Themes > Current Issues
11.12.2001
Jayati Ghosh
The unfolding and devastating financial crisis in
Argentina is a terrifying example of how a country can be led by
multilateral institutions and financial interests into economic policies
that eventually culminate in disaster, and then be abandoned by these very
players when the crisis breaks.
On December 5, the international financial press was abuzz with the story of the imminent debt default by the Argentina, and the possible breakdown of the currency board arrangement which had fixed the value of the Argentine peso to the US dollar over the last few years. But by the following day the relevant news items were already relegated to the back pages, and a few days later Argentina was barely visible in the business media.
The reason, of course, was not that somehow the Argentine economy had miraculously recovered from the crisis and avoided almost certain collapse. Rather, it was because the rest of the developing world and therefore their bankers had avoided "contagion" from the Argentine mess, and so could afford to watch from the sidelines with only minimal discomfort. One report in a leading financial daily could smugly announce that, unlike three years ago when problems in one emerging market spread rapidly to others, Argentina's woes have been largely discounted in financial markets. For much of this year there has even been a negative correlation between Argentine government bond spreads over US treasuries and those of other emerging economies. And there were few indications of any spillover effect of the Argentine crisis even on other Latin American markets.
Of course, that did not mean that the crisis in Argentina was any less acute, or any closer to viable resolution, but that did not seem to worry the financial markets unduly. Instead, there were more chilling reminders of how the financial world actually views emerging markets : thus an article in the Financial Times of December 5, 2001, entitled "Ray of light in Argentine gloom" suggested that the silver lining for investors was that "provided Argentina's financial system does not collapse completely foreign banks could benefit from the shake-out and foreign banks, which control about 48 per cent of the banking sector, could raise their share dramatically".
It is now commonplace that the economy that is singled out for praise by the IMF or by the mouthpieces of international financiers as a model for other developing economies and an attractive choice for investors, is likely to suffer a major financial crisis within a few years of such commendation. But in Argentina, the crisis is all the more remarkable not just because of its extreme nature, but because so much of it is the explicit handiwork of the IMF itself, which was then applauded by private markets for its actions.
Of course the original sin of the external debt of Argentina has an even longer history. The infamous military junta run by General Videla, which was in power between 1978 and 1983, increased the external debt more than fivefold from $ 8 billion to $ 43 billion. Ordinary workers saw very little of the benefits from the expenditure based on such debt in fact, the share of wages in national income fell over this period from 43 per cent to 22 per cent. The Argentine Tribunal which enquired into this debt blamed not only Videla but the close economic nexus around him, especially the then Governor of the Central Bank, Domingo Cavallo.
The Report claimed that "the Argentine Central Bank was able to make discretionary investments with American banks, this without securing the agreement of the Minister of the Economy, but relying on the generous help of the American Federal Reserve. The arrangement between these different lead players was such that the bank loans granted to Argentina were never to come under that country's control, but were to be directly diverted by the banks to tax havens in the name of front- companies. So the debt did not benefit the local people but rather the dictatorial regime and the banks of the North which provided important technical financial support for the passage." [Report of Judicial Inquiry into Argentine Debt]
When the debt crisis broke in 1982, Argentina sought a loan from the IMF, and has subsequently been almost continuously under its direct or indirect control in terms of economic policy. However, if the 1980s were a "lost decade" for all the major Latin American debtors, the 1990s have proved to be possibly even more disastrous for ordinary people in Argentina. The regime of Carlos Menem - who, along with four of his former ministers, was until recently being held in custody for international arms trafficking during 1991 and 1995 engaged in widespread and rapid privatisation of key assets and reduction of public services through "downsizing". The man dominantly responsible for overseeing this was Menem's "Super Minister in charge of Economy" none other than Domingo Cavallo.
The Currency Board arrangement, which was a drastic fixing of the exchange rate by linking the domestic money supply to the amount of Central Bank dollar reserves and establishing a one-to-one relationship between the US dollar and the peso, was supposedly a measure to extinguish inflation and thereby create conditions for growth. However, while this did provide some degree of currency stability, which made it the temporary darling of international capital, it entailed draconian control on public expenditure which effectively meant that basic economic rights of citizens work and minimal public goods and services were denied.
The effects have been disastrous for the real economy. For the last four years the economy has been in serious recession. The public health system is in tatters and the public education system is a shadow of its former self. Basic public services are negligible and privatisation has denied access to most of Argentina's poor. The average wage in real terms is now worth half of its 1974 value. So the deterioration in both economic and social terms has been dramatic indeed. Meanwhile, the economic tailspin has also adversely affected tax revenues, so that government deficits remained high despite expenditure cuts.
Meanwhile, the external debt has ballooned, from $43 billion in 1983 to more than $ 135 billion this year. Early this year, Domingo Cavallo, whose personal history has been so closely intertwined with the economically problematic periods of Argentina's history, was brought back in by President Fernando de la Rua, to reassure restive financial markets that Argentina could cope with its huge debt burden. But Cavallo described as a market magician - had already used up most of the tricks up his sleeve in his previous incarnation, by selling off almost everything there was to sell and bringing public services and infrastructure to rock bottom levels. There was precious little scope for any more of that. And, given the commitment to monetarist orthodoxy and the determined dependence upon external capital, there was no question of Keynesian recovery measures to stimulate the economy.
