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Monday, May 16, 2005

Argentina: Events leading to breakdown/crisis in late 2001. Part I in series

Part I

It proved difficult for the international community to place in proper context the events that took place in Argentina at the end of 2001 and in 2002. The international press found it difficult to present/voiceover images of looting, rioting, and protests with the world’s attention focused on the war on terrorism. International news organizations concentrated their resources on events in Afghanistan, Pakistan, Iraq and other Middle Eastern countries, and the United States. Few news organizations possess newsgathering and analytical capability on the ground in Argentina. Argentines did not simply wake up in mid December 2001 and riot because of unhappiness with their miserable lot in life. The reasons behind the events are complex. The following attempts to explain the events that unfolded in late 2001. Events in Argentina are not of an isolated nature and present important lessons for the world.


Argentina is a country almost one third the size of the United States. It achieved independence from Spain in 1816. After about a half century of squabbling between and within various provinces Argentina adopted a Federal constitution based on the U.S. model and began to focus on improving its lot in life. Fortunately it counted with substantial agricultural and cattle resources, whose placement in international markets for good prices financed investment in infrastructure, imports of manufactures and development. By the late 1800s immigrants were flocking to Argentina and the country was undergoing rapid development so that by the 1920s Argentina was one of the ten wealthier nations in the world.[1] The advent of the great depression led to the bottom falling out of the agricultural and cattle markets and Argentina’s terms of trade began a fairly consistent decline. Since 1930, with brief respites, Argentina’s economy has been in constant decline. When compared to the United States, Argentina, which in 1916 counted with about 70% of the U.S. per capita income now has about 10% (GNI Atlas Method World Bank 2003). For most of the 20th century governments focused on redistributing the shrinking wealth instead of providing the necessary framework for growth (enlarging pie). Peron’s ascent in the 1940’s led to the adoption of import substitution schemes and semi isolationist policies. The problems were compounded between 1955-1983 by various incompetent military regimes punctuated by weak democratic regimes shadowed by the exiled Peron and powerful military. The return of democracy in 1983 while owing much to the debacle of the Malvinas-Falklands conflict with Great Britain also responded to the military’s abysmal economic track record, which left the nation with astronomical inflation and a sizable foreign debt.

Argentines were generally optimistic in 1983 that having rid themselves of the military (for the first time nobody could contemplate a return to military rule) the decline could be reversed. The general concensus was that Argentina possessed untapped resources, an educated population, and a lack of ethnic or social strife. With judicious and consistent government Argentines envisioned if not a wealthy country at least a middle tier nation. Spain’s accomplishments in the post-Franco period and the era of Felipe Gonzalez as Prime Minister would soon be viewed as the model. Unfortunately, the first democratic government of the Union Civica Radical President Raul Alfonsin proved unable to meet the challenge and acquiesced to leaving office six months early on the heels of the worst hyperinflation and food riots in Argentine history.[2]

The next President, the Peronist Carlos Saul Memem, pulled a “Nixon in China” move and although elected on a traditional peronist plank of nationalization, salary hikes, and increased government services implemented important structural reforms to convert a largely state owned and dominated economy into a free market economy. In this manner Menem undid much of Peron’s legacy. Menem also served to delegitimize the nascent democracy by running on one platform and governing with another.

Menem also closely aligned Argentina with the United States.[3] Menem oversaw a complete globalization of the economy with unregulated capital flows and a very large presence of foreign multinationals that set up for business in Argentina and purchase large numbers of local businesses. In 1991, and still attempting to eliminate the scourge of inflation, the economy minister, Domingo Cavallo, implemented a so called “convertibility” regime that had reaching implications. In order to tame inflation which was viewed as the bigger threat to the Argentine economy he fixed or “pegged” the argentine peso to the dollar at a 1 to 1 rate. The “Convertibility Law” established that the Central Bank would have to hold a dollar in reserve for each peso in circulation. Therefore the Central Bank could grow the money supply in so far as dollar inflows permited and the Peso would never lose its value. In this manner Argentina would break the cycle of currency devaluation led inflation. The scheme worked and it stuck. Argentine inflation between 1991 and 2001 was on the order of 0% and the currency as predicated by law maintained its value. In fact Argentina’s inflation rate proved to be lower than that of the United States. The simplicity of the law meant that it became political dogma that the Convertibility Law must be maintained; this lack of flexibility and a rather simplistic understanding of the convertibility scheme would sow the seeds of a painful demise.

