The Decline of The Peso: The Argentina Crisis Essay

This essay has a total of 1907 words and 7 pages.

The Decline of The Peso: The Argentina Crisis

In 1998, Argentina entered what turned out to be a four-year depression, during which its
economy shrank 28 percent. Argentina's experience has been cited as an example of the
failure of free markets and fixed exchange rates. Contrarily, Argentina's economic woes
have been attributed to bad economic policies which converted a typical recession into a
full depression. Three big tax increases in 2000-2001 discouraged growth, and interfering
with the monetary system in mid 2001 created fear of currency devaluation. Consequently,
the confidence people had in Argentina's government finances evaporated. "In a series of
mishaps that made the situation ever worse, from December 2001 to early 2002, succeeding
governments undermined property rights by freezing bank deposits; defaulting on the
government's foreign debt; ending the Argentine peso's longstanding link to the dollar;
forcibly converting dollar deposits and loans into Argentine pesos at unfavorable rates;
and voiding contracts."

Argentina has a history of constant economic, monetary and political problems. After
achieving independence from Spain in a war that began in 1810, Argentina's provinces
fought among themselves for many years, and no stable nationwide government existed until
1862. Until the late 1800s the provinces and the national government often financed budget
deficits by printing money. The results were persistent inflation and low economic growth.

More recently, in 1989, Carlos Menem became president and the core of his policies was the
Convertibility Law. It ended hyperinflation by establishing a pegged exchange rate with
the U.S. dollar and backed money issued by the central bank substantially with dollars.
The exchange rate was initially 10,000 Argentine autrales per dollar: on January 1, 1992
the peso replace the austral at 1 peso = 10,000 australes = US $1. The major disaster of
the period was that the unemployment rate rose. "From 1989 to 1999, the number of jobs
grew as fast as the population, but the number of people who wanted to work grew even
faster." Inflexible labor laws and high taxes on formal employment made creation of new
jobs in the above-ground economy slower than growth in the number of new job seekers.

In 1998 Argentina entered a recession but by late 2001 the economy was in a full-blown
depression. External forces provoked a recession. The East Asian currency crisis of
1997-98 and the Russian currency crisis of August 1998 made investors in developing
countries much more cautious about investing in developing countries generally. "Brazil,
Argentina's largest trading partner, withstood a currency crisis from August to October
1998, on the heels of the Russian crisis, but when confronted with a crisis in 1999,
Brazil allowed its currency to float rather than maintaining the "crawling peg" to the
dollar that had previously existed." The Brazilian real quickly depreciated from 1.21 per
dollar to 2.18 per dollar before recovering. Brazil's economic growth fell from 3.3
percent in 1997 to 0.1 percent in 1998 and was only 0.8 percent in 1999. After years of
gains, Argentine-Brazilian trade was flat in 1998 and shrank in 1999.

The January 2000 tax increase destroyed a growing economic recovery. In late 1999 and
early 2000, the economy was showing signs of growth. In December 1999, Fernando De la Rua
succeeded Carlos Menem as president. His government promptly enacted the first of three
packages of tax increases, which took effect in January 2000. Economic indicators quickly
turned negative again as the tax increase killed the growing economic recovery.

New blunders in tax and monetary policy didn't make matters improve in 2001. The return to
a shrinking economy in 2000 and 2001 led to political problems. "On March 18, 2001,
ministers of the Frepaso political party resigned from President De la Rua's coalition
cabinet in protest over proposed cuts in spending." The resignation marked the start of
the true crisis phase of Argentina's economic problems. The resignations weakened
President De la Rua's base of support in the Argentine Congress. The next day interest
rates in Argentina moved to permanently higher levels, with further spikes during the rest
of the year related to bad news about economic policy.

In response, President De la Rua appointed Domingo Cavallo as minister of economy. In
monetary policy, the government made key blunders in April and Jun 2001. On April 17,
Cavallo introduced a bill to switch the exchange rate link of the peso from the U.S.
dollar to a combination of the dollar and the euro. The president of the central bank,
Pedro Pou, had advocated replacing peso with dollars one-to-one if necessary to ensure the
credibility for the peso. His views put him at odds with Cavallo and De la Rua. On April
25, De la Rua fired Pou and replaced him with a more malleable official. On June 15,
Cavallo announced a preferential exchange rate for exports. The special exchange was a
step back towards the interventionist practice, frequent before the convertibility system,
Continues for 4 more pages >>




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