It has been quite clear for several months now that the Argentine economic boat is stuck between a rock and a hard place, with almost no room for manoeuvre in any direction. This being so, it was only to be expected that speculative pressure in the markets would begin to attack the Currency Board system itself. That is not surprising, nor should Cavallo's recent complaints that economists writing in financial papers have caused markets to move in this way be taken too seriously.
What is much more surprising is the response of the IMF, which has now decided that the fixed exchange system is unsustainable and should be abandoned with a (presumably) stiff depreciation of the exchange rate. After all, it was the IMF which first championed and then supported the highly restrictive macroeconomic austerity measures Argentina undertook to support the Currency Board, and praised the anti-inflationary bias. Until recently, the open love fest between Cavallo and IMF staff was being played out very much in the public eye.
Now, however, the scene is rather different. In fact the proximate cause of the current financial crisis is the refusal of the IMF to make a payment of $1.26bn due in the middle of the month because of Argentina's deteriorating accounts and its refusal to consider a devaluation. This immediately put the government's ability to service its huge debt in jeopardy. In response the Government imposed measures which can only be called drastic. Already, for more than a year, Argentina has depended on local banks and pension to finance government spending and meet payments on its debt. After the IMF announcement, the government took control of $3.5bn in private pension assets to pay bills.
There were new banking and exchange restrictions as well. Bank account-holders were limited to withdrawing $250 a week in cash. Any amount above that would have to be spent by cheque, credit card or debit card. In addition, Argentines were allowed to take no more than $1,000 in cash abroad. Companies would have to obtain official clearance to make foreign payments above that amount.
Of course, these measures do no more than to keep the ship afloat for a short time. In fact many have argued that these measures locking the stable doors after the horses have bolted - may be not just ineffective but even counterproductive. The extreme pessimists have said that lifting the restrictions even if the economy is completely dollarised could trigger a total run on deposits, given that confidence has been damaged by imposing these controls.
Market analysts have declared that the choices for Argentine policy makers are between dollarisation at the current rate, devaluation and then dollarisation at a lower rate, or floating the peso. But none of these options offers much relief for ordinary Argentines, who are likely to find that things will get even worse before there is any hope of their getting better. The more obnoxious part of this hard reality is that the sufferings of Argentine people will be certainly not shared, and probably barely even noticed, by the international economic bureaucrats and financial investors who have contributed so greatly to this mess.
On December 5, the international financial press was abuzz with the story of the imminent debt default by the Argentina, and the possible breakdown of the currency board arrangement which had fixed the value of the Argentine peso to the US dollar over the last few years. But by the following day the relevant news items were already relegated to the back pages, and a few days later Argentina was barely visible in the business media.
The reason, of course, was not that somehow the Argentine economy had miraculously recovered from the crisis and avoided almost certain collapse. Rather, it was because the rest of the developing world and therefore their bankers had avoided "contagion" from the Argentine mess, and so could afford to watch from the sidelines with only minimal discomfort. One report in a leading financial daily could smugly announce that, unlike three years ago when problems in one emerging market spread rapidly to others, Argentina's woes have been largely discounted in financial markets. For much of this year there has even been a negative correlation between Argentine government bond spreads over US treasuries and those of other emerging economies. And there were few indications of any spillover effect of the Argentine crisis even on other Latin American markets.
Of course, that did not mean that the crisis in Argentina was any less acute, or any closer to viable resolution, but that did not seem to worry the financial markets unduly. Instead, there were more chilling reminders of how the financial world actually views emerging markets : thus an article in the Financial Times of December 5, 2001, entitled "Ray of light in Argentine gloom" suggested that the silver lining for investors was that "provided Argentina's financial system does not collapse completely foreign banks could benefit from the shake-out and foreign banks, which control about 48 per cent of the banking sector, could raise their share dramatically".
It is now commonplace that the economy that is singled out for praise by the IMF or by the mouthpieces of international financiers as a model for other developing economies and an attractive choice for investors, is likely to suffer a major financial crisis within a few years of such commendation. But in Argentina, the crisis is all the more remarkable not just because of its extreme nature, but because so much of it is the explicit handiwork of the IMF itself, which was then applauded by private markets for its actions.
Of course the original sin of the external debt of Argentina has an even longer history. The infamous military junta run by General Videla, which was in power between 1978 and 1983, increased the external debt more than fivefold from $ 8 billion to $ 43 billion. Ordinary workers saw very little of the benefits from the expenditure based on such debt in fact, the share of wages in national income fell over this period from 43 per cent to 22 per cent. The Argentine Tribunal which enquired into this debt blamed not only Videla but the close economic nexus around him, especially the then Governor of the Central Bank, Domingo Cavallo.
