Argentine Peso Currency Crisis Team IV Aliya Riddle Andrew Kenna Steve Roszak

Chronology of Major Events April 1, 1991 Congress enacts the Convertibility Law. The law pegs the Argentine peso to the American dollar at a one-to-one ratio. The government can not issue pesos without the backing of foreign reserves The U.S. Dollar experiences a real appreciation. This also causes the Argentine peso to appreciate relative to trading competitors. The peso becomes overvalued. July 1997 East Asian financial crisis begins Financial crisis moves to Russia and then Brazil Brazil devalues their currency, hurting Argentina’s competitiveness in export markets.

Chronology of Major Events 1999 – 2001 Excessive government deficits lead to large debt borrowing. December 7, 2001 Argentina announces that they can no longer guarantee payments on foreign debt. The suspension of payments on $142 billion foreign debt marks the largest default in history. January 6, 2002 Argentina announces the end of the currency peg. The government announces plans to devalue the peso by 29%. January 15, 2002 The peso falls as low as 2.05 to the dollar in active trading. March 17, 2005 Exchange rate of 3.3 Pesos/$

Exchange Rate, What Went Wrong?

Currency Crisis Causes Excessive Government Deficits Too much spending by national and provincial governments was combined with low government revenues. This caused large government deficits. Too much spending by national and provincial governments was combined with low government revenues. This caused large government deficits. Large fiscal budget deficits persisted during the entire 1990’s through Large fiscal budget deficits persisted during the entire 1990’s through 2002.

Excessive Government Spending Instead of reducing government spending, the country attempted to levy taxes against the citizens to solve their problems. Instead of reducing government spending, the country attempted to levy taxes against the citizens to solve their problems. Historically, Argentines paid very little taxes with about 40% not paying any taxes. Thus, increasing taxes was met with high resistance and little success. Historically, Argentines paid very little taxes with about 40% not paying any taxes. Thus, increasing taxes was met with high resistance and little success. In December 1999, new president Fernando de la Rua issued a higher tax which killed a potential economic recovery. In December 1999, new president Fernando de la Rua issued a higher tax which killed a potential economic recovery.

Too much spending by Argentina during this period. Excessive spending made it difficult to meet debt payments.

Debt Borrowing The government financed the deficit through debt borrowing. Argentina relied heavily on international capital flows to finance the large gap in national spending. The government financed the deficit through debt borrowing. Argentina relied heavily on international capital flows to finance the large gap in national spending. Not all the problems were the fault of the Argentina government in the 1990’s, however. Half of the $142 billion in debt had already been assumed in Not all the problems were the fault of the Argentina government in the 1990’s, however. Half of the $142 billion in debt had already been assumed in 1991.

Loss of Export Competitiveness High government deficits and debt would not have been a major problem if the economy had been able to generate capital inflows through trade. But, the economy had very poor export growth and entered a recession in the late 1990’s. High government deficits and debt would not have been a major problem if the economy had been able to generate capital inflows through trade. But, the economy had very poor export growth and entered a recession in the late 1990’s. As the dollar strengthened against other currencies in the 1990’s, Argentina’s exchange rate became overvalued. As the dollar strengthened against other currencies in the 1990’s, Argentina’s exchange rate became overvalued. An overvalued fixed exchange rate eroded Argentina’s export competitiveness. Also, the Brazilian currency devaluation hurt Argentina. Brazil was their main trading competitor, so Brazilian goods were relatively much cheaper. An overvalued fixed exchange rate eroded Argentina’s export competitiveness. Also, the Brazilian currency devaluation hurt Argentina. Brazil was their main trading competitor, so Brazilian goods were relatively much cheaper. Since Argentine exports were too expensive relative to their competitors, the economy exported too little and imported too much. Since Argentine exports were too expensive relative to their competitors, the economy exported too little and imported too much.

Poor Export Performance These factors caused a major trade imbalance and led to large trade deficits. These factors caused a major trade imbalance and led to large trade deficits.

Other Export-Related Factors Low productivity growth kept costs of production high. Low productivity growth kept costs of production high. GDP change from 1995 to 1996 was +5.5% GDP change from 1995 to 1996 was +5.5% GDP change from 1998 to 1999 was –3.4% GDP change from 1998 to 1999 was –3.4% GDP change from 2001 to 2002 was –12% GDP change from 2001 to 2002 was –12% Resistance of unions to lower wages further prevented a fall in production costs. Resistance of unions to lower wages further prevented a fall in production costs.

Additional Causes High unemployment and underemployment levels hurt productivity. High unemployment and underemployment levels hurt productivity. Inconsistency of government policies. Inconsistency of government policies. Institutional and political weaknesses. Corruption often limited the country’s ability to reduce government spending. Institutional and political weaknesses. Corruption often limited the country’s ability to reduce government spending. Declining industrial activity denied the government funds needed to balance the budgets. Declining industrial activity denied the government funds needed to balance the budgets.

Summary The Argentine currency crisis was the result of a variety of factors. The Argentine currency crisis was the result of a variety of factors. Large government deficits lead to excessive debt borrowing. Large government deficits lead to excessive debt borrowing. Debt payments could not be met because of poor export performance. Debt payments could not be met because of poor export performance. Eventually, the economy was forced to devalue their currency as foreign reserves dried up. Eventually, the economy was forced to devalue their currency as foreign reserves dried up. Bad Policy Bad Policy Fixed Exchange Rate kept too long. Overvalued the Argentine Peso. Fixed Exchange Rate kept too long. Overvalued the Argentine Peso. Used to much debt to finance government deficits. Even issued debt to meet debt. Used to much debt to finance government deficits. Even issued debt to meet debt. Attempted to eliminate deficit by levying excessive taxes rather than by reducing spending. Attempted to eliminate deficit by levying excessive taxes rather than by reducing spending. Bad Luck Bad Luck Brazilian crisis hurt trade competitiveness. Brazilian crisis hurt trade competitiveness. U.S. Dollar success hurt trade position. U.S. Dollar success hurt trade position. Unions and low productivity growth raised costs of production. Unions and low productivity growth raised costs of production.

Could the crisis have been avoided? Many experts believe the crisis could have been avoided if Argentina had abandoned the peg and devalued in 1997, 1998, or Many experts believe the crisis could have been avoided if Argentina had abandoned the peg and devalued in 1997, 1998, or Why did they keep the fixed exchange rate? Why did they keep the fixed exchange rate? 1.) The peg cured hyperinflation of the late 1980’s. If the peg was abandoned, Argentina may have lost price stability. 2.) Much of the country’s debt was in dollar-denominated amounts. If the peso had devalued then the peso size of the debt would have increased. This could have lead to bankruptcies. 3.) They expected the dollar to devalue to more competitive rates. Hoped problems would reverse themselves.