Living with high inflation is not something new for Argentines.
Although the country is now going through a historic increase in prices -of more than 100%-, this is not the first time that the third largest economy in Latin America has exceeded triple digits of inflation.
30 years ago, in fact, the situation was even worse: the Consumer Price Index (CPI) came to register an annual rise of 3,079% in 1989 and 2,314% the following year, in the midst of a serious financial crisis and high poverty levels among its population.
But only five years later, during the second presidential term of Carlos Menem, the CPI fell to 0%.
What did Argentina do at that time to counteract hyperinflation? Could the same solution be used now? Here we explain it to you.
Convertibility Law
In the early 1990s, the inflationary spiral affecting Argentina seemed unstoppable.
To deal with this financial crisis, Menem’s then Economy Minister, Domingo Cavallo, carried out a profound change in the country’s economic organization, which included the famous Convertibility Law.
The measure – which came into force in April 1991 after its approval in Parliament – established a fixed parity of the Argentine peso to the US dollar. In other words, an Argentine peso became worth the same as a dollar.
This period was popularly called the “one on one.”
To make this possible, the Central Bank of that country became a virtual “conversion box”, which had the obligation to back each peso in circulation for one US dollar.
Thus, in a short time, Argentina managed to drastically reduce its inflation and stabilize its economy, which was followed by a long period of price consistency.
“(Convertibility) helped the country to stabilize its deficit -although not completely-, receive investments and increase its productivity,” Argentine economist and academic Eduardo Levy explains to BBC Mundo.
Levy adds that this economic policy directly benefited from the Brady plan, which restructured the debt contracted by developing countries -including Argentina, Brazil, Ecuador, Mexico and Venezuela- with US commercial banks.
It also benefited from other reforms led by Minister Cavallo, such as the opening of trade or the privatization of public companies, and the global cycle of the dollar.
It is necessary to remember that in those years (early 1990s) many Latin American countries were carrying out stabilization programs for their economies after the debt crisis of the 1980s, which has been described as one of the “worst economic episodes”. traumatic events” for the region and had strong social implications, including a considerable increase in poverty.
It is not for nothing that this stage was called the “lost decade”.
But, for the economist and director of the consultancy Eco Go, Marina Dal Poggetto, Argentina was the only Latin American country that used the dollar as a “rigid anchor” through its exchange rate to survive this chaos.
And that, he affirms to BBC Mundo, is one of the main reasons that explain why convertibility ended up being a failure and causing one of the most serious economic, political and social collapses in the history of Argentina.
Why did it fail?
“We went from a closed economy, with high inflation and highly protected, to an open economy, with very low inflation, but which ran into problems starting in 1996,” explains Dal Poggetto.
So what happened to the convertibility model that seemed so successful but gradually began to show its first cracks?
There are several reasons for the collapse, but economists agree that “external shocks” played a key role, including the strength of the dollar.
“The strength of the dollar, generated by an increase in the interest rate in the United States, ended up causing crises in emerging countries such as Argentina,” says Dal Poggetto.
At the same time, the Asian crisis – which quickly spread to other regions of the world – and the sharp devaluation of the ruble, Russia’s national currency, also impacted the economic system of the South American country.
But the most important blow came from Brazil in 1999 when, after a strong crisis characterized by capital flight and a drop in the level of activity, it was decided to devalue its currency -the real- with respect to the dollar.
Argentina, then, saw its exports to Brazil fall, which profoundly affected various industries, such as the automotive, textile, dairy, and footwear industries.
“The devaluation of the real in 1999 was the death certificate of convertibility,” says Dal Poggetto.
“Argentina should have also devalued its currency that same year, when Brazil did, but it could not because of the rigid regime it had,” adds the economist.
In the following two years -between 1999 and 2001- the financial crisis deepened more and more.
Argentines had to endure a strong recession, amid rising record unemployment (with 3 out of 10 workers unemployed).
The “playpen”
In 2001, the demand for dollars had far exceeded the South American country’s ability to generate those currencies.
With its stagnant economy and an expensive and uncompetitive peso, Argentina was increasingly dependent on foreign financing: 97% of its external debt was in dollars.
Worried about the stifling economic situation, many Argentines began to mistrust the soundness of the system and sent their dollars to accounts abroad, particularly to neighboring Uruguay.
With the reserves of the Central Bank falling, the government of Fernando de la Rúa asked the International Monetary Fund (IMF) for help, negotiating a restructuring of its debt.
But faced with the growing capital flight and the economic collapse, a few months later the IMF decided to suspend its disbursements, which caused an even more massive bank run.
It was in this context that on December 3, De la Rúa signed decree 1570, devised by Domingo Cavallo -the “father of convertibility”-, to try to stop the bleeding of dollars.
The measure, which would be dubbed the “corralito” shortly after, imposed restrictions on the withdrawal of bank deposits, further suffocating the population, paralyzing trade and leaving the vast informal sector of the economy with no chance of subsisting.
The story that follows is well known: social protests and looting broke out, which ended up causing the resignation (and flight by helicopter) of President De la Rúa, opening an unprecedented political and institutional crisis.
Faced with this complex situation, at the beginning of 2002 the parity between the dollar and the peso came to an end, and the “pesification” of dollar deposits. This caused a severe devaluation that caused poverty to skyrocket, which affected two out of every three Argentines.
The country also defaulted on its foreign debt, declaring what was at the time the largest default in history: $144 billion.
Could a similar model be used today?
The abrupt end of the convertibility model makes it difficult to think of it as a viable solution to the current inflationary crisis that Argentina is experiencing.
However, there are those who have put it back on the table.
One of them is Javier Milei, the economist and representative of the libertarian right who aspires to be president of the South American country.
Milei has said that the exchange parity was one of the most successful processes in the country to control macroeconomic variables and therefore implementing a similar model would be key to changing the current course of the economy.
“Convertibility was launched on April 1, 1991, in January 1993 we were the country with the least inflation in the world. I propose free currency competition, reform of the financial system. Thus, most likely, Argentines will choose the dollar and there you make dollars”, he pointed out.
The economists consulted by BBC Mundo, however, see this option as not very viable.
“An exchange regime does not solve your problem. If you do not have a correction of the fiscal accounts and an ordering of relative prices, you are not going to stop inflation. Then you need a stabilization program,” says Marina Dal Poggetto.
“What is the optimal exchange rate monetary regime? For me, it is not a fixed exchange rate, it is not a currency board. Convertibility ended badly because the shock was so long lasting that it did not survive.”
For Eduardo Levy, meanwhile, in practical terms a new convertibility law “would only be possible if international reserves were previously accumulated.”
“If there is a run, like the one we see today in Credit Suisse, there would be no way to stop it, unless the government or the banks hoarded liquid reserves. In the 90s, both the Central Bank of Argentina and the commercial banks maintained liquidity funds in dollars”.
In economic terms, Levy affirms that “convertibility proved that it serves to stabilize but it does not replace the need for fiscal balance and development policies.”
“To think of it today as a shortcut to stability seems naive to me,” he concludes.
Remember that you can receive notifications from BBC Mundo. Download the new version of our app and activate them so you don’t miss out on our best content.
BBC-NEWS-SRC: https://www.bbc.com/mundo/noticias-america-latina-65027059, IMPORTING DATE: 2023-03-24 12:40:06
fernanda paul
BBC News World
#Argentina #inflation #years #happen #today