Argentina's Currency Crisis

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Argentine Peso

THE ORIGINS OF ARGENTINA'S CRISIS

Argentina has had a long and monotonous economic history. In the past few decades, the Latin American country has tried to develop a solution to high inflation and stagnant output, which reached its pinnacle in 1989 with the hyperinflation of the Argentinian economy. The government, therefore took a drastic measure to create a solution to their problems, which did indeed solve their problems in the short run, but eventually led them into their most recent economic crisis.

Law of Convertibility

• April 1991- Ley de Convertibilidad (Law of Convertibility) is passed and becomes Argentine law.
• This law, passed in 1991, tied one US dollar to one Argentine peso. This allowed any Argentine citizen to go to the bank and ask for any amount of cash in pesos to be changed into an equal amount of US dollars.
  • The original intent was to decrease the potential for inflation by pegging the peso to the US dollar.
  • In the beginning of the 90s, the law achieved success by initiating rapid growth in the economy, producing large amounts of capital inflow, and leading to quick stabilization in the Argentine market.
  • This success was later demonstrated when the Argentine economy experienced an economic surge rate of 6% per year from the early 90's to 1997.
  • Initially, it was a solid plan until the Argentine peso was unable to further appreciate with the US dollar, against other currencies in the global market, specifically the Euro.
  • Due to the inequality in the strength of these currencies, there was an increase in the price of exported Argentine products, which forced buyers to search elsewhere for these goods. This, therefore caused a decrease in their export sales, which caused a strong decrease in their economic growth and the capital inflow for the country. An example of this, can be viewed through their trading relations with their neighbor Brazil. Brazil experienced a devaluation in their currency, the real, so they were unable to buy the more expensive Argentine products. This caused a problem, because 30% of Argentina's total trade was with Brazil. In this way, Brazil was unable to continue trading with its neighbor with this fervour.

Circumstances initiating the crisis

• Ineffective Fiscal Policy
  • The policies which were enacted during the years leading up to the depression and during the depression proved to worsen and exacebate the depression. There was widespread tax avoidance and evasion, and repetitive issues with deficits. Throughout these actions, its obvious to see that fiscal operations and policies were not at their strongest.

• The Problematic convertibility regime
  • The Convertibility Regime also proved to be a bad decision for the Argentine economy, because it took away the wage and price flexibility that had previously exisited in the economy. This therefore caused issues, because the real effective exchange rate of the peso was not allowed to depreciate when it needed to. They were also in trouble with public debt and were unable to meet their debt payments.

• Rapidly Changing Capital Flows
  • Throughout this experience, Argentina relied heavily on capital inflows for the stabilibity of their economy. This became an issue because instead of increasing domestic financial markets and accumulating domestic savings, they placed their hopes abroad and in capital inflows. When investors became concerned and stopped investing in the Argentine emerging market, these inflows stopped, and slowly became out flows. A strong and structured domestic market could have alleviated them from the severity of this depression.

• Lack of openess to trade
  • Throughout the 1990's the Argentine economy mostly remained a closed economy, even though most trade barriers had been removed. This affected the country in another manner, because it did not allow the country to recieve the needed amount of foreign currency to pay for its external debts. The only solution left, was for the massive depreciation of the peso after the country abandoned the fixed exchange rate. If the country had been more open to trade, it remains a possibility that the depression would not have been as severe as it was.

• Political Issues
  • Political issues also resulted in the Argentine depression, because during the crisis the federal government lacked the cohesion and therefore the ability to function smoothly. Instead in the midst of the crisis, the President of Argentina resigned, while the government's finance minister was temporarily sent to jail under charges of corruption.

• External Influence
  • External influences also played an integral role in causing the Argentine currency crisis. The East Asian Currency Crisis in the years before the Argentine crisis, scared international investors from investing in emerging markets. This caused many investors to halt their input in the Argentine economy. This fear and speculative attack started the ball rolling on what would later develop into a depression.

The years that followed: repercussions of the law

The value of the US dollar appreciated against other currencies, and the Argentine peso continued its struggle to keep up with the currency with which it had been pegged. External shocks reached a pinnacle, and signs demonstrated the potential downfall of the economy, as investors began to withdraw slowly. Due to the limiting nature of the convertibility plan, policy makers were unable to take necessary macro-economic action to counterbalance this.

1998 - In the years prior to 1998, the Argentinian economy, due to the law of convertibility, began to enter into a recession which converted itself into a four year depression in the year of 1998. The economy continued to experience a decline until 2001, when the measures put into place began to take effect.

• Investors became fearful and afraid, and therefore there occured a speculative attack - the investors became flighty due to the instability of the economy, although the fixed rate was still in place. Because of this, they caused a speculative attack. As stated earlier, a speculative attack is self-fulfilling and usually causes a recession. Investors had mistrust because of other countries such as Mexico and Brazil which were also trade partners of Argentina had had economic crisis.
• in an effort to save funds, control excess losses, and increase stabilty, the government increased interest rates. However, this plan backfired and enlarged the problem.

1999 - GDP dropped 4%

2001 - Speculative attack effects are seen.

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