Sunday, October 21, 2012

What's Greek for "Corralito?"

From the start of this big mess, I haven't heard anybody describe anything that looks like an end game, save for hitting the big red button labeled "Argentina."
With that in mind, I give you a few excerpts from a paper I wrote last year about Argentina.  Sounds just like Greece, just a decade or so ahead.
Argentina has long had a dysfunctional economy...Rather than pursue a policy that explicitly taxed one group or another, government was largely financed by the central bank printing money. Since this method of raising funds depends inherently on the "surprise" nature of the inflation created, to raise a steady supply of funding requires an exponential growth in price levels, and by 1989 inflation had reached well over 3000%. As this dysfunction came to a head, the political climate of Argentina was also liberalizing and moving towards a less authoritarian tone, which set the stage for the neo-liberal reforms of the the early 1990s (Baer 2002).
After several failed efforts at control of the now-self-sustaining hyperinflation, the government turned to an aggressive liberal policy that we will call here "neo-liberal." This was a policy aimed with an almost single-minded focus on providing stable markets that would be attractive to international capital, as well as a scheme of privatization that would, ideally, both raise funds for the government and additionally improve services provided by previously public utilities. The reforms enacted were broad and deep, including removal of subsidies industrial, layoffs of redundant public workers, and tax reforms. These reforms were largely in line with western orthodox economic management, and in significant ways served to modernize the economy of Argentina. The reform of greatest interest from a monetary perspective however was the policy of "Convertibility." In this policy the central bank was granted independence and tasked with the role of maintaining a 1:1 currency peg between the peso and the United States Dollar. To insure confidence in this plan, the central bank only issued currency against their USD reserves, and freely converted between Pesos and USD. This effectively eliminated the discretion of the Central Bank, giving it a clear policy rule that avoid any temptation towards macroeconomic manipulation (Baer 2002).
Measured in standard macroeconomic terms, this policy worked well for a decade. Within the first 3 years following the implementation of convertibility inflation fell to single digits, and with the exception of 1995 (the “Tequila Crisis”), GDP growth was above 5% each year between 1991 and 1997. Relatedly, over the same time period international trade more than doubled as a portion of GDP, and investment nearly did the same. In virtually every aggregate macroeconomic measure, the 1990s were a period of rapid industrialization and modernization for the economy of Argentina (Baer 2002).
Over the lead-up to the crisis, Argentina's debt changed in both composition and magnitude. In the decade before the crisis, debt as a portion of GDP increased from under 35% to over 50%, and perhaps most tellingly govermnent debts owed abroad ballooned from 1.2 Billion USD in 1993 to 74 Billion USD in 2001 (Kitano 2005, Baer 2002).
It was this huge outstanding level of debt, combined with the inflexible currency peg, that set Argentina up for an economic and monetary disaster. In the early years of the convertibility plan, the government largely closed its revenue gap through its privatization program, a policy that maintained a budget that was approximately balanced for several years, but was necessarily limited by the number of governmental monopolies that could be sold. The fundamental problem facing the Argentinean government, the inability to form a consensus on the funding of social policies, continued unabated, the result being that a policy of irresponsible financing via seigniorage was shifted to an equally irresponsible policy of financing via debt. This policy was able to successfully mask the underlying problem until the aftermath of two international economic crises, the “Tequila Crisis" of 1995 and then another crisis in 1998. The contagion effect of these crises, combined with the exchange rate peg and resulting inability to use monetary policy to mitigate the business cycle, left the country in a deep recession, reducing the tax base and leading the markets to become concerned about sovereign debt default. The government pursued austerity measures to restore fiscal balance in hopes of restoring creditor confidence, however this pro-cyclical fiscal policy deepened the recession, further weakening the tax base, further eroding investor confidence. As the economy went deeper into recession and the central bank's ability to finance it's debt became further in question, the ability to maintain the currency peg came into question, leading to a flight out of pesos. As the banks were allowed to accept deposits denominated in foreign currency that were backed by the Central bank, loss of confidence in the central bank led to a bank run, leading to a banking crisis. As investors rapidly attempted to remove capital from the Argentinian economy, the central bank imposed capital controls, culminating in a bank holiday at the end of 2001 and the forcible conversion of foreign currency deposits to Pesos at an unfavorable exchange rate and the abandonment of convertibility (Baer 2011).

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