The Origins of Crisis
Eric Osborne spells out the Argentine economic collapse of the 2001
With a cursory glance around Argentina, most would never guess that a scant eight years ago it was embroiled in a disastrous financial crisis. Things seem rather in order here. Businesses function well, tourism is booming, prices are relatively stable, and the government is a functioning democracy. However, the prosperity we see today is not a reflection of the way things have always been, and any Argentine will be quick to tell you that the next big downturn might be just around the corner; and for good reason. Argentina’s history has been rife with crisis, and the latest may have been the worst.
Origins
The origins of Argentina’s economic crisis go back to the mid 1970’s to early 1980’s, when Argentina’s militant government acquired large amounts of debt with botched projects, corrupt political dealings, the Falklands War, and the state’s assumption of private entities. By the time democracy was restored in 1983, unemployment was skyrocketing, wages were dropping, and inflation was on the rise. Argentina simply didn’t have the means or adequate leadership to recover, and in 1989, with a declining gross domestic product (GDP) and inflation in excess of 5,000%, the economy collapsed.
Stabilization of the Peso
Starting in 1989, new president Carlos Menem took the country in a different direction by introducing a gamut of new economic policies, the most significant of which was the fixing of the peso to the US dollar at a rate of one to one. In doing so, Menem hoped to ease the minds of international lenders who had been disenfranchised by their currency’s hyperinflation, and who had begun to reject pesos as payment.
Initially, it appeared as though this would be a successful endeavor, as the economy began to stablize and inflation immediately came to a halt. Also, as Argentines now effectively held dollars, they could afford to travel abroad, buy imported goods, and had access to credit at low rates for the first time ever. As a result, quality of life skyrocketed.
“It was a time of plenty, and quite a change from what life had been like before,” Romina Yacabone, co-owner of Hostel Simplemente Mendoza, told Wine Republic. “It seemed like everyone was traveling, especially abroad. For the fiesta de quinceanera, which is our version of the sweet-sixteen, parents would send their daughters to Miami instead of throwing a party locally. That’s how inexpensive it was.” But despite the improvements, trouble loomed on the horizon. With no control over its monetary policy, Argentina’s economy was very vulnerable to external phenomena. Any shock or revaluations in the worldwide market had the potential to cause serious problems for their foreign exchange. So, unsurprisingly, when the dollar dramatically appreciated relative to the Japanese yen in 1996, the European currencies in 1999 and 2000, and the Brazilian real in 1999, the peso also increased in relative value. With 53% of Argentina’s total trade flows going to Brazil and Europe, Argentina’s export market evaporated.
Inversely, with the low foreign exchange price, importers (both private and public) had an artificial inducement to buy. And buy they did. From 1990 to 1994, firms and consumers trippled the amount of imported capital goods they purchased; and from 1992 to 1999, Argentina amassed over $22 billion debt on imported capital alone. The effects were felt throughout the economy. With the notable exception of the service sector, the entirety of the economy immediately began to flounder. The manufacturing sector, which includes Argentina’s largest exporter, agriculture, was hit particularly hard.
Still, the government was reluctant to abandon the peg, and instead opted to tighten macroeconomic policy by reducing spending, increasing interest rates, and increasing taxes. The hope was that if they could hold out long enough, the peso would actually become undervalued, meaning the peso would increase in value when the peg was removed, thereby giving a further boost to price stability. This, however, would never happen; and when Argentina finally defaulted on its debt in December 2001, the $155 billion they left on the table was the largest sovereign debt default in history.
The End of Convertibility
In January 2002, the one to one dollar peg was finally abandoned. In a matter of days, the peso lost significant value in the unregulated market, officially dropping to 1.4 pesos per dollar. This would usually suggest an increase in exports, but since the county was structured for an import heavy market, export income came slowly. Accordingly, the value of the peso continued to drop, bottoming out at approximately 4 pesos to 1 dollar. Export sluggishness also reduced tariff revenue and government saving, which caused inflation to rise significantly, reaching 20.2% in April 2002.
To avoid a run on the banks, the government proceeded to put a cap on withdrawls, which meant residents had no means of buying necessities.
“A lot of businesses reverted back to a barter system,” Romina continued. “And even if you did have money, everything was rationed. They had to. Inflation was so bad that people wanted to purchase everything they could in the morning before stores raised their prices in the evening.” Further complicating matters, the Ministry of Economy required all bank accounts denominated in dollars to be exchanged into pesos at the official rate. Effectively, this meant that people’s savings were cut by 75% overnight. Nationwide, wealth plummeted, businesses closed, imported products became virtually inaccessible, and the unemployment rate soared to nearly 25%.
“That was when things got really bad,” Romina explained. “Buses didn’t run, most other public works didn’t function, there were protests… People were so desperate that they started looting, but only at grocery stores and kiosks; they mostly left other stores alone. They just needed food.”
Efforts to Fix the Problem
In response to these issues, the government began to promote their exports with subsidies and improved access to credit for export related industries. They’ve had some success too. Behind skyrocketing soy prices, Argentine exports eventually began to gain footing in international markets. In fact, between 2003 and 2008, Argentina has managed to amass a $77 billion trade surplus. Things have been looking up elsewhere, as well. GDP has grown since 2003, and the gap between the richest 10% and poorest 10% began decreesing after March 2005. “Things are certainly improving,” Romina concluded. “We couldn’t have run a hostel ten years ago. We’re actually pretty happy with the way things have changed. I think most Argentines are.”
