Thirty Years of Currency Crises in Argentina: External Shocks or Domestic Fragility?

Argentina has had an active presence in international capital markets since its independence in the early nineteenth century. However, its participation has been quite volatile. In the early 1800s, in the midst of the lending boom fueled by the end of the Napoleonic wars, Argentina and many other countries in Latin America were able to issue bonds in London to finance their wars of independence and the civil wars that followed. This lending boom ended in the summer of 1825 when the Bank of England raised the discount rate to stop the drain in its reserves. The tightening of liquidity was followed by stock market crashes, banking problems, and recessions in England and on the Continent. Within months the crisis also spread to Latin America. Argentina defaulted in 1827, in the midst of what is known as the first Latin American debt crisis, only resuming payments in 1857.

Similar international capital flow booms to emerging markets occurred in 1867-72, 1880-90, 1893-1913, and 1920-29, fueled by an easing monetary stance in the financial centers of those times and by the financial needs of railway expansion, urbanization, and development of the banking sector of countries in the periphery. While Argentina was heavily involved in all these capital flow bonanzas, its participation was quite volatile, with financial crises often following booms.¹

In the aftermath of the crisis of the 1930s, international capital markets all but disappeared, and Argentina was unable to borrow again until the 1970s. The period from the mid-1970s to 2002 was as tumultuous as that of the earlier eras and was characterized by booms and busts in international capital flows, crises, and failed stabilization programs. During this period, Argentina had eight currency crises, four banking crises, and two sovereign defaults. Many argued that domestic fragilities were at the heart of these crises.² Others blamed erratic international capital markets by pointing out the lending boom of the late 1970s that ended with defaults across all Latin American countries, or the lending cycle of the 1990s that triggered banking and currency crises in the most active participants in international capital markets, such as Argentina, Brazil, Colombia, Mexico, Peru, and Venezuela.³ This important debate is still unsettled. Now, in the midst of the worst international financial crisis since the Great Depression, untangling the roots of financial distress becomes crucial. This is the question we plan to examine in this paper.

We focus on Argentina's currency crises of the last thirty years and cast our net wide to examine the role of three external shocks and four sources of domestic vulnerability in the development of currency turmoil. Our selection of external shocks centers on the easing and tightening of monetary policy in the world financial centers, financial contagion and overall "international investors' sentiment" about emerging markets, and real exchange rate misalignments caused by currency depreciations among Argentina's major trading partners. With respect to domestic vulnerabilities, we focus on the boom-bust cycle of domestic credit and monetary policy, fiscal problems, shocks to economic activity, and increases in households' risk aversion triggered by spells of hyperinflation, controls on foreign exchange transactions, cycles of controls on prices and wages, and bank deposit confiscations that have plagued Argentina's recent history. To capture the onset of the crises and track the buildup of fragility during fixed exchange rate regimes, we look at the evolution of foreign exchange reserves of the central bank as a proportion of domestic credit. For short periods of time in the early 1970s and late 1980s, Argentina adopted a dual exchange rate regime, with a fixed exchange rate for commercial transactions and a freely floating exchange rate for capital account transactions. For these episodes, the onset of a crisis is captured by an index of exchange market pressure, which is constructed as a composite index of losses of reserves of the central bank and the dual exchange market premium. Structural Vector Autoregression (VAR) techniques are used to identify the effects of domestic and external shocks on the...