The Report claimed that "the Argentine Central Bank was able to make discretionary investments with American banks, this without securing the agreement of the Minister of the Economy, but relying on the generous help of the American Federal Reserve. The arrangement between these different lead players was such that the bank loans granted to Argentina were never to come under that country's control, but were to be directly diverted by the banks to tax havens in the name of front- companies. So the debt did not benefit the local people but rather the dictatorial regime and the banks of the North which provided important technical financial support for the passage." [Report of Judicial Inquiry into Argentine Debt]
When the debt crisis broke in 1982, Argentina sought a loan from the IMF, and has subsequently been almost continuously under its direct or indirect control in terms of economic policy. However, if the 1980s were a "lost decade" for all the major Latin American debtors, the 1990s have proved to be possibly even more disastrous for ordinary people in Argentina. The regime of Carlos Menem - who, along with four of his former ministers, was until recently being held in custody for international arms trafficking during 1991 and 1995 engaged in widespread and rapid privatisation of key assets and reduction of public services through "downsizing". The man dominantly responsible for overseeing this was Menem's "Super Minister in charge of Economy" none other than Domingo Cavallo.
The Currency Board arrangement, which was a drastic fixing of the exchange rate by linking the domestic money supply to the amount of Central Bank dollar reserves and establishing a one-to-one relationship between the US dollar and the peso, was supposedly a measure to extinguish inflation and thereby create conditions for growth. However, while this did provide some degree of currency stability, which made it the temporary darling of international capital, it entailed draconian control on public expenditure which effectively meant that basic economic rights of citizens work and minimal public goods and services were denied.
The effects have been disastrous for the real economy. For the last four years the economy has been in serious recession. The public health system is in tatters and the public education system is a shadow of its former self. Basic public services are negligible and privatisation has denied access to most of Argentina's poor. The average wage in real terms is now worth half of its 1974 value. So the deterioration in both economic and social terms has been dramatic indeed. Meanwhile, the economic tailspin has also adversely affected tax revenues, so that government deficits remained high despite expenditure cuts.
Meanwhile, the external debt has ballooned, from $43 billion in 1983 to more than $ 135 billion this year. Early this year, Domingo Cavallo, whose personal history has been so closely intertwined with the economically problematic periods of Argentina's history, was brought back in by President Fernando de la Rua, to reassure restive financial markets that Argentina could cope with its huge debt burden. But Cavallo described as a market magician - had already used up most of the tricks up his sleeve in his previous incarnation, by selling off almost everything there was to sell and bringing public services and infrastructure to rock bottom levels. There was precious little scope for any more of that. And, given the commitment to monetarist orthodoxy and the determined dependence upon external capital, there was no question of Keynesian recovery measures to stimulate the economy.
It has been quite clear for several months now that the Argentine economic boat is stuck between a rock and a hard place, with almost no room for manoeuvre in any direction. This being so, it was only to be expected that speculative pressure in the markets would begin to attack the Currency Board system itself. That is not surprising, nor should Cavallo's recent complaints that economists writing in financial papers have caused markets to move in this way be taken too seriously.
What is much more surprising is the response of the IMF, which has now decided that the fixed exchange system is unsustainable and should be abandoned with a (presumably) stiff depreciation of the exchange rate. After all, it was the IMF which first championed and then supported the highly restrictive macroeconomic austerity measures Argentina undertook to support the Currency Board, and praised the anti-inflationary bias. Until recently, the open love fest between Cavallo and IMF staff was being played out very much in the public eye.
Now, however, the scene is rather different. In fact the proximate cause of the current financial crisis is the refusal of the IMF to make a payment of $1.26bn due in the middle of the month because of Argentina's deteriorating accounts and its refusal to consider a devaluation. This immediately put the government's ability to service its huge debt in jeopardy. In response the Government imposed measures which can only be called drastic. Already, for more than a year, Argentina has depended on local banks and pension to finance government spending and meet payments on its debt. After the IMF announcement, the government took control of $3.5bn in private pension assets to pay bills.
There were new banking and exchange restrictions as well. Bank account-holders were limited to withdrawing $250 a week in cash. Any amount above that would have to be spent by cheque, credit card or debit card. In addition, Argentines were allowed to take no more than $1,000 in cash abroad. Companies would have to obtain official clearance to make foreign payments above that amount.
Of course, these measures do no more than to keep the ship afloat for a short time. In fact many have argued that these measures locking the stable doors after the horses have bolted - may be not just ineffective but even counterproductive. The extreme pessimists have said that lifting the restrictions even if the economy is completely dollarised could trigger a total run on deposits, given that confidence has been damaged by imposing these controls.
Market analysts have declared that the choices for Argentine policy makers are between dollarisation at the current rate, devaluation and then dollarisation at a lower rate, or floating the peso. But none of these options offers much relief for ordinary Argentines, who are likely to find that things will get even worse before there is any hope of their getting better. The more obnoxious part of this hard reality is that the sufferings of Argentine people will be certainly not shared, and probably barely even noticed, by the international economic bureaucrats and financial investors who have contributed so greatly to this mess.
© MACROSCAN 2001