billion loan from the U.S. Treasury, but he’s trying to strongarm another $20 billion from private financial institutions.
What’s happening here? Argentina is entering a “foreign exchange crisis,” essentially a subset of the broader phenomenon of “financial crises.” Start by understanding both.
In generic financial crises, that often appear quite suddenly, many individuals, businesses or governments cannot meet their financial obligations, whether payments of interest or principal on loans or simply paying for goods purchased or even wages due. Those stiffed in this initial round are rendered unable to meet their own bills and a vicious cycle ensues. Businesses go broke, financial institutions fail and economic activity shrivels. Like one icicle falling from an alpine crag onto an unstable snow cornice below, a small slide rapidly turns into a thundering avalanche.
The Wall Street crash of 1929 was a financial crisis. So was the collateralized mortgage debacle starting in 2007. Ditto for “panics” in 1873, 1893 and 1907.
A “foreign exchange crisis,” such as the European exchange rate crisis of September 1992, involves a country’s or countries’ need for foreign currencies to facilitate economic activity. In 1992, pre-euro, several European countries had entered an exchange rate “mechanism” to fix relative values of the different currencies across the continent. However, there is always a danger of a sudden shortage in some country of the other currencies it needs for payments to trade partners, financial institutions or governments.
Trump’s current Treasury secretary, Scott Bessent, then a young protégé of financier George Soros (yes, the same now-noted target of right-wing political derision), thought in 1992 that the United Kingdom had pegged the British pound at too high a value. Soros bet that the U.K. would be forced to decrease the value of the pound relative to other European currencies and bought financial derivatives that would pay off if it did, essentially short-selling the pound. Other traders soon joined in. Britain did have to devalue after burning through billions of pounds trying to defeat the speculators. Bessent and Soros alone earned something over $1 billion. So our Treasury secretary understands exchange rate crises.
The European crisis was followed by the Mexican peso crisis in 1994-1995 and exchange crises in South Korea and other Asian countries in 1997. These also had affected many countries in the generalized Latin American debt crisis of the 1980s-1990s and in many African countries. Argentina has had repeated episodes.
Financial crises, including foreign exchange crises, resemble bankruptcies. They can stem from two problems. One is true insolvency — not having enough assets to pay all debts. The other is illiquidity, when the value of assets actually exceeds obligations, but assets like real estate or bonds cannot be converted to cash fast enough to meet demands. In the classic 1946 Christmas movie “It’s a Wonderful Life,” banker George Bailey pleads to angry depositors that his small-town Building and Loan is only illiquid and not insolvent.
Any country whose currency, unlike the dollar, is not wanted by others to park extra cash, must wrestle with exchange rates. Fixing the rate reduces uncertainty. Businesses can grow with imported machinery financed abroad. Firms that use foreign raw materials or import retail goods can plan.
However, the nation with the fixed rate must always sell enough abroad to provide foreign currencies for those needing it. Or it must continually attract new investment from foreigners.
Yet maintaining a fixed exchange rate isn’t easy. If domestic inflation gets above that of other countries, imported consumer goods or industrial inputs get relatively cheaper in local currency. Retailers in neighboring Chile and Uruguay have booming businesses right now as Argentines snap up electronics, appliances and other goods now cheap in terms of Argentine pesos.
Those who export, however, find that for any given world price of soybeans, iron ore, automobiles or apparel, the limited local currency gotten for each shipment pays fewer for the same hours of labor, gallons of diesel fuel, electricity or facilities needed to produce the goods. This hits exporting producers hard.
Understand that a country can be on sound long-term footing in terms of its exchange rates, but still suffer temporary shortages of foreign currencies. Without help, the value of its currency must drop. Central banks help each other with “swap lines.” If Sweden, still using krona, runs short of euros or dollars to pay for oil or fertilizer imports, the European Central Bank or U.S. Federal Reserve may lend it euros or dollars. These usually are repaid in weeks or months.
It is crucial, however, to understand that such intra-central bank swaps are to counter illiquidity problems. They most certainly are not suited to any “fundamental disequilibrium” of insolvency.
That brings us back to the Argentina bailout. That Bessent and the U.S. Treasury, instead of the Fed, is making a $20 billion loan to Argentina shows the problem is deeper than a temporary shortage. The Trump administration’s “urging” private U.S. banks and investment funds to lend another $20 billion shows it wants these institutions to assume risks of large write offs later. Or is a future bailout by the U.S. Treasury to cover eventual loan losses for these same institutions?
The final kicker is that all sorts of financial institutions, including many run by donors to Trump campaigns, can do to the Argentine peso what Soros, Bessent and others did to Britain in 1992 and what speculators worldwide did to South Korea and other Asian nations in 1997. The very financial firms Trump asks to join him and Bessent in lending to Millei’s government may be using derivative securities to force Millei’s government to throw in the towel.
Outraged U.S. soybean growers losing export dollars to Argentina and other South American countries make news, but why should the rest of us care? Well, while the reserve status of the dollar still protects us from foreign exchange crises, we hurtle hell-bent toward a federal debt crisis, perhaps in less than a decade, that will be the mother of all financial crises, not only for ourselves but for the world.
It’s a sad irony that the Nobel prizes were given just as Argentina, a nation rich in natural resources, is falling into yet another financial crisis. “Creative destruction” indeed. Despite highly unusual aid from our nation, an acute crunch including a devaluation of Argentina’s currency and a 10th default on its debt is very possible.
Yet we in the United States, a nation in its worst political crisis since 1860, cannot gloat. We rapidly are making our nation’s finances as dodgy as many a Third World country. A congressionally orchestrated government shutdown manifests the collapse since 2010 of a functioning legislative branch. Are we really all that different from Argentina, where political deadlock has for years begat stagnation? Might we, in fact, be on track for a debt crisis even more severe?
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St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
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