Clive Crook returns from a trip to Argentina and gives his view. As always, it is extremely insightful and very well written. In some ways it's not fair: no one should be able to write like an angel to such a degree.

One bone to pick, however: Crook says that:

"...what Argentina shows is not the folly of any particular initiative. Rather, it highlights in an unusually stark way an ultimately irresolvable dilemma that confronts all emerging-market economies. To grow as fast as your potential allows, you must attract foreign capital. The more you succeed in this, the more you will come to depend on foreign capital-and, for as long as it takes to build a strong, diversified economy, the more fragile your success will be..."

It's the currency mismatch in debts and credits plus the hard currency board peg of the peso plus the unsustainable deficits that together brought Argentina down. Remove any of those three, and Argentina today would be likely to be in quite good shape. Prosperity doesn't have to be "fragile"...

National Journal Magazine Archive

COLUMN: Argentina Crossed the Line Between Triumph and Disaster | by Clive Crook

During the past 100 years, excluding ruin caused by war, Argentina has suffered two of the most astonishing economic reversals ever seen. The first one took the better part of a century, as this once-mighty exporter slipped, crisis by crisis, to the bankruptcy of the 1980s. By then its standing as one of the least successful middle-income"developing" countries (not an apt term, in Argentina's case) seemed secure. In fact, another cycle of resurgence and ruin was coming.

COLUMN - Argentina Crossed the Line Between Triumph and Disaster

06-22-2002

During the past 100 years, excluding ruin caused by war, Argentina has suffered two of the most astonishing economic reversals ever seen. The first one took the better part of a century, as this once-mighty exporter slipped, crisis by crisis, to the bankruptcy of the 1980s. By then its standing as one of the least successful middle-income "developing" countries (not an apt term, in Argentina's case) seemed secure. In fact, another cycle of resurgence and ruin was coming.

At the start of this decade, experts held up Argentina's economic policies to the world as exemplary. Ten years before, the nation had embarked on a bold strategy to halt its long decline. It abandoned control of its own monetary policy and irrevocably tied its currency to the dollar. Next came a stunning array of measures to open the economy and spur private enterprise. Argentina, up to then a byword for backwardness and stifling regulation, became a champion of liberal economics.

The policies brought instant success. Foreign capital poured in and, far more impressively, was put to good use. Investment soared, and so did growth. Remarkably, there was no sign of inflation: Argentina's chronic tendency to inflate its way to financial collapse was cured. The country shrugged off Mexico's "tequila crisis" of 1994-95 and came through the broader emerging-markets crisis of 1997-98 relatively unscratched. Here was proof of what good government could do. In October 1998, President Carlos Menem was asked to speak alongside Bill Clinton at the annual meetings of the International Monetary Fund and the World Bank, so he might tell others how he had worked this miracle.

Things have changed a bit. At the end of last year, with investors starting to panic, the government closed the banks to stop a run: Seven months later, the country has defaulted on its debts, and the domestic financial system is in ruins. In effect, the banks are still closed. Even if depositors could get hold of their money, they will be repaid not in dollars or in dollar-linked pesos, as the government had pledged, but in pesos that have been massively depreciated. In other words, their savings have been wiped out, and what little remains is shut up in a banking system that is bust.

During my visit to Buenos Aires this week, it was hard to see how things could get worse. The economy is trapped in a ferocious recession. Unemployment is 20 percent and rising. Wages are depressed, and prices (because of the collapsed currency) have surged. Parallel currencies are circulating as lower tiers of government pay their workers with "bonds" that look like banknotes, quite outside the control of the central bank. The ground work for hyperinflation has thus been laid. The riots seen earlier in the crisis, causing some 30 deaths, have subsided for now. Today's weary little demonstrations of pot-banging protesters outside banks and foreign-owned businesses are a lot less frightening, no doubt, but sadder. People are dismayed and without hope.

In recent days, spirits may have sunk as low as they can go. I was woken before dawn one morning by noise outside my hotel. It was the sound of wailing-that is the word-as the news came in that Argentina's beloved soccer team, favorites to win the World Cup, had been knocked out of the competition. After everything else, that tested even the Argentine capacity to absorb bad news. But if the country's mood of exhausted fatalism may now have hit rock bottom, the economy has not.