Origins
The origins of Argentina’s economic crisis go back to the mid 1970’s to early 1980’s, when Argentina’s militant government acquired large amounts of debt with botched projects, corrupt political dealings, the Falklands War, and the state’s assumption of private entities. By the time democracy was restored in 1983, unemployment was skyrocketing, wages were dropping, and inflation was on the rise. Argentina simply didn’t have the means or adequate leadership to recover, and in 1989, with a declining gross domestic product (GDP) and inflation in excess of 5,000%, the economy collapsed.
Stabilization of the Peso
Starting in 1989, new president Carlos Menem took the country in a different direction by introducing a gamut of new economic policies, the most significant of which was the fixing of the peso to the US dollar at a rate of one to one. In doing so, Menem hoped to ease the minds of international lenders who had been disenfranchised by their currency’s hyperinflation, and who had begun to reject pesos as payment.
Initially, it appeared as though this would be a successful endeavor, as the economy began to stablize and inflation immediately came to a halt. Also, as Argentines now effectively held dollars, they could afford to travel abroad, buy imported goods, and had access to credit at low rates for the first time ever. As a result, quality of life skyrocketed.
“It was a time of plenty, and quite a change from what life had been like before,” Romina Yacabone, co-owner of Hostel Simplemente Mendoza, told Wine Republic. “It seemed like everyone was traveling, especially abroad. For the fiesta de quinceanera, which is our version of the sweet-sixteen, parents would send their daughters to Miami instead of throwing a party locally. That’s how inexpensive it was.” But despite the improvements, trouble loomed on the horizon. With no control over its monetary policy, Argentina’s economy was very vulnerable to external phenomena. Any shock or revaluations in the worldwide market had the potential to cause serious problems for their foreign exchange. So, unsurprisingly, when the dollar dramatically appreciated relative to the Japanese yen in 1996, the European currencies in 1999 and 2000, and the Brazilian real in 1999, the peso also increased in relative value. With 53% of Argentina’s total trade flows going to Brazil and Europe, Argentina’s export market evaporated.
Inversely, with the low foreign exchange price, importers (both private and public) had an artificial inducement to buy. And buy they did. From 1990 to 1994, firms and consumers trippled the amount of imported capital goods they purchased; and from 1992 to 1999, Argentina amassed over $22 billion debt on imported capital alone. The effects were felt throughout the economy. With the notable exception of the service sector, the entirety of the economy immediately began to flounder. The manufacturing sector, which includes Argentina’s largest exporter, agriculture, was hit particularly hard.
Still, the government was reluctant to abandon the peg, and instead opted to tighten macroeconomic policy by reducing spending, increasing interest rates, and increasing taxes. The hope was that if they could hold out long enough, the peso would actually become undervalued, meaning the peso would increase in value when the peg was removed, thereby giving a further boost to price stability. This, however, would never happen; and when Argentina finally defaulted on its debt in December 2001, the $155 billion they left on the table was the largest sovereign debt default in history.
The End of Convertibility
In January 2002, the one to one dollar peg was finally abandoned. In a matter of days, the peso lost significant value in the unregulated market, officially dropping to 1.4 pesos per dollar. This would usually suggest an increase in exports, but since the county was structured for an import heavy market, export income came slowly. Accordingly, the value of the peso continued to drop, bottoming out at approximately 4 pesos to 1 dollar. Export sluggishness also reduced tariff revenue and government saving, which caused inflation to rise significantly, reaching 20.2% in April 2002.
To avoid a run on the banks, the government proceeded to put a cap on withdrawls, which meant residents had no means of buying necessities.
“A lot of businesses reverted back to a barter system,” Romina continued. “And even if you did have money, everything was rationed. They had to. Inflation was so bad that people wanted to purchase everything they could in the morning before stores raised their prices in the evening.” Further complicating matters, the Ministry of Economy required all bank accounts denominated in dollars to be exchanged into pesos at the official rate. Effectively, this meant that people’s savings were cut by 75% overnight. Nationwide, wealth plummeted, businesses closed, imported products became virtually inaccessible, and the unemployment rate soared to nearly 25%.
“That was when things got really bad,” Romina explained. “Buses didn’t run, most other public works didn’t function, there were protests… People were so desperate that they started looting, but only at grocery stores and kiosks; they mostly left other stores alone. They just needed food.”
Efforts to Fix the Problem
In response to these issues, the government began to promote their exports with subsidies and improved access to credit for export related industries. They’ve had some success too. Behind skyrocketing soy prices, Argentine exports eventually began to gain footing in international markets. In fact, between 2003 and 2008, Argentina has managed to amass a $77 billion trade surplus. Things have been looking up elsewhere, as well. GDP has grown since 2003, and the gap between the richest 10% and poorest 10% began decreesing after March 2005. “Things are certainly improving,” Romina concluded. “We couldn’t have run a hostel ten years ago. We’re actually pretty happy with the way things have changed. I think most Argentines are.”
