Argentina's Currency Crisis

THE ORIGINS OF ARGENTINA'S CRISIS

Argentina has had a long and monotonous history that caused government officials to seek a solution to the high inflation and stagnant output of the 1980s 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)
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.

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.

- 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.

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 Argenina.

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.
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.

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%.