06 February 2012 at 10:11 GMT
CPI component can lead to wrong conclusions about GDP growth
In light of recent events in Greece and the possibility of a sovereign default it would be wise to look at a previous default example - namely Argentina. We look at how a currency devaluation and sovereign default in Argentina distorted the country's subsequent economic data.
Many point to Argentina as a positive case for sovereign default by showing a chart of real GDP (see chart below). It shows real GDP is up 110 percent since the crisis ended at the end of 2001.
Our Macro Strategist Mads Koefoed points to an interesting fact that when the Argentinian currency devalued the CPI basket was probably altered quite significantly to reflect that imported goods now were not part of a “normal” basket anymore due to rapidly rising prices on imported goods such as cars, computers etc. By transforming the CPI basket (and we know that many have reservations about Argentinian CPI) after a sovereign default a country's future real GDP figures might be vastly overstated.
Source: Bloomberg L.P.
Private sector profits are less prone to CPI distortions
Now turning to a different measure of real economic activity we see a completely different picture of Argentina’s economic recovery since 2001.
The chart below shows EPS (trailing 24 months) and Retained Earnings (trailing 24 months) adjusted for inflation including the inflation adjusted leading stock index (Merval). As you can see Argentina’s private sector has not yet recovered to former aggregate profitability in real terms – in fact aggregate profits are down more than 50 percent in real terms! The results would be even more devastating if Argentina's inflation figures were revised up.
Source: Bloomberg L.P. and Saxo Bank Strategy & Research
Argentina's official economic data paints a picture of a country that has come out of its debt crisis with high economic growth. Instead we think that this conclusion is probably based on a distorted CPI basket and the evidence from publically traded companies in Argentina shows that the private sector is still not back to its former strength.
Overall, looking at the Argentinian economic data you wonder how much of the improvement in Argentina is due to higher commodity prices (agricultural) and not related to domestic policy changes.
Why a sovereign default may not solve anything in long-term economics
Let's take a step back and think about a sovereign default and what good comes out of it. Concerning Argentina: it still does not have access to foreign credit markets, inflation has gone through the roof since the crisis (see chart below) and many economists believe the inflation numbers do not even reflect true inflation. The unemployment rate is still high and the private sector has not fully recovered in real terms, as previously shown.
If you think about it, a sovereign default does not force a country to structurally change itself. It only puts creditors in a hole - that is i!. The true problem is that creditors cannot overtake the control of a sovereign, as you normally do in a distressed private asset, and force structural reforms because the population is normally against it, much like the situation in Greece right now.
Source: Bloomberg L.P.
Overall the dynamics and implications of sovereign defaults are probably very complex and not very clear cut. If Greece defaults and leaves the Euro it will hardly force structural changes to the country and it is very likely that the subsequent economic trajectory in real terms would be as dismal as in Argentina. We should remember that in the context of a Greek default.