By Steven Pearlstein
Washington PostDecember 21, 2001
Often when a country's finances collapse, people remark that they never saw it coming, that it happened so fast. Not so with Argentina.
For the past two years, many of the world's top economists have said that Argentina was caught in a vicious downward spiral that would lead to political unrest and economic collapse.
Argentina's big mistake, it is now clear, was hanging on too long to a currency regime that tied the value of the Argentine peso to the U.S. dollar. For eight years the system worked wonders to help Argentina tame its notorious hyperinflation. But in the past three years, the peg to the rising U.S. dollar made Argentine products too expensive on world markets, throwing the country into recession.
For a while, the government, companies and households were able to shield themselves from some of the consequences of a shrinking economy by borrowing increasing amounts of money from its own banks and pension funds, from foreigners and eventually from the International Monetary Fund -- to sustain a middle-class lifestyle that had become the envy of the rest of Latin America.
When the economy did not turn around, lenders became more cautious and demanded ever-rising interest rates. The higher rates drained even more money from the economy, causing still more unemployment and slower growth.
The way countries normally deal with such crises is to devalue their currencies, usually by printing more money to cover their debts. For Argentina, however, the peg to the dollar had become politically and economically sacrosanct. For all intents and purposes, the Argentine economy had been dollarized. Much of the debts of governments and businesses and households were in dollars, as were much of household savings. To devalue the currency would throw much of the economy into bankruptcy and reignite inflation.
Over the past few months, Domingo Cavallo, the economy minister, launched a last, desperate effort to avoid official devaluation and default by putting through what amounted to an unofficial bankruptcy. Government workers and pensioners were required to take cuts in pay and benefits of more than 10 percent, while banks and pension funds that held government bonds were required to exchange them for new bonds paying lower interest rates. Strict limits were placed on how much money Argentines could take out of their bank accounts each week. The Argentine peso began trading unofficially at a 30 percent, 40 percent, then 50 percent discount against the dollar.
By the end of last week, Cavallo was at the end of his string. On Dec. 5, the International Monetary Fund, which had lent $18 billion to Argentina since 1999, declared that it was turning off the spigot. The official reason given by the fund was that the coalition government of President Fernando de la Rua had been unable to push through budget cuts it had promised over the summer as a condition for another IMF loan. But the fund's chief economist, Kenneth Rogoff, probably got closer to the truth when he acknowledged last week that "the mix of fiscal policy, debt and the exchange rate regime" had simply become unsustainable.
In effect, the IMF and its leading member, the United States, concluded that without a dramatic change in policy, lending more money to Argentina would be throwing good money after bad.
In response to angry criticism from Argentines, spokesmen for the IMF and the Treasury Department yesterday expressed concern about developments in Argentina and rejected charges that they were to blame for the collapse.
"We will continue to be supportive of Argentinians as they take the difficult steps they determine are necessary to address the problems they face," said Anthony Fratto, a Treasury Department spokesman. Fratto said officials from the Treasury, State and other departments met at the White House yesterday to discuss Argentina.
The IMF said it would work with any new Argentine government to develop an acceptable economic program that could trigger release of $10 billion more in previously approved loans.
Most economists expect that Argentina will now do what it probably should have done, in some fashion, a year ago.
The peso will inevitably be devalued, either by being pegged to the dollar at a lower exchange rate or by floating freely, as most other currencies do.
Foreign banks and bondholders will be forced to accept lower rates and longer repayment terms on the $135 billion in loans they hold. Major U.S. banks had already signaled their willingness to accept such a "haircut." In anticipation, Argentine bonds are already trading at 20 to 35 cents on the dollar on world markets, according to J.P. Morgan Chase.
Meanwhile, to avoid widespread corporate bankruptcy and the collapse of the banking system, dollar-denominated debts within Argentina will be reduced in line with the devaluation, along with dollar deposits in Argentina banks. Some temporary controls on moving money out of the country are also likely to be imposed.
Taken together, these measures are almost certain to cause widespread economic dislocation and pain and force nearly all Argentines to accept lower incomes and lower values for the assets. For a time, the country will find it harder and more expensive to borrow money. Government budgets and services will have to be cut even more than they already have been.
The collapse of Argentina is raising serious concerns about governments that set rigid currency pegs or borrow large sums of money in currencies such as the dollar. It has also raised anew criticism that the IMF demands too much fiscal austerity from developing countries when such budget-cutting deepens recessions and leads to political instability.
This week's development will give ammunition to critics of U.S.-style capitalism who question whether privatization, open markets and unfettered foreign investment are the best policies.
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