the mid-1990s Argentina was lauded as an economic miracle. Today, after three
years of stagnation, it represents one of the world's most intractable
economic trouble spots. Why?
How did it all go wrong for Argentina?
In 1991, during Domingo Cavallo's first spell as economy
minister, the government decided to peg the peso to the US dollar to restore
confidence and combat hyperinflation.
At the time, the strategy worked, but in time Argentina
suffered the disadvantages of such a fixed peg.
By linking the peso to the dollar, Argentines adopted a
currency whose exchange rate bore little relation to their own economic
This was a boon in times of hyperinflation.
But when stability returned to Argentina, the inability of
its currency to respond proved more of a burden than a benefit.
Argentina had, in effect, ceded control over monetary policy
- consider how important cutting interest rates has been to the US and UK
Buenos Aires was left dancing disco when the tango would have
been wholly more appropriate.
And while Argentina was able to sidestep the fallout from the
Mexican currency collapse of 1995, the so-called Asian crisis, which began
two years later, provided a more troublesome beat.
When the Brazilian real plummeted in 1999, the peso was
unable to follow suit, leaving Argentine exports vastly more expensive than
those of its neighbour.
A decline in world prices for farm products, and the global
economic slowdown of recent months, only worsened Argentina's problems.
Lower export takings have limited the country's ability to
earn the foreign currency needed to repay dollar-denominated debts.
Allowing industrial activity has denied the government the
cash to balance budgets, while seeing levels of unemployment and
"underemployment" top 30%.
How will devaluation help?
The new Argentinean government has now devalued its currency
by 30% and ended the fixed link with the dollar.
This will boost exports and help restore Argentina's foreign
currency earnings which may ultimately be needed to pay off its huge foreign
That is because exports will become cheaper in comparison to
the Argentinean peso.
But it will hurt businesses which have invested in Argentina
by making their investments in the country less valuable, and their profits
And it will be bad news for those people in Argentina who
have borrowed money in dollars and are paid in pesos - for example, some
small businesses and many with mortgages.
They would then have to pay back their debts in a currency
that was worth less than before, so the real value of their debts will
There are suggestions, however, that the government will bail
out anyone who has a loan of less than $100,000 by converting it to pesos at
the 1:1 rate.
But that could be expensive for the government.
And devaluing the peso could boost inflation, as imported
goods will become much more expensive.
What about Argentina's debt?
In the meantime, Argentina's huge debt problems had not gone
The country went on borrowing on international financial
markets, until debt reached some $140bn.
Now the government has also said it will default on these
The default may bring the country some breathing space, but
it is sure to make negotiating a final deal with its creditors that much
And it will make it much harder for Argentina if it tries to
borrow money again on international financial markets.
However, the sums Argentina owes are so massive that it is
very much in its creditors' own interest to eventually come to an
To paraphrase the old adage, if you owe the bank $1,000, it's
your problem, but if you owe it $140bn, it's the bank's.
How did Argentina lose its way after being a former economic
In the 1930s Argentina was, thanks largely to beef exports, a
global power, boasting income per capita similar to that of France.
But from the 1940s the country tumbled from the international
stage, weakened first by isolationism, then military rule and internal
With the crisis-stricken government printing cash wholesale,
inflation soared to 200% a month by the end of the 1980s.
Shoppers would pay more for goods in the afternoon than they
had in the morning.
How did the country escape that particular crisis?
Carlos Menem, on gaining presidency in 1989, liberalised
trade, privatised many state businesses and cut red tape in a bid to foster
The programme initially failed, undermined by concerns over
levels of state deficits.
But the decision in 1991 to peg the peso to the US dollar
boosted confidence - investors deemed dealing in greenbacks a safer bet.
The move also fostered financial stability - prices
denominated in dollars could hardly be adjusted so quickly.
With world economic conditions fair, and seeds of recovery
sown, Argentina became locked in a virtuous circle of foreign investment
fostering growth which attracted further cash.
From 1991-94, Argentina's economic output
expanded by an average of 7.7% a year.
Adapted from bbc.co.uk: 7.1.02