Argentina has a new president: Nestor Kirchner has succeeded Edurado Duhalde. The BBC says

President Kirchner has promised to defend domestic jobs and industry after more than a decade of unbridled free market policies.

Well this to me sounds like a recipe for disaster: crude protectionism and nationalism stink of early 20th century Latin American economics - precisely the sort of economics that got Argentina into this mess.

Any thoughts on the crisis or this, msg me and I'll post your views at the bottom of this node.

The Argentine Economic Crisis

Long as it is, I assure you the below is not a c&p. I'm really surprised at the lack of nodes on economic events that have shaped out world in the last few decades. Hope you learn something from this, and will follow Argentina situation more carefully.

It may be a little inaccurate to talk about the `Argentine Economic Crisis' when the crisis was (and still is) a general period of economic instability. In fact, Argentina seems to follow an economic version of Sod's Law - everything that could have gone wrong, did. I mean it couldn't get any worse. Oh, wait. Every day open the newspaper and you'll read about some farcical situation where the IMF has lent Argentina $X billion (where X is a very large number) just so Argentina can pay off another loan from the IMF that is still outstanding.

What caused all this? I don't want to get bogged down in fatalism, saying, "Oh, it's clear that Argentina was doomed from the 1880s when this happened" but it's important to show Argentina's development, if only to show how a seemingly healthy economy in good shape can collapse, and particularly how this can happen several times within a short period of time. Contrary to popular belief, history seems to teach us very little, and if it does, we pretty much ignore it.

The Beginning

What the hell happened? Well, the first problem hit in the 1930s - the Great Depression and the general world economic slowdown in the 1930s hit Argentina. Unemployment and recession began to creep up on the country, and it had brief on-off periods of military rule. Crucially, however, in 1942 Argentina (and a few other countries) refused to break diplomatic ties with Japan for Pearl Harbor and the country was isolated by the world. In 1943 a military regime (including the then insignificant Colonel Juan Peron) took over the country, and adopted inward looking, protectionist policies that one could claim really set the stage for the crises.

A country whose economy is based on exports cannot become protectionist.

Argentina was thrown off the world stage, and internal conflict built up . Peron bizarrely put his wife Eva Peron (she of `Evita' fame) in charge of labour relations, and in 1949 showed the world just how a military ruler can fuck up a perfectly good country - Mugabe and Hussein, take note. A brand-spanking new constitution strengthened the power of the president, and Congress passed legislation that allowed the courts to jail people for disrespect for the government. The Free Press became a thing of the past, and political opponents of Peron just vanished.

Gandhi once said, "When I despair, I remember that all through history the way of truth and love has always won. There have been tyrants and murderers and for a time they seem invincible but in the end, they always fall - think of it, always."

Oh, crap.

In 1955, coups throughout the armed forces culminated in Peron's exile in first Paraguay, then Spain. The Federal Constitution of 1853 (based on America's) was restored, but in 1966 yet another military coup led to General Juan Carlos Ongania taking over. In 1973, however, the Peronist party won elections and later, Peron becomes president again. Argentines just don't seem to learn. The country during this time was wracked with violence, and the economic problems began to arrive by the bucketful. Inflation hit 300% in 1975, and a year before that Peron died. Inside Argentina the social problems, however, still outweighed the economic ones - there were numerous strikes and demonstrations, with political unrest reaching an all-time high. In 1976, another military junta seizes power and the `Dirty War' begins, where thousands of opponents of the regime disappear mysteriously.

Deficit spending increased to stupid levels and in ridiculously complicated foreign exchange regulations prevented enterprise and fostered corruption, which proves to be one of Argentina's real flaws. Then, in 1981, a total psychopath, General Leopold Galtieri, takes over the country and in 1982 begins the Falklands War. This isn't exactly relevant to the crisis, so I'll skip over it, but the economic problems were intensified during this period with inflation hitting jaw-dropping levels (900% in 1983). In 1983 civilian rule returns, and the new president, tries, and fails to introduce a new currency (the Austral).

Around this time it becomes clear something went terribly, terribly wrong. In 1989, inflation hits a totally astounding, unbelievable 3000% - think of the consequences.

• Prices in the evening are far higher than they were in the morning. How the hell do you work out the price of, say, a coffee in real terms? Do the maths in your head? Carry around a calculator?
• Investment plummeted: business can't forecast growth or predict any sort of numbers, so they respond by just stopping investment. This has a serious, long-term effect ton the structure of the economy with the all-important export sector getting a real bruising.
• Menu costs: imagine the prices in having to change price boards every single day!
• Many other damaging effects - Argentina lost all competitiveness with other countries and so its export industry, upon which the economy was built, was well and truly fucked. The situation was alleviated a little, because at least then, the peso could devalue. Not so later on.

