Argentina's Currency Crisis

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

The Central Bank of Argentina therefore was required to maintain its dollar reserves at the same level as the circulating cash. As a consequence of the law, the quality of Argentinian life increased, people able to buy plenty of imports.

• April 1991- Ley de Convertibilidad (Law of Convertibility)
• This law, passed in 1991, tied the dollar to the peso by stating that any citizen could go to the bank and ask for any amount of cash in pesos to be changed into an equal amount of dollars.
  • original intent was to decrease the potential for inflation by pegging the peso to the US dollar, and then in early 90s, rapid growth in the economy, large amounts of capital inflow, quick stabilization
  • initially, it was a solid plan until the Argentine peso was unable to further appreciate with the US dollar
  • increase in the price of Argentine exports which had buyers search elsewhere for products, therefore exports decrease, and this caused a strong decrease in economic growth and capital inflow.
  • dollar changes with the emergence of the euro
  • inability to keep up with the growth of the US economy
  • the law allowed for an economic surge at a 6% per year rate through 1997.

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 the had previsoulsy 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.

• 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 flows. When investors became concerned and stopped investing in the Argentine emerging market, their inflows stopped, and slowly became out flows. A strong and structed domestic market could have saved them from the depression.

• Lack of openess to trade
  • Throughout the 1990's the Argentine economy mostly remained a closed economy, eventhough 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 ben 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 he 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...

Ineffective Fiscal Policy

The years that followed: repercussions of the law

• devaluation of the Brazil real, effect on Argentina because they were trading partners. The peso appreciated against the real. Harmed Argentine exports as Brazil had 30% of the total trade flows for Argentina.

• Investors are afraid because of the speculative attack - they are scared (become flighty) of the instability of the economy regardless of the fixed rate. Because of this, they take part/cause the 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.
• external shocks reached its pinnacle, there were signs appearing about the potential downfall of the economy, investors began to withdraw
• because of the convertibility plan, policy makers were unable to take necessary macro economic action

Essentially, the beginning of this crisis that some argue were caused, or strongly influenced, by the law of convertibility, was in 1998. The economy continued to experience a decline until 2001, when the measures put into place began to take effect. 1998 - In the year prior to 1998, the Argentinian economy due to the law of convertibility began to enter into a recession which converted itself into a depression in the year of 1998. Beginning of the four-year depression.

• economy shrank 28%.
• external shocks reached its pinnacle, there were signs appearing about the potential downfall of the economy, investors began to get scared
• in an effort to save funds, control excess losses, and increase stabilty, they increased interest rates. However, this plan backfired and enlarged the problem.

1999 - GDP dropped 4%

2001 - Speculative attack effects are seen. People begin withdrawing large amounts of money from banks, exchanging their pesos for dollars and therefore further depreciating the amount of money that banks had. The withdrawals were limited to $250 per month.

• Government took reactionary measures that were too strict. In another effort to dampen the blow on the Argentinian people, limits were placed on the amount which people could withdraw from bank accounts. This led to intense riots and protests in which people were killed.
• December 2001 - unemployment rate soared to 23%.

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