Hard Money's Soft Underbelly: Understanding the Argentine Crisis

Argentina has imploded, and among policy gurus and op-ed writers there is no shortage of simple reasons why. Some blame the International Monetary Fund (IMF), others theneo-liberal model(whatever that may be), yet others a singularly corrupt and incompetent batch of politicians. The implication is often clear: had Argentina just done this or that differently, the tragedy surely could have been averted.

If only life were that simple. Argentina's was not a crisis that caught people by surprise. Instead, it was a protracted affair that, as it marched inexorably toward a catastrophic demise, attracted the attention of some of the best minds in Washington, Wall Street, and Buenos Aires for months on end. During this long agony, many well-trained economists proposed various diagnostics and innovative policy initiatives. The country's much-maligned politicians and parties supported austerity policies (such as cutting nominal public sector wages) that would be very hard to swallow in most democratic societies; and, until late in the game, the international community provided ample financial support. Yet the catastrophe proved impossible to avoid.

It may seem like ancient history now, but not long ago Argentina was thought to be a development model. Through much of the 1990s, Washington and Wall Street toasted Argentina's success in axing inflation, privatizing, deregulating, and linking its currency to the dollar through the so-called convertibility system. This was not pure ideology. In the 1991-97 period the Argentine economy grew 6.7 percent a year (on average), a performance second only to Chile's within Latin America. Most important, Argentines themselves relished this new combination of low inflation and strong, if erratic, growth. In 1995 they reelected Carlos Menem—the president who had first applied the reform policies—in spite of double-digit unemployment and Menem's penchant for fast cars and tainted associates. In 1999 they elected Fernando de la Rua, who promised to be like Menem minus the antics: a solid if boring politician committed to responsible, market-friendly policies. It was not until very late (the crucial date is October 2001, when congressional elections were held) that Argentine voters reacted with dismay to the deteriorating economic situation.

True, Argentina's convertibility had been in trouble before. During the tequila crisis of 1995, the system had been tested by a massive collapse in capital inflows and deposit demand. But the economy came out roaring in 1996-97 without any changes in its currency regime. Moreover, Argentine authorities used the experience to lengthen the maturity of public debt, improve the liquidity of the Treasury, upgrade banking regulation, and create a novel liquidity policy that helped reassure investors and kept deposits growing through the recession that started in 1999 and until as late as February 2001. ¹

The theories put forward as the crisis deepened spanned the whole scope of the academic literature. For some, the problem had a fiscal origin and required a fiscal response. ² Proponents argued that a fiscal contraction could even be expansionary, since it would eliminate fears of insolvency and make capital markets more forthcoming. These ideas led to a series of fiscal adjustment efforts that in fact increased the non-Social Security national primary fiscal surplus by over 2 percentage points of gross domestic product (GDP) in spite of the recession. ³ They involved raising taxes, and by the summer of 2001 even cutting nominal public sector wages, pensions, and mandated intergovernmental federal transfers.

For others, it was a multiple equilibria story, in which self-fulfilling pessimism kept interest rates too high and growth too low for the numbers to add up. Analysts pointed to liquidity needs and rollover risks. In order to reassure the markets and reestablish access, the government negotiated a $40 billion lending package led by the IMF in December 2000, and negotiated a $30 billion...