Recovery? Well...

1989 was a turning point for Argentina.

Carlos Menem of the Peronist party is elected president, and he follows Mexico's example, appointing Harvard and MIT educated economists to his cabinet. A particularly significant appointment is Domingo Cavallo, who is appointed Finance Minister. He, like Mexico's Pedro Aspe, has a PhD from Harvard, and likes unorthodox policies. Crazy policies, some might say.

At this point maybe it's interesting to note that he was last year arrested and charged with arms smuggling and fraud.

Along with Menem, he imposed a brutal `economic austerity' program consisting of economic and structural reform:

• He tried to cut red tape, encouraging enterprise (still a big problem in Eastern Europe). This was pretty tough when you consider that corruption had been a way of life for much of Argentina's history.
• He liberalised trade (possible going against his Peronist ideals) by lowering tariffs and entering Argentina into MERCOSUR, a Latin American group of trading countries. This was actually a good move, because if you remember the inflation had really damaged Argentina's competitiveness. In fact, this removal of inward looking policies was a great move, and he deserves credit for that - for a long time, Argentina's military governments had isolated Argentina. Pre-war Argentina had flourished precisely because of its exports, and so Menem hoped for some sort of renaissance in trade.
• As The Economist says, "just about anything that moves ... is in private hands." This revolutionised Argentina's economy and structure, but still had little effect on inflation because investors were still scared off by the huge budget deficit Argentina was running.

Encarta puts it like this: "During the early 1990s, his government curbed inflation, balanced the budget, sold off state enterprises to private investors, and rescheduled the nation's debts to commercial banks. In 1992 full diplomatic relations with Britain were restored, helping to heal the wounds of the Falklands War." Look at that first bit: "curbed inflation." That is very significant. How on earth an a country that is running inflation at 3000% just bring it down to almost 0%? How?

In 1991 came the big shock...

The Currency Board (or `How to mess up a country's economy because of sheer stupidity and factors way beyond your control')

In 1991, Domingo Cavallo came up with a strange idea to curb inflation: a currency board. "What the hell is a currency board?" I hear you ask. Well, I'm not entirely sure, but here's the gist of it: Argentina decided to peg the Peso to the Dollar

• That's right: they just said $1 = 1 Peso
• And for every single Peso in circulation, there had to be a Dollar in reserves.
• the Argentine central bank (the equivalent to the Federal Reserve) basically couldn't print any Pesos in excess of the foreign reserves that backed them.

This was brilliant in bringing down inflation, which plummeted down to almost 0%. Why? Investor confidence rose, and people began to save more and more. Other than that, I don't really understand the transmission mechanism - that is, how exactly the peg bought down inflation. But it did.

GDP increased an average of 8.2% between 1991 and 1994.

Foreign investment poured in.

Stability returned.

But something was wrong...

The pegged currency had very serious implications: Argentina had effectively ceded control of monetary policy. Say growth in Britain is running too high and inflationary pressures are building up. The Bank of England can just raise interest rates and slow spending. Argentina couldn't.

Low inflation? Want to lower interest rates? Well too bad, you can't! Want to stimulate growth by raising the money supply? Hey, guess what, you can't! Basically, you're screwed, Mr. Cavallo!

Maybe Argentina could have survived the aforementioned problems, but I feel that their own stupidity didn't actually trigger the crisis - it was someone else's.

More problems - Latin American meltdown and the "Tequila Crisis"

Unfortunately, Menem and Cavallo had to learn the hard way that we live in a global economy. In 1994, the media began to talk about the Mexican miracle. The thing is, in 1993, more than $20 billion in foreign capital had been invested in Mexico, and they were running a huge deficit on their current account (not necessarily a bad thing at all, I should say).

In 1985, then president Miguel de la Madrid adopted the "Washington Consensus," where he renounced the inward looking protectionist economies (USA 2003 anyone?) that Latin American military governments had embraced and went for balanced budgets, low and stable inflation as well as free trade.

Madrid surrounded himself with MIT and Harvard trained economists; the cream of the crop.

But there was no growth! No real growth underneath all of that hype. The economic growth was 2.8%, which was barely ahead of population growth yet no one raised any objections.

Then came the "tequila crisis"

Mexican deficit spending had reached 8% of GDP, and crucially, the (Mexican) Peso was way too strong and this priced Mexico out of world export markets.

