Interest Rates In Dollars Within Argentina example essay topic

In 1998, Argentina entered what turned out to be a four-year depression, during which its economy shrank 28 percent. Argentina's experience has been cited as an example of the failure of free markets and fixed exchange rates. Contrarily, Argentina's economic woes have been attributed to bad economic policies which converted a typical recession into a full depression. Three big tax increases in 2000-2001 discouraged growth, and interfering with the monetary system in mid 2001 created fear of currency devaluation.

Consequently, the confidence people had in Argentina's government finances evaporated. "In a series of mishaps that made the situation ever worse, from December 2001 to early 2002, succeeding governments undermined property rights by freezing bank deposits; defaulting on the government's foreign debt; ending the Argentine peso's longstanding link to the dollar; forcibly converting dollar deposits and loans into Argentine pesos at unfavorable rates; and voiding contracts". Argentina has a history of constant economic, monetary and political problems. After achieving independence from Spain in a war that began in 1810, Argentina's provinces fought among themselves for many years, and no stable nationwide government existed until 1862. Until the late 1800's the provinces and the national government often financed budget deficits by printing money.

The results were persistent inflation and low economic growth. More recently, in 1989, Carlos Menem became president and the core of his policies was the Convertibility Law. It ended hyperinflation by establishing a pegged exchange rate with the U.S. dollar and backed money issued by the central bank substantially with dollars. The exchange rate was initially 10,000 Argentine australes per dollar: on January 1, 1992 the peso replace the austral at 1 peso = 10,000 australes = US $1. The major disaster of the period was that the unemployment rate rose. "From 1989 to 1999, the number of jobs grew as fast as the population, but the number of people who wanted to work grew even faster".

Inflexible labor laws and high taxes on formal employment made creation of new jobs in the above-ground economy slower than growth in the number of new job seekers. In 1998 Argentina entered a recession but by late 2001 the economy was in a full-blown depression. External forces provoked a recession. The East Asian currency crisis of 1997-98 and the Russian currency crisis of August 1998 made investors in developing countries much more cautious about investing in developing countries generally. "Brazil, Argentina's largest trading partner, withstood a currency crisis from August to October 1998, on the heels of the Russian crisis, but when confronted with a crisis in 1999, Brazil allowed its currency to float rather than maintaining the "crawling peg" to the dollar that had previously existed". The Brazilian real quickly depreciated from 1.21 per dollar to 2.18 per dollar before recovering.

Brazil's economic growth fell from 3.3 percent in 1997 to 0.1 percent in 1998 and was only 0.8 percent in 1999. After years of gains, Argentine-Brazilian trade was flat in 1998 and shrank in 1999. The January 2000 tax increase destroyed a growing economic recovery. In late 1999 and early 2000, the economy was showing signs of growth. In December 1999, Fernando De la Rua succeeded Carlos Menem as president. His government promptly enacted the first of three packages of tax increases, which took effect in January 2000.

Economic indicators quickly turned negative again as the tax increase killed the growing economic recovery. New blunders in tax and monetary policy didn't make matters improve in 2001. The return to a shrinking economy in 2000 and 2001 led to political problems. "On March 18, 2001, ministers of the Fre paso political party resigned from President De la Rua's coalition cabinet in protest over proposed cuts in spending". The resignation marked the start of the true crisis phase of Argentina's economic problems.

The resignations weakened President De la Rua's base of support in the Argentine Congress. The next day interest rates in Argentina moved to permanently higher levels, with further spikes during the rest of the year related to bad news about economic policy. In response, President De la Rua appointed Domingo Cavallo as minister of economy. In monetary policy, the government made key blunders in April and Jun 2001. On April 17, Cavallo introduced a bill to switch the exchange rate link of the peso from the U.S. dollar to a combination of the dollar and the euro. The president of the central bank, Pedro Pou, had advocated replacing peso with dollars one-to-one if necessary to ensure the credibility for the peso.

His views put him at odds with Cavallo and De la Rua. On April 25, De la Rua fired Pou and replaced him with a more malleable official. On June 15, Cavallo announced a preferential exchange rate for exports. The special exchange was a step back towards the interventionist practice, frequent before the convertibility system, of using government decrees for applying different exchange rates to different types of buyers or sellers by government decree, rather than allowing everyone access to the same exchange rate in a free foreign-exchange market.

The Argentine government entered a "debt trap" by mid 2001. The new taxes further burdened an already struggling economy. "The changes in monetary policy reduced confidence in the peso. Even interest rates in dollars within Argentina rose substantially, because of concern that loans and deposits in dollars were also at risk from government policies".

High interest made it costly for businesses to expand using credit and contributed to the recession. The government's failure to take effective measures to end the recession created a crisis of confidence in government debt, because a shrinking economy meant a striking base of tax revenue from which to pay the debt. Argentina's federal government had been paying anywhere from 3 to 9 percentage points more than the U.S. Treasury to borrow. After the monetary policy blunders of April 2001, the premium jumped to almost 13 percentage points. In July 2001, when rating agencies reduced the credit rating of Argentina's government debt, it rose above 16 percentage points, and by the end of October it exceeded 20 percentage points. Such high rates indicated many investors feared a default.

The government was in a "debt trap": at the interest rates it faced for borrowing, the debt would quickly grow so fast as to exceed the capacity of the government and the Argentine economy to repay it. Government policies "contaminated" the private sector in late 2001 and 2002. In December 2001 the crisis entered its final phase, in which the government spread its problems to the private sector through a variety of policies rather than trying to minimize the spread. The difficulty the government was having in refinancing its debt led to fear that it would freeze bank deposits, as it had done in 1982 and 1989. During those freezes, the government had in effect confiscated part of the savings of bank depositors to finance itself and pay some foreign debt. After heavy withdrawals of deposits from banks on Friday, November 30, Cavallo announced a freeze of deposits on December 1.

The deposit freeze brought much private-sector activity to a halt, because under the rules of the freeze, businesses and individuals could not use their deposits to pay anybody except other depositors at the same bank. The estimate of monthly economic activity calculated by Argentina's national statistical institute suffered a year-over-year fall of 15.5 percent, the biggest since the series began in 1993. The economy plunged from what still might arguably have been termed a very bad recession into a true depression. By December 20, Minister Cavallo and President De la Rua had resigned after deadly riots brought about by the shrinking economy and the deposit freeze.

On December 23, the short-lived administration of President Adolfo Rodriguez Saa declared a default on the federal government's debt to foreign private-sector creditors. The situation was by then so disorganized that default would have been almost impossible to avoid, but rather than presenting the default as a reluctant step by a debt pr willing but unable to pay its bills, President Rodriguez Saa presented it as an act of defiance to creditors. He had ideas for other sweeping changes in economic policy, such as issuing a second national currency in parallel to the peso, but did not implement them because he resigned after a week following demonstrations against him. Eduardo Duhalde, who became president on January 1, 2002, was a strong critic of the economic policies of the 1990's.

He instituted revolutionary changes by devaluing the peso; forcibly converting dollar deposits and loans into pesos and voiding many kinds of contracts. He upset property rights that had been well established in Argentine law for at least a decade, and in some cases since the 1800's. The economy plunged further, with the year-over-year estimate of monthly economic activity falling a record 16.9 percent in January and 16.6 percent in March. The estimate did not turn positive until December 2002. The economy shrank 10.9 percent in 2002 following a 5.5 percent decline in 2001. Initially, Argentina's lower house of Congress gave approval to an emergency economic plan in a key vote granting President Eduardo Duhalde broad powers to devalue the peso and try to rebuild the shattered economy.

"The legