Introduction
In the 20th century, Argentina was one of the world’s richest economies but it is now counted as a third world country having about 25% of the world’s debts owed by third world countries. The recent Argentine economic crisis was experienced between 1999 and 2002 causing the slump of Argentina’s economy. This crisis also affected other countries like Paraguay and Uruguay which suffered economic recession as a result. Brazil is the biggest trading partner for Argentina suffered most and its economic growth slowed down. The Argentinian economic crisis resulted from the currency and financial crisis which started in late 1998.
The economic growth declined by 28% between 1998 and 2002. Economists argue that the main cause of the crisis was the failure of the fixed exchange rate regime and free markets that caused the country to sink into chronic economic problems1. There were also bad economic policies undertaken by the government which made the crisis become a chronic depression that lasted for four years. The government defaulted on foreign debts and broke the link of its currency with the dollar. They converted dollar deposits into Pesos at exchange rates that were not favorable to the economy. This essay discusses the causes and the events that led to the economic crisis in Argentina.
The causes and events leading up to the economic crisis in Argentina
The Argentina currency and financial crisis were the most recent to happen in a developing country following Mexico’s crisis that occurred between 1994 and 1995. The Argentinian crisis describes the dangers associated with free-market economic policies. The crisis is also attributed to fixed exchange rates that failed to work in Argentina.
The crisis is believed to have roots in Argentina’s long history of economic downturns that are associated with monetary and political problems. There was political unrest in the country after it gained independence in 1810 from Spain. The country’s provinces were fighting among themselves and this brought a split among various groups in the country. The first stable government was established in 1862 a big economic mistake of persistently financing budget deficit through minting money4.
As a result, the country suffered inflation for a long time. The country experienced economic growth from the 1800s but it suffered a financial crisis in 1890-01. This crisis was owing to the 1889 budgetary problems of the federal government where domestic debts were financed using national currency instead of gold. This caused a lot of investments to fly out of the country4. Most of the banks also collapsed and the currency depreciated against other currencies.
The rate of inflation increased and the government defaulted on foreign debts thus creating a bad relationship with other countries. The president of Argentina resigned as a result. The problem was fixed and the country enjoyed renewed growth for 20 years until 1914. The country had by that time established a gold standard and currency board system but these were later abandoned following the disruption of financial markets by World War 1 in 1914.
The other argentine crisis occurred between 1998 and 2002 which is also connected to the past economic problems. This was the deepest crisis that Argentina has ever experienced. The crisis started when Fernando De la Rúa became president in 1999. He came with policies of reducing the federal budget deficit through increasing taxes. The deficit was about 2.5% of the gross domestic product by the end of 1999.
The increase of tax policy became effective in January 2000 and this encouraged tax evasion. As a result, the economy continued to decline in growth in 2000. The minister of the economy resigned due to political pressures and his successor proposed a reduction in government spending to strengthen the financial position of the government. He was then sacked on the allegation that his policies were faulty.
His successor Domingo Cavallo, proposed a change in the currency convertibility system in 2001. The Peso was proposed to be exchanged on a 50-50 basis for dollar and euro. The investors who were complaining that Peso was too strong liked the proposal as they thought it will lead to the devaluation of the Peso. The new convertibility system caused short-term interest rates to rise and there was also a bank run although it was not pronounced.
The government-financed debts at a higher cost due to the rise in interest rates. The government started debt swaps where it borrowed from local institutions to ease the burden of high-interest rates on foreign debts2. The government also borrowed a $22 billion loan from international monetary funds (IMF) towards the end of 2001 and the loan was to be disbursed in installments. By that time, the economy was in severe debts problems and IMF loan was thought to delay economic growth policies.
In November 2001, there was an excessive withdrawal of bank deposits that caused bank deposit freezes in December 2001. The already receding economy became depressed as business entities were unable to pay their debts1. Most of the credit evaporated and lenders suffered a huge loss.
The freeze was the same as the one suffered in 1989 and another one that was caused by Cavallo in 1982. This made people protest against Cavallo. Argentina was unable to fulfill the loan agreement made with IMF and this caused IMF to announce that it will not release the remaining disbursements.
This situation made it hard for Argentina to get a loan from any other foreign source.
Cavallo, the minister of the economy, and president De la Rua resigned on December 19th and 20th 2001 respectively. Adolfo Rodríguez Saá took over power as president and on December 23rd, 2001, he proposed to the government to default $50 billion debt due to foreign lenders but he later resigned after his policy was protested against3.
Argentina’s congress chose Eduardo Duhalde to take over as president following the resignation of Adolfo Rodríguez Saá’s. Duhalde came up with policies to help contain the economic situation in the country. He proposed a reversal of the policies that were made by his predecessors. He argued that the convertibility system was the one responsible for the recession. The president made some reforms under the law that governs the exchange rate regime. First, the convertibility system was abolished and the Peso was devalued by 40 percent. “Pesofication” effected earlier was also reversed at 1.4 exchange rate for bank deposits and 1 Peso per dollar for the loans to prevent the borrowers2. The free exchange rate was also abolished and exchange rate controls were enacted to prevent further crisis3…
The 2002 chronic argentine crisis was due to the new policies adopted by Duhalde. It was characterized by a further decline in economic growth to 10% in 2002 compared to 5.5% in 2001. The rate of unemployment also increased to 23.6% in 2002 because many companies continued to make losses during the year. Foreign and local banks and also many utility companies suffered huge losses due to the reversal of the Pesofication policy.
Conclusion
The major cause of the Argentinian economic crisis was political turmoil and the adoption of fiscal policies that are not appropriate for the economy. The continuous change of government and ministers of the economy has contributed a lot to the emergence of the crisis. Each minister comes with policies that contradict those of his predecessor.
Reference List
Calomiris, C, & A, Powell, the Argentine Financial System under The Currency Board. Mimeo, Columbia University, 2001.
Eichengreen, B, Financial Crises and What to Do about Them, New York: Oxford University Press, 2002.
Tonelson A, The real root of argentine financial crisis. New York: united States business & industry council, 2002. Web.
World Bank, Argentina: From Insolvency to Growth, Washington: World Bank, 1993.