The tequila crisis is a whole new story, so I'll cut to the chase: Mexico needed a devaluation of the Peso. It had one. It fucked it up. The devaluation wasn't big enough, and the government didn't seem certain itself, so how were investors meant to be happy? They weren't, and they fled the country with their money and investment.>/b> This, along with speculators' actions, made the Peso fall and fall and fall until it was worthless. To make things worse, Argentina had converted short-term loans to Dollar-indexed `tesobonos' whose value exploded. Businesses went bankrupt, unemployment exploded, and in 1995 real GDP plummeted 7.5%. Its industrial production fell 15%.

The uncertainty spread all over Latin America, and even though they are different countries all together, investors would beg to differ. Argentina's credit began to contract. So now we have 2 problems:

• Firstly, everyone began to get out of the peso (Argentine and Mexican). In Mexico, that caused further devaluation weakening the currency. In Argentina, it couldn't cause a devaluation - remember? $1 = 1 Peso, whether you like it or not.
• So, the second problem is that Mexico's exports became cheaper - think how low the Peso fell. It just kept falling until $1 would get loads of Pesos. In Argentina, $1 would only get you 1 Peso. That's it. So everyone bought from Mexico and other countries, and Argentina's export market took another hammering.
• Bank runs also began with people demanding to take money out and convert it to Dollars, and this was eerily similar to the Great Depression - Dollars flowed out the country, but the Peso just didn't fall in value.

Quoting a BBC News article, "Argentina was left dancing disco when the tango would have been wholly more appropriate."

But it survived. Somehow. Mexico was famously bailed out by the Clinton administration in a brave move that led to around $50 billion being lent to the country. Argentina too was bailed out, but it still had these huge structural problems - notably the currency board which resulted in macroeconomic inflexibility and an inability to actually respond to changing market conditions.

If anyone in Argentina had any sense they would have devalued the Peso and done it properly. But they didn't.

So, what's happening in Argentina meanwhile? Carlos Menem is re-elected in 1995, and Cavallo was dismissed in 1996. Although we still have a recession (that leads to general strikes) investors in both Mexico and Argentina calm down. Interest rates fell, and a recovery is underway. Money started coming back in the country, and The Economist states that Argentina led an "export-and investment led recovery."

Recovery? No, false alarm.

The Asian currency crisis (see the node Asian Financial Crisis) began in 1997, when the Baht's value plummeted, and this hit world prices of exports.

Yet the real problem (I know I've said that so many times) came in 1999, when Brazil's currency, the real, was devalued. Its value plunged, leaving Argentine exports far more expensive than that of their neighbours. What should have happened? Well, any decent economics textbook says that if a neighbour's competitiveness increases, yours drops. True. The, the demand curve for your currency shifts inwards, and thus the equilibrium exchange rate falls, making your currency cheaper and thus making your exports relatively cheaper. This increases your competitiveness, so the situation is sorted. This of course couldn't happen. The peso was still pegged to the Dollar.

What's more, world prices of commodities tumbled, meaning that Argentina's "export led recovery" was over.

The Brazilian currency's (the `real' - that's the name of the currency) devaluation led to a full-blown recession, with GDP plummeting (notice how often I've used that word?).

Earlier, during more stable times, Menem had also taken out massive loans to encourage stable growth. These, however, led to higher domestic interest rates and costs rose. The botched privatisations also led to higher utility prices (as I've mentioned) which no one could pay for. Credit became more and more expensive and many businesses went bankrupt. Ladies and gentlemen, we give you an economic crisis. So, as exports fall, Argentina has more and more trouble paying off the debts (in dollars, don't forget - that'll be significant later) because they can't get foreign currency.

GDP falls 30%, incomes fall and so tax revenues fall. The budget deficit increases.

In 1999 Fernando de La Rua was elected and he inherited a $114 billion deficit. This is bad, in case you haven't realised. The IMF refused completely to bail out the country, although between 1999 and 2000, it actually gave Argentina tonnes of cash (not literally) in exchange for reforms, like fiscal restructuring. The foot-and-mouth disease outbreak lowers beef export prices further, and Soya exports suffer because of worries about GM crops. The situation for Argentina's exports couldn't get any worse. But it did. The Dollar also began appreciating, and so, so did the Peso (as they were linked - do I have to remind you?).