One problem proved to be the maintenance of the dollars in reserve. The Government was unable or unwilling to eliminate its budget deficit (including provincial governments) and therefore more dollars were required. During the 1991-1995 period capital inflows more than made up for any trade and budget deficits as inflows from privatization revenues and investments by the new owners of privatized companies flowed in to the economy. However, as with most “neat” ideas there were some catches. For example, the one to one rate meant that Argentina’s currency began to value itself against other world currencies artificially or in relation to how the dollar valued itself to other currencies. Obviously this held little relation to economic fundamentals responding to the realities of the argentine economy. Imports became cheaper in Argentina and Argentine exports became more expensive abroad. Initially the impact was small and it was felt that by exerting pressure on Argentine companies to become more competitive and productive the scheme would lead to more investment in capital which would allow Argentine companies to provide an increasing share of goods and services demanded domestically. This in turn would lead to higher export revenues and therefore a trade surplus with which to finance the need for dollars.

The 1995 Tequila crisis followed by the Asian crisis followed by the Russian Crisis followed by the devaluation of the Brazilian real (Brazil is Argentina’s largest trading partner within the Mercosur liberalized trade bloc) resulted in a lack of capital inflows combined with increasing inflows of imports. Since the Government was unable or unwilling to control its budget deficit this meant it somehow needed to obtain the dollars necessary to maintain the 1 to 1 scheme. The Government’s solution was to borrow money (unlike the 1980s this time the convertibility law banned printing pesos without dollar backing). Some critics maintain that the borrowing increased because President Menem wished to pacify the provinces in order to amend the constitution in order to seek reelection. In any case by the mid 1990s Argentina was resorting to international capital markets to finance its budget deficit. By 1997 after the aforementioned external shocks had taken their toll Argentina’s economy entered a recession.

Social Crisis

Although the numbers that were being bandied about the corridors of the World Bank and IMF and reported in the liberal economic press (i.e., Wall Street Journal, the Economist, etc.) pointed to large rates of economic growth, and I have no reason to doubt these figures, the fact of the matter was that income inequality, poverty, unemployment and economic marginalization were all increasing in the Argentina of the 1990s. The international consensus about Argentina in the mid 1990s was that it was an example for the rest of the world to follow. In fact, Argentina became the poster child for neoliberal market reforms and globalization. For example, I participated in coordinating and leading a group of Pakistani government officials on a World Bank sponsored study tour of Argentina in late 1997. The idea at this time was that Argentina had made most of the right moves. The international community recognized that there remained a bit of corruption but that this would be ironed out. The fact that most Argentines were getting poorer was not the important thing; what was important was that the pie was growing! As far as borrowing, Argentina’s access to and use of capital markets was looked upon positively. After all, the argument went, that’s what development is about: obtaining capital and investing it in order to develop the economy. As the economy continued to grow it would easily repay these loans. It remains strange to me that few remembered that in the early 1980s Argentina had come close to defaulting on its international debt commitments or that Argentina has consistently proved to be a boom and bust economy. And the banks were happy lending to Argentina as the economy was growing and it was seen as a low risk proposition (actually lending to countries is always a low risk proposition given that countries cannot declare bankruptcy- so called “moral hazard” issue [i.e., banks often lend to countries when they should not]).

Somewhere in the mid 1990s companies in Argentina began to find it difficult in the face of an overvalued currency to compete with foreign (particularly Brazilian products which enjoyed lower or inexistent tariff barriers and benefited from the devaluation of the Brazilian real) products and began to unload workers. Also, foreign companies now controlling a large segment of the economy laid off large numbers of workers while some Argentine companies relocated to Brazil. The layoffs were understandable given the substantial overstaffing that afflicted many argentine companies. The government meanwhile absorbed some of the layoffs into the public sector. However, formal unemployment in the 1990s grew from the low teens to twenty percent by 2001.

[1] As difficult as it may seem to believe now in the 1920’s the French coined the phrase “…riche comme un argentin.” (Rich as an argentine)
[2] The first indication of the emerging social crisis resulting from increased income inequality.
[3] Argentine Foreign Minister Guido Di Tella characterized the new bond between the two nations as “relaciones carnales” (carnal relations).

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