March 04, 2003

Those Who Do Not Remember History...

Those who do not remember history are condemned to repeat it, and the rest of us are condemned to repeat it with them. Gerardo della Paolera and Alan M. Taylor point out that those who have studied the 1929 collapse of the gold standard in Argentina would have found few surprises indeed in the 2001 collapse of the currency board.

Yet another brick in the wall suggesting that it is long-lasting institutional deficiencies that are the causes of the "bad policies" that overoptimistic economists like me think stand in the way of successful development and growth.

Gaucho Banking Redux: Gerardo della Paolera, Alan M. Taylor | NBER Working Paper No. w9457 | Issued in January 2003 | Argentina's economic crisis has strong similarities with previous crises stretching back to the nineteenth century. A common thread runs through all these crises: the interaction of a weak, undisciplined, or corruptible banking sector, and some other group of conspirators from the public or private sector that hasten its collapse. This pampean propensity for crony finance was dubbed 'gaucho banking' more than one hundred years ago. What happens when such a rotten structure interacts with a convertibility plan? We compare the 1929 and 2001 crises the two instances where rigid convertibility plans failed and reach two main conclusions. First, a seemingly robust currency-board can be devastated by an ill-conceived approach to the problems of internal and external convertibility (or, to rephrase Gresham, 'bad inside money drives out good outside money'). Second, when modern economic orthodoxy collides with caudillo-style institutional backwardness, a desperate regime with its hands tied in both monetary and fiscal domains will be sorely tempted by a 'capital levy' on the financial sector (for, as Willie Sutton said when asked why he robbed banks, because that's where the money is)

Posted by DeLong at March 4, 2003 02:02 PM | TrackBack


The abstract links to an interesting digest at

(Those dang French again.)

Posted by: Jim Glass on March 4, 2003 04:59 PM

Nice one Jim. However, while accepting completely the point about institutions, I still can't help feeling that there are far more problems attached to hard-peg type arrangements than is generally accepted. In particular for the reasons Krugman has identified: if you hold your currency, and open to capital flows, you lose effective control of monetary and fiscal policy, as Argentina found out to its cost.

This is also what makes the euro such a questionable enterprise. You get locked-in to a rigidity that makes it difficult to steer away from problems. I was brought up as part of a generation that was fed the idea that sacrificing everything for the sake of currency stability was the kind of folly of which great Depressions are made (see eg Eichengreens 'Golden Fetters'). Today in Europe it's a paper fetter backed by the ECB. Yes Brad, without learning from the past we are condemned to repeat its errors: the only remaining question is whether this will be as tragedy or farce.

By the way, has anyone checked out Bulgaria lately. I have the impression that this is another Argentina just waiting to happen?

Posted by: Edward Hugh on March 4, 2003 10:14 PM

I'd be interested in knowing what evidence the authors have for their proposition that the Argentine banking system was notably corrupt, weak or indisciplined. My understanding was that it was one of the best-capitalised banking systems in the world, and there was substantial foreign ownership. The Argentine "financial transactions tax" was only levied after the crisis was already evident.

There's a working paper version of this on the author's site at

and I'm desperately unimpressed. Vast reams of unrelated material from the authors' other book appear to have been cut and pasted intothe working paper to justify a shaky thesis. There is no detailed analysis of the 2001 crisis at all, and they seem to be treating the "megaswap" as being a trigger of the crisis in Argentina rather than what it was; a last roll of the dice for a government that was already beyond the event horizon.

I don't really see the point of this WP other than to throw mud at the Argentines. The authors seem far too happy to chuck around the word "corrupt" and blame everything on the government (and they seem to regard "Gaucho Banking" as a much more attractive and clever phrase than it actually is), but they're living in cloud cuckoo land. They don't have an alternative policy -- from time to time, they start claiming that what the Argentine government should have done is "recognise the need for debt restructuring", which is hardly helpful -- and they don't seem to recognise that this was a macroeconomic problem largely driven by factors outside Argentinian control.

Lastly, they still appear to be citing Krugman as if he believed that the Korean crisis of 1998 was caused by "crony capitalism", which I believe is a view he no longer holds.

Posted by: dsquared on March 4, 2003 11:37 PM

"Gaucho banking" should not be confused with "Groucho banking", the technique that Mr. Marx used to avoid paying his hotel bill.

Posted by: Seth Gordon on March 5, 2003 04:01 AM

Those who remember Santayana are condemned to repeat him...

In defense of the authors' argument, it may well be that Argentina, for political or cultural reasons, has never been able to maintain sound finances.

