Argentina errors key to its woes

Political, economic crises are linked to interrelated mistakes - starting with government failure to implement needed free market reforms in 1990s

January 06, 2002|By Steve H. Hanke | Steve H. Hanke,SPECIAL TO THE SUN

WITH five presidents in the span of two weeks, Argentina is mired in a deep political crisis. And since 1999, it also has been in the grip of a downward economic spiral.

The chattering classes lay most of the blame at the feet of Argentina's currency regime. To rid the country of hyperinflation and give it a confidence shock, President Carlos Menem's government installed a convertibility system April 1, 1991. The Convertibility Law fixed the peso's exchange rate at 1-to-1 with the U.S. dollar and required the peso to be fully backed with dollar reserves. Under convertibility, the owner of a peso had a property right in a dollar and could exercise that right by converting a peso into a dollar.

The pundits say that by linking the peso to the strong dollar, convertibility has rendered Argentina uncompetitive. This, they say, is at the heart of Argentina's economic crisis. Consequently, a peso devaluation and a floating exchange rate are necessary. As an editorial Friday in The New York Times put it: "A devaluation, though politically difficult, is needed to make the country's exports more competitive."

The claims about Argentina's lack of competitiveness are nonsense. A classic sign of uncompetitiveness caused by an overvalued currency is declining exports. But, Argentina's exports have increased every year for the past decade except 1999, when Brazil, its largest trading partner, suffered a currency crisis. Exports during the first 10 months of last year were about 4 percent higher than the same period in 2000.

The export sector has been one of the few bright spots in the economy. If the rest of the economy had been growing as fast as exports in the last two years, Argentina would not be in a recession, and the government would not be bankrupt.

Like the assertions about uncompetitiveness, the idea of floating the Argentine peso suffers from a disregard for economic realities.

The history of independent monetary policy and a floating exchange rate in Argentina is not just bad; it is one of the worst in the world. Inflation was never below 90 percent a year from 1975 until the convertibility system was established. From the time the central bank was established in 1935 until the convertibility system began in 1991, the peso depreciated against the dollar by a factor of 3 trillion.

If devaluation and floating were the elixirs for Argentina, it would have long ago been one of the most booming economies in the world.

But, if not the convertibility system and the peso, then what? Argentina's acute political and economic crises have resulted from an interrelated set of self-inflicted blunders.

In the 1990s, Argentina failed to carry out comprehensive free market reforms. Contrary to claims by Eduardo Duhalde, Argentina's new president, the neo-liberal economic model was never implemented, or if it was, it was half-baked. The fiscal system is a mess, and tax rates are sky-high. More than half of the working-age population in many provinces is employed by the government. The Mussolini-style labor laws and the public health care and social security systems remain unreformed and in need of modernization.

In 1999, Menem failed to replace the peso with the dollar as he promised. This has left the peso vulnerable to meddling by Argentine politicians.

In 1999, Argentina's voters elected a weak left-wing government. It was led by President Fernando de la Rua. Although a decent man, he remained distant and removed from the economic realities and tone-deaf to politics.

In 2000 and last year, the de la Rua government introduced three tax increase packages on the recommendation of the International Monetary Fund. These pushed the top tax rates to much higher than those in the United States. Not surprisingly, the tax-increase packages forced the economy to slow rapidly and tax revenues collapsed. As a result, Argentina was unable to service its debt.

In March of last year, Domingo Cavallo was appointed minister of the economy. Cavallo's economic principles were subject to constant change. This fact, combined with his hyperactivity, was a deadly cocktail.

On April 25, de la Rua replaced the president of the central bank, Pedro Pou, with Roque Maccarone, a Cavallo man who was inclined toward meddling with the rules governing the peso-dollar exchange rate.

On June 19, Argentina introduced a multiple exchange-rate system. Under this setup, exports (excluding oil) take place with a devalued peso; imports with a revalued peso. All other transactions take place at a peso-dollar rate of 1-to-1. This was the beginning of the end because Argentina abandoned the convertibility rules. External drains of Argentina's foreign reserves accelerated.

On June 25, a law was put into effect in which the peso's anchor would switch from the dollar to a basket of 50 percent euros and 50 percent dollars once the euro reached parity with the dollar. This constituted another breach of the Convertibility Law and gave rise to further external drains of foreign reserves.

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