Bad as things are, they are likely to get worse. The country's political system has been paralyzed for the past six months-notwithstanding frantic activity, of a sort. Presidents have come and gone. And politicians fight, emote, and maneuver, as you would expect. But the government is actually doing next to nothing: It has taken no steps to repair, or even begin to repair, the damage that the economy has suffered.

The most pressing need is to get the financial system working. The economy cannot function otherwise. The fall in the peso (which now trades at around four to the dollar, compared with 1-to-1 during the 1990s) has made everything in Argentina dirt cheap for foreigners with hard currency. This phenomenal boost to competitiveness gives the country an opportunity to export its way out of recession. But any such recovery needs a reliable supply of domestic credit. With the banks shut down, the supply of credit is zero.

Clearing the wreckage of the banking system requires Argentina to recognize and share out the full extent of its losses. Politically, that is a severe test-one that Argentina's politicians show no sign of wishing to face. The present banking chaos goes on because it delays the crucial reckoning. In the meantime, the economy is not just unlikely to recover, it is likely to sink even further into recession and maybe into hyperinflation as well.

How did all this ever happen? So spectacular a calamity makes one long for a single, correspondingly egregious cause-the one mistake so bad that it is capable of carrying all the blame. And an obvious candidate, of course, presents itself. Argentina's "convertibility" system, which is what the country called its supposedly unbreakable exchange-rate peg to the dollar, was the most distinctive aspect of policy during the 1990s. This system caused exporters to lose competitiveness as the dollar strengthened (especially after Brazil devalued its real in 1999). It stopped the government and the central bank from using lower interest rates to cushion the resulting slowdown. It encouraged too much capital to flow into the economy during the 1990s-so that the halt in external financing, when it happened, caused a much more violent crash. Here, it seems, is the perfect leading culprit.

Because few countries have ever even thought of adopting a currency-board system like Argentina's, this would be a wonderfully reassuring conclusion. Unfortunately, the closer one looks at Argentina's crisis, the less plausible this account seems. The causes of the crisis are complicated. Entire academic careers in economics are going to be built on studying it. But it is pretty clear, at least, that convertibility did not in fact condemn Argentina inescapably to its fate.

The country ran seemingly moderate fiscal deficits during its boom years in the 1990s. If the government had adopted even a slightly more cautious fiscal policy-gathering surpluses to run down in harder times-the crisis might well have been avoided. A bit less bad luck might have made the difference, too. Suppose the dollar had not been so strong for so long; or that Brazil's real had not collapsed, pulling the region's other currencies down with it; or that the emerging-markets crisis of 1997-98 had not suppressed, directly and indirectly, Argentina's export markets.

It is true that convertibility greatly increased the penalty for the government's failure (as it now seems) to run a suitably conservative fiscal policy, and for the country's run of bad luck. But remember that if Argentina had been a little more prudent on taxes and spending, or had had some of the breaks in those other respects, the result may well have been not merely that the country avoided the current crisis, but that it continued to outperform its regional competitors and most of the world's other emerging-market economies. What is so sobering about the Argentine debacle is that the line between remarkable success and devastating failure can be so narrow.

Follow the history and you see, for the most part, a vicious cycle of apparently small mistakes and adverse external events. Even as Argentina's recession, worsened by Brazil's depreciation, persisted into 2000, the situation seemed retrievable. But as investors grew nervous, the cost to Argentina of financing its debts went up, the position seemed harder to sustain, investors worried more, the risk-spreads widened again, and so on.

At the very end, Argentina's government did turn what was by then a daunting setback into the present catastrophe, with a series of missteps under pressure. Worst of all was the decision to "pesify" the banks, using one exchange rate to convert deposits and a different rate to convert loans-thus rendering the banking system, which not long before had been one of the world's best capitalized, instantly insolvent. With that, finally, there was no way back.

Yet up to that point, what Argentina shows is not the folly of any particular initiative. Rather, it highlights in an unusually stark way an ultimately irresolvable dilemma that confronts all emerging-market economies. To grow as fast as your potential allows, you must attract foreign capital. The more you succeed in this, the more you will come to depend on foreign capital-and, for as long as it takes to build a strong, diversified economy, the more fragile your success will be. With cautious policies, the terms of this trade-off can doubtless be improved. For a while, Argentina and its admirers thought it had been repealed. They were wrong.

Clive Crook | National Journal

Posted by DeLong at June 25, 2002 11:07 AM