However, these reasons may also have little in common with Gaucho cronyism. If the Argentine system is unable to force certain sectors of society to shoulder a larger burden, either through increased taxes and tax collection on the rich, reductions in corruption, or service cuts, then we should expect to see a never-ending series of economic crises. The fact that the current crisis resembles a past crisis tells us that many of the important factors contributing to Argentine instability are still present, but it does not tell us which is most important. Argentina's large external debts took decades to accrue, and in those decades cronyism was not always the biggest drain on economic growth.

This may be a result of structural problems in Argentine institutions, or of cultural problems in the refusal of large segments of society to agree on the need for a solution or compromise. But to suggest that only one aspect of the problem - cronyism - took Argentina to the brink of collapse, is to overlook the widespread dysfunction in Argentine (and much of South American) politics, which has evidently persisted for 80 years or more.

Posted by: Ethan on March 5, 2003 08:59 AM

The essay never accounts for the fact that the Argentine currency peg quickly produced an impossible trade problem for Argentina. Brazil and Spain had falling currency prices, the dollar price was rising. Argentina began to lose its largest foreign markets because its currency was needlessly appreciating along with the dollar. The economy weakened, the Argentine government led by Wall Street cheers supported the currency peg with more and more austerity. A slowdown became a recession, became a depression. Krugman and Stiglitz understood from the beginning. Wall Street cheered, Argentina suffered and suffered more, and the IMF cheered with Wall Street and did nothing until the bitter collapse.

Articles that merely bash the Argentines need to be seriously questioned. Krugman had it just right on the impossible problem the currency peg presented.

Posted by: anne on March 5, 2003 10:54 AM

March 2, 2003

Once Secure, Argentines Now Lack Food and Hope

TUCUMÁN, Argentina — A year after the Argentine economy collapsed, the authorities in Buenos Aires are boasting about a record grain harvest and suggesting that the country is finally on the mend. Yet in recent months, 19 children have died of malnutrition here, so "the garden of the republic," as this city is known, is also the leading symbol of its agony.

Just a few years ago, this was a largely middle-class nation, with the highest per capita income in Latin America. But the crisis that began in December 2001 has turned millions of Argentines into paupers without jobs, hope or enough food for themselves and their children.

According to the most recent statistics, issued in January, at least 60 percent of the country's 37 million people now live in poverty, defined as an income of less than $220 a month for a family of four. That is nearly double the number toward the end of 2001. Even more alarming, more than a quarter the population is classified as "indigent," or living on less than $100 a month for a family of four....

Enough with the darn bashing. Help is needed!

Posted by: anne on March 5, 2003 10:58 AM

The heck with Goucho Banking. What slandering rubbish. What should we call the Spanish or American banks in Argentina? Spanish and American banks used the currency peg to make what they thought were risk free investments. Spanish and American banks were hugely influential, perhaps dominant in Buenos Aires. Gringo banking?

Posted by: jd on March 5, 2003 11:11 AM

Slurring Argentine culture is not what researchers should be about. Argentines are hurting. We could have helping more before the collapse of the currency, at least by urging an easing of the peg. After all, England and France did allow devaluations in 1993! Remember? In lieu of proper advice we could have helped more after the currency collapse and could be helping more now.

Posted by: anne on March 5, 2003 12:06 PM

Of course, by easing the peg in the face of currency market pressure, you run into the credibility problems that the peg is supposed to prevent, as well as having serious difficulty in getting different vested interests to accept the need for a change. Floating seems a much better way for a political system as incapable as the Argentine to address these matters - don't leave currency valuations under any particular control.

Why didn't they ease the peg when it's clear that it was becoming detrimental and the currency was overvalued?

Posted by: Ethan on March 5, 2003 12:29 PM

Why didn't they ease the peg when it's clear that it was becoming detrimental and the currency was overvalued?

Great question. American and Spanish banks, Wall Street and IMF officials prodded and threatened Argentina about the need to "honor" the peg guarantee. Brazil, by the by, urged a peg adjustment. Brazil had fortunately resisted using a peg.

Posted by: anne on March 5, 2003 12:57 PM

Gerardo dela Paolera is Argentinian, so one can't automatically dismiss the paper as the work of bigots who want to play blame the victim while absolving foreign investors of responsibility.

Still, I have to be skeptical of their argument: banks in Argentina became vulnerable because of a combination of the currency board and neoliberal reform measures, and not the other way around. In addition to the rigid peg which made Argentina's goods more and more expensive as time passed, Argentina also privatized the social security system at the wrong time, which added many millions explicitly to the fiscal deficit, and the rush to privatize and to open the financial account to foreign investment resulted in millions being thrown out of work.

To this day, I still can't figure out why so many critics, Brad DeLong included, blame the Argentinian government for not running a fiscal surplus during the boom years of 1996-1998. Even at the top of the boom, unemployment in Argentina was well over 12%. How on earth do you attempt fiscal contraction under such conditions?