In 2001, however, all hell breaks lose and de La Rua's cabinet starts resigning. There are general strikes all over Argentina, because of the general level of poverty, and in March 2001 Domingo Cavallo (yep, him again) was reinstated as Finance Minister. Along with his president, he announced spending cuts and tax hikes as well as sweeping reform. He slashed pensions 13% and cut state salaries aggravating the already high levels of poverty.

In December 2001, Cavallo announced restrictions that tried to stop people taking money out of banks. On the 13th December, Argentina came to a stop, as this prompted another general strike. The problem is, Between July and November, Argentines withdrew $15 billion from the banks - Cavallo, in response to this, imposed a ceiling of $1,000 a month on bank withdrawals. "That was a deadly blow to the informal service economy, which functions on cash. Three weeks later, a coalition of pot-banging savers, and looters from the underclass ... took to the streets," says The Economist. On the 20th, de La Rua resigns after 25 people die during rioting outside banks and on the street. This was probably about time - again, quoting The Economist, as I can't put it better myself: "Mr de la Rua's Alliance government was weak and indecisive." What else was going wrong? Well, Domingo Cavallo was wreaking havoc with investors' confidence, publicly considering linking the Peso to first to HALF of the Dollar, then the Euro and this just scared everyone. This, while maybe a decent idea, shouldn't have been discussed in public - it raised the absolutely horrific idea of devaluation. Foreign investment slowed further, interest rates rose further, the recession became worse. Cavallo also resigned (just before de La Rua).

I think at this point, Argentina went through 5 presidents in 2 weeks or something like that. I'm really not sure of the numbers, but it was something crazy. Basically, In January Eduardo Duhalde, the current president, took over and after a few days it happened.

Devaluation. The nightmare scenario.

Consider this: Argentina's revenue (tax, for example) is in Pesos. Their liabilities (billions of Dollars worth of IMF loans) are in Dollars. This is fine while $1 = 1 Peso. It most certainly is not fine if $1 = lots of Pesos, because the value of their debt has exploded.

Devaluation was hard to stomach. But Duhalde, who had the guts for such a decision, did it, and it resulted in chaos. The Peso fell over 70% against the Dollar, providing a massive boost for the export market in Argentina. Yet many, many businesses went bankrupt, as their income was in Pesos yet debts in Dollars. Do the math or see my node on devaluation. Either way, you can see the consequences of lowering the value of a currency.

What then happened is Argentina just could not pay back its loans to the IMF, which were huge, and that leaves in the current situation. In November 2002 it defaulted on an - get this - $800 billion debt repayment, and it is considered to be in default, which damages its chances of getting more funds. This is the third largest sovereign debt in history.

A BBC News quote reads, "To paraphrase the old adage, if you owe the bank $1000 it's your problem, but if you owe it $140 billion, it's the banks."

So, what now? Well, the IMF is doing all sorts of things with Argentina. What I find amusing is how it's lending Argentina money so Argentina can pay back its old loans from the IMF, which are still outstanding. It needs money and lots of it. It also needs foreign currency to pay back the loans. Ironically, in the near future, this will need to come from loans. They need solid growth to get out of 1999s recession, and they need to get their export markets booming again.

Diane Coyle summed it up in her most recent book, calling Argentina a "macroeconomic basket-case." I'm not a professional economist, and I'm aware that with hindsight it's easy to look back and claim particular decisions were silly. But the important thing is that people, especially emerging market countries, learn from these mistakes which they didn't learn from after the 1995 Tequila Crisis. They need to realise that if you're going to have a currency board, then you can't run incompatible fiscal policies like taking out large loans.

President Nestor Kirchner was elected into office in May 2003 after an election battle with Carlos Menem - how Mr. Menem had the nerve to run again I will never know.

We can only wait and see how Kirchner manages, but I wish him luck. He'll need it.

Some Current Information:

The currency is at Pesos 3.28:US$1 as of January 30th 2003 the 2002 average was Pesos 3.06:US$1. As you can see, it really has fallen - a debt in Dollars is now three times higher as it was when USD1$= 1 Peso so it takes three times as many Pesos to pay it off.

The GDP is at Pesos 267bn as of 2001 (I'm having trouble obtaining current figures) and this equates to US$267bn at the 2001 market exchange rate, but a whopping US$382bn according to 2001 PPP figures. PPP stands for Purchasing Power Parity, and it kinda measures the real value of a currency. GDP growth was 0.8% p.a. between 1997-2001 (an average figure) and GDP per head is US$7,116 at the market exchange rate and US$10,202 at the 1002 PPP rate. Inflation is a pretty high 4.7% p.a. (this is a 1998-2002 average, so it's inaccurate, though).