Abyss’ Final Feedback

I will talk about the Argentinian crisis of 2001. This was clearly a currency crisis. The Argentinian government had decided to establish a fixed exchange rate, i.e., one peso was equivalent to one dollar. To do so, the Central Bank of Argentina bought every supplied dollar and gave one peso in exchange and it also sold every demanded dollar at the price of one peso. This was decided to end once and for all with the hyperinflation episodes that happened in 1988, 1989 and 1991. The cost was to resign to the possibility of doing monetary policy.

At first, the “Convertibility plan” seemed to be working. Since 1993, the country had grown very fast due to the raise in the private consumption. But, although the economy was growing fast, the job market was paralyzed. Local companies didn´t want to hire, because they couldn´t compete with the imports from international companies. In other words, the exchange rate was too low, so the country wasn´t competitive. In this situation, the natural solution is to devaluate the currency. But this was unthinkable in Argentina due to the fear of coming back to a high-inflation situation. Instead, the current account deficit was financed with external public and private debt.

So, between 1993 and 2001, Argentina got used to live in a dollarized economy. This means that it was the same to do the contracts in pesos or dollars. What is more, it was not the same. Everyone preferred to do it in dollars, because it was a more trusted currency.

The country grew at a good rate until 1998. During the second semester of this year, the economy stopped growing. The debt accumulated by the public sector, as well as the private, was very high and the creditors stated doubting about the capacity of Argentina to pay. So they stopped lending and the country couldn´t finance its current account deficit any more. If one country can´t do that, the natural solution is, again, to devaluate the currency. But the government and the people wasn´t ready to do so. The alternative was to reduce the imports. But this foreign goods and services were fundamental for the national production, given that they were mainly capital and intermediate goods. Thus, if the country could not import, it could not produce either. The unemployment started rising, the consumption falling and the economy decreasing every year faster. If the economy does not growth, the tax collection deteriorates. And, if so, the debt is very hard to pay.

The deterioration of the economy reached an unimaginable level. The unemployment rate reached 25%, the poverty rate more than 50% and the GDP reduced 25% in the four years the recession lasted. In this dramatic social situation, and in the middle of the biggest social claim ever, the government declined. Its successors finally decided to devaluate and to stop paying the public debt.

After all this, Argentina started recovering. First the GDP, then the employment and then some part of the debt was restructured. But there is some part of the debt that remains unpaid until now. It is likely that Argentinian new government finally reached an agreement to pay this until now unpaid debt. We´ll see at what cost…

This crisis clearly started as a currency crisis, but then it turned into a debt as well as a banking crisis. It had the common characteristics of a lack of foreign currency (international reserves), an over indebtedness, and a consumption boom (in particular in the housing market, where a bubble was generated). The particular characteristic was that the country had a fixed exchange rate and most of the contracts valuated in dollars. The main risk of this crisis was sovereign risk and, thus, credit risk. The policy makers not only failed to foresee, but they also seemed not to worry about avoiding it. They seemed to accept that the boom would last until the financial markets would finance the country. And when they decided not to do it any more, there was nothing to be done, just to accept the consequences.