Real World Economics: ‘Creative destruction’ and Argentina’s debt crisis

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 predicament 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 chosen 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 innovation was piecemeal An example would be that years ago the new efficient Bessemer converter to make steel did not work with a great number of iron ores Modern chemistry exposed the predicament was phosphorus content and that a different firebrick to line the converters solved the issue 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 th century years after Smith Smith had argued that leaving fund allocation to arena forces fostered efficient deposit use But why and how did this cause expansion Schumpeter identified 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 field forces territory forces drive out less-efficient less-convenient mechanism Think automobiles replacing horse-drawn buggies and electric lights supplanting kerosine lamps Why however was such creative destruction more prominent in certain countries than in others say Japan or the United States versus Peru or Argentina Did beliefs play a role in such programs 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 prospective billion rescue package to help Argentina First let s note that Argentina s dilemma is acute rather than its traditional chronic ones that have hindered the creative destruction needed to foster rise President Javier Milei Argentina s charismatic but mercurial leader had been lauded until up-to-date weeks for turning his nation s commercial sector around after 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 billion loan from the U S Treasury but he s trying to strongarm another billion from private financial institutions What s happening here Argentina is entering a foreign exchange dilemma essentially a subset of the broader phenomenon of financial crises Start by understanding both In generic financial crises that often appear quite suddenly multiple individuals businesses or governments cannot meet their financial obligations whether payments of interest or principal on loans or purely 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 was a financial situation So was the collateralized mortgage debacle starting in Ditto for panics in and A foreign exchange predicament such as the European exchange rate problem of September involves a country s or countries need for foreign currencies to facilitate economic activity In 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 reliably a danger of a sudden shortage in several country of the other currencies it demands for payments to agreement partners financial institutions or governments Trump s current Treasury secretary Scott Bessent then a young prot g of financier George Soros yes the same now-noted target of right-wing political derision thought in 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 billion So our Treasury secretary understands exchange rate crises The European predicament was followed by the Mexican peso situation in - and exchange crises in South Korea and other Asian countries in These also had affected various countries in the generalized Latin American debt predicament of the s- s and in several 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 truly exceeds obligations but assets like real estate or bonds cannot be converted to cash fast enough to meet demands In the classic 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 longed 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 unfailingly sell enough abroad to provide foreign currencies for those needing it Or it must continually attract new venture 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 the majority 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 billion loan to Argentina shows the issue is deeper than a temporary shortage The Trump administration s urging private U S banks and capital funds to lend another 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 a great number of run by donors to Trump campaigns can do to the Argentine peso what Soros Bessent and others did to Britain in and what speculators worldwide did to South Korea and other Asian nations in The very financial firms Trump asks to join him and Bessent in lending to Millei s regime may be using derivative securities to force Millei s regime 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 emergency 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 information is falling into yet another financial predicament Creative destruction indeed Despite highly extraordinary aid from our nation an acute crunch including a devaluation of Argentina s currency and a th default on its debt is very realizable Yet we in the United States a nation in its worst political situation since cannot gloat We rapidly are making our nation s finances as dodgy as multiple a Third World country A congressionally orchestrated regime shutdown manifests the collapse since 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 problem even more severe Related Articles Real World Economics How farm payouts violate basic principles Real World Economics Ignorance of Social Protection s problems is not bliss Real World Economics How bad is 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