Argentina: Background to the Dollar Peg
In January 1991 the Chilean Lake District enjoyed perfect summer weather. Thousands of tourists, mosdy Argentinean but including a few Europeans, enjoyed the stunning views of shimmering lakes, verdant mountain sides and snow-capped volcanoes in the picturesque resorts of Osorno, Puerto Montt and Chiloe Island, enjoying day after day of clear sunshine in a country completing its first year of democracy following the years of the Pinochet dictatorship. On one day towards the end of the month, however, the resorts suddenly became close to deserted.
The weather and Chile’s politics were unchanged, but the beaches and lakeside hotels became strangely empty. Puzzled, the few remaining North American and European tourists asked the hotel staff what had occurred. The Argentineans, they explained, had had to return home. There had been a plunge in the value of their currency, the austral, and they could not afford to be abroad for a day longer.
Even this shock was not the peak of hyperinflation in the South American country; two years earlier the consumer price index for Buenos Aires had reached more than 5,000 per cent. An estimate of the longer-term impact of hyperinflation was that, by the time the new peso replaced the austral in 1991; one new peso was equal to 100,000,000,000 pre-1983 pesos.
The end of the twentieth century and beginning of the twenty-first witnessed a dramatic fall for what had been the most prosperous country of South America, and one of the ten richest nations in the world in the first half of the twentieth century. By the 1980s and 1990s, a stream of Argentineans of Italian descent were returning to Italy to look for work, in a poignant reversal of the journey their entrepreneurial parents and grandparents had made to one of the more promising of the ‘New World’ countries.
Some Argentineans will confess that by the late twentieth century the economy had developed the dimensions of a dwarf ‘con una cabeza gigante pero un cuerpo pequeño (‘with a giant head but a small body’). The airport and capital city were everything that you would come to expect of an advanced economy, but there was not the backbone of medium large enterprises and successful business clusters that one finds in the USA, France, Germany or Japan. It had Yankee ambitions for regional leadership based on a Confederate economy – income based primarily on agriculture and commodities.
When Carlos Menem was elected as president of Argentina in 1989 the country had been suffering from hyperinflation, a recurring problem since the return to democracy six years earlier. He initially pursued some crude anti-inflation measures, such as the confiscation of short-term, high-yielding bank deposits and their replacement with long-term bonds, but these had only short-term effects, and by the end of 1990 inflation had returned, accompanied by a plummeting exchange rate that was to prompt the sudden exodus of Argentinean tourists from their summer holiday destinations.
Early in 1991 Menem changed course. Though from a Peronist background characterized by protectionism, he surprised many critics by following many elements of the orthodoxy of the Washington Consensus: major privatization programmes, an end to tariffs, and anti-inflation monetary policies. The end of January 1991 saw the appointment of Domingo Cavallo as the country’s finance minister, who was about to embark on a bold monetary experiment designed to crush inflation. The idea was brutally simple: in a modern version of the Gold Standard, Argentina introduced convertibility: one peso equaled one US dollar. The system, which began in April 1991, required that the central bank kept enough dollars or gold in reserve to back the total amount of pesos that had been printed.
It fitted perfectly with Argentina’s psychology of regional leadership and with recent anxieties over the value of the currency. One of the experts Cavallo consulted was Horacio Liendo, who had written a doctoral thesis on social and economic emergencies. In his account of the crisis, Paul Blustein notes that Liendo was struck by the apparent success of the monetary rule that the Argentine government had adopted in the period 1899 to 1929, the ‘three most successful decades’ in Argentina’s history.
There appear to be some cognitive biases at play here. Liendo may have been misled by an apparent correlation between adoption of the Gold Standard and economic development that was no more than a coincidence. It appears to be a case of confirmation bias – the tendency to interpret information in a way that confirms one’s preconceptions; and problem of induction – making an unsafe inference from an apparent correlation. The ‘three most successful decades in Argentina’s history’ that he noted, between 1899 and 1929, may have been created by a combination of rising immigration, increasing agricultural productivity and wars and revolutions in Europe that affected output in the old continent, creating a strong demand for imports from South America.
A currency arrangement can bolster a strong economy, but it cannot create one – a narrative fallacy we will encounter again and again in the course of this course. It could have been a spurious correlation.
