Living with extreme inflation is nothing new for Argentines. Although the inflation rate in the country has exceeded 100 percent as a result of the historic rise in inflation. However, this is not the first time that Latin America’s third largest economy is going through such difficult times.
30 years ago the situation was even worse. In 1989, the Consumer Price Index (CPI) rose 3079 percent annually, and the following year saw an increase of 2314 percent. The financial crisis in the country had become serious and the level of poverty had reached extremes.
But five years later, during President Carlos Manam’s second term, the CPI dropped to zero percent.
Artificial exchange rate or convertibility policy
In the early 1990s, inflation in Argentina was out of control. To deal with this, President Manam’s Economy Minister Domingo Cavallo introduced the artificial exchange rate or convertibility law in financial reforms.
After approval by parliament in April 1991, the Argentine peso was pegged to the US dollar under this law. That is, the value of the local currency was artificially increased.
To make this convertibility possible, the Central Bank took steps to strengthen the peso for every US dollar circulating in the economy.
Soon, Argentina controlled inflation and the economy stabilized. For a long time the prices of goods remained unchanged.
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According to economist Eduardo Levy, this stabilized the country to some extent. Investments started coming in and production increased. But the loss was not fully controlled.
Levy points out that Argentina’s economic policy benefited from the Brady Plan. In which US commercial banks signed new loan agreements with Argentina, Brazil, Ecuador, Mexico and Venezuela to end the crisis.
Argentina’s Minister Cavallo opened up trade, privatized state-owned enterprises and increased the circulation of the dollar, which benefited the economy.
It should be noted that in the early 1990s, many Latin American countries were trying to stabilize their economies after the debt crisis of the 1980s. It was one of the worst crises in the region. Which had greatly increased the level of poverty. That is why it is also called the ‘lost decade’.
However, according to economist Marina de Pogueto, Argentina was the only country in Latin America that artificially controlled its exchange rate to avoid chaos.
He has said that this is the reason why this policy proved to be a failure, which led to the greatest economic, political and social collapse in Argentina’s history.
Why did this policy fail?
“Our economy was closed, facing severe inflation and austerity,” says de Poguito. After this policy, our economy opened up, which brought down the level of inflation, but in 1996, problems started to emerge.
When the convertibility model was adopted to closely monitor the exchange rate, initially it was beneficial, but gradually its negative effects began to emerge. According to economists, the move hurt Argentina because the dollar was a strong trade currency, making foreign payments difficult, while the value of exports fell.
“The increase in interest rates in the United States strengthened the dollar and led to a crisis in developing countries such as Argentina,” De Poguito said.
At the same time, the crisis faced by the Asian economy spread throughout the world and the value of the Russian currency, the ruble, fell rapidly, which had negative effects on the economic system of Argentina.
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In 1999, due to financial instability and balance of payments deterioration, Brazil devalued its currency, the real, against the US dollar. This caused Argentina’s exports to Brazil to fall. This affected several industries including automobiles, textiles, dairy and footwear.
“The devaluation of the riyal in 1999 proved to be the death certificate for the currency convertibility policy,” says de Poguito.
Argentina should have devalued its currency the same year Brazil did. However, the strict government of Argentina could not do this.
From 1999 to 2002, the financial crisis deepened. Argentina faced a severe crisis with rising unemployment (three out of every 10 people were unemployed).
Freeze funds in commercial banks
During 2001, demand for US dollars increased, but Argentina did not have the capacity to control its production. Argentina was dependent on external financing to deal with the devaluation of the peso and inflation, and 97 percent of its debt was denominated in foreign dollars.
Many Argentine citizens had lost faith in the economic system, so they started sending their dollars to other foreign accounts, including neighboring Uruguay.
With central bank reserves falling, Fernando de la Rua’s government sought help from the IMF and began negotiations for a loan. A few months later, the IMF stopped credit transfers, putting pressure on banks.
In this context, on December 3, de la Rua, on Cavallo’s suggestion, issued an order aimed at stopping the transfer of dollars from the country.
Under this, withdrawal of money from banks was banned and trade stopped. People protested and demanded their money back.
The following story is well known: protests and looting. President de la Rua resigned and left in a helicopter. Thus a political and institutional crisis arose.
At the beginning of 2002, the difference between the values of the dollar and the peso became clear. The devaluation of the peso increased poverty and affected two-thirds of Argentine citizens.
The country became bankrupt due to foreign debts. It was the largest bankruptcy in history: $144 billion.
Can Argentina’s model be implemented today?
Given the sudden demise of the convertible currency model in the past, it is difficult to see whether it can be re-implemented in Argentina’s current crisis.
Some are calling for a reversal of his policy.
Economist Yavir Meli, who wants to become the country’s president, has said that the artificial exchange rate policy was successful in keeping macroeconomic variables (inflation, fiscal policy, employment, national income and international trade) under control. brought and the same path should be adopted in future also.
He said that the policy of convertibility was adopted on April 1, 1999. Till January 1993 our country had the lowest inflation in the world. I propose reforms in the monetary system and free currency competition. Argentinians will probably choose the dollar and earn you an income in dollars.
But most economists have not called it a good way.
Artificial exchange rates are not the solution to all problems, de Poguito says. According to him, inflation remains uncontrollable if financial accounts and prices are not corrected. You need a financial stability program.’
Asked what is the best exchange rate policy, he said artificially fixing it fails because it has negative effects in the long run.
According to Levy, an artificial exchange rate is only possible if a country already has world reserves. For example, in the 90s, Argentina’s central bank and commercial banks held large amounts of dollars. “If there is a crisis like Credit Suisse today, there is no way to stop the chaos, except for the government and the banks to accumulate reserves.”
According to Levy, stability requires fiscal balance and reforms, and artificial exchange rates are no substitute for them. “To think of it as a shortcut to stability today would be foolish in my opinion.”