As far as the banking system was concerned, the only major policy mistake, I think, again goes back to the Convertibility Law--huge amounts of dollar-denominated liabilities (mainly deposits for banks, but also including huge amounts of debt for other institutions) which made a devaluation unimaginable and which were just waiting to be seized once the government's fiscal situation became desperate.

I'm afraid I have to be unequivocal here. Krugman, Eichengreen, and Temin were right. Dornbusch, Hanke, Schuler, and all the other rabid advocates of hard currency pegs were wrong--with tragic results for Argentina. The greatest damage that hyperinflation inflicts is the political windfall that advocates of hard pegs get from it. Argentina now has to start again.

Posted by: andres on March 5, 2003 01:47 PM

“Dornbusch, Hanke, Schuler, and all the other rabid advocates of hard currency pegs were wrong--with tragic results for Argentina.”

The Argentineans are not victims. They are responsible for their own troubles. Nobody told them to adore the ludicrous economic dogmas of Evita and Juan Peron. Indulging in scapegoating and self-pity isn’t going to help them adjust to the modern world. These folks require some tough love and not the sopping excuse making of Andres.

Posted by: David Thomson on March 5, 2003 10:58 PM

What happened David? Did someone put you in a grumpy mood simply by being nice to you? No one is trying to excuse the Argentinians, least of all myself. They had their own rabid proponents of hard pegs/dollarization, Cavallo and Pou among them and they deserve what they got for having kept Cavallo's system for so long. All I'm saying is that they got encouragement from quite a few U.S. economists for this course of folly. By the way, David, Juan Peron and Evita ran the government in the 1950's, not the 1990's. Just thought you ought to know.

Posted by: andres on March 6, 2003 08:00 AM

"American and Spanish banks, Wall Street and IMF officials prodded and threatened Argentina about the need to "honor" the peg guarantee. Brazil, by the by, urged a peg adjustment. Brazil had fortunately resisted using a peg."

IIRC, the problem was that conventional wisdom had decided that you either needed a VERY firm peg, or a total float, to work. Currency boards, movable pegs, and other half-measures were the worst outcomes. A stiff peg reinforces credibility in the government by demonstating a willingness to defend a temporary currency imbalance. The government signals to speculators and investors that it is willing to endure short-term pain for stability, thus reducing the threat of capital flight, and preventing speculative attack. A pure float allows the government to completely avoid questions of credibility - the government is simply not committed to defending any particular value.

But a mixed system signals that the government (or board, or whatever) will cave when pressure gets too great, and that encourages uncertainty among investors and speculation by currency traders about whether a curency will be devalued. The mixed system makes clear that the government will throw money into the currency markets briefly to defend the peg, but then capitulate. This encourages currency holders to get out now when the rate is good, as well as rewarding speculators who want to short, thus building downward pressure on the currency.

In hindsight, the advice to hold the firm peg was bad advice - Argentina should have cut and run long before. But perhaps the real lack of wisdom was using a peg at all (or at least one that would be so hard to meet - few economies could match the US in the late 1990s) in a country with political and economic institutions so incapable of meeting the peg's demands. The peg, after all, requires that the government be committed to it, even in the face of mounting costs and sacrafice, so as to build investor confidence. Argentina does not have a confidence-inspiring record when it comes to voluntarily making fiscal or social sacrafices....

Posted by: Ethan on March 6, 2003 09:55 AM

Ethan, a currency board _is_ a firm peg, not a half-measure as you seem to suggest. The only thing firmer would have been total dollarization. As time wore on, the drawbacks of a firm peg to the dollar became obvious for all the world to see: (1) overvaluation of the currency and lack of competitiveness of domestic goods in world markets, (2) very high interest rates during capital flight periods which make it impossible to refinance debt and thus provoke bankruptcy, (3) inability to have the central bank function as a lender of last resort, which forces a reluctant IMF to assume the role, (4) the illusion of macroeconomic stability in the early 1990's encouraged capital inflows which were used to finance both privatization and automation, throwing millions of workers out of jobs, and leading eventually to (5) deflation, which creates more financial nightmares as it erodes firms' ability to service debts.

Only the collective insanity created by 2 years of over 2000% inflation could have induced Argentinians to accept such a system, which led inexorably to economic collapse. This again, though, is history repeating itself, but as Weimar Germany rather than as 1930's Argentina, as Della Paolera and Taylor claim. If there's one thing that I hope has been buried forever by Argentina's experience, it is the idea of hard pegs and hard money. Good riddance to bad rubbish.

Posted by: andres on March 7, 2003 10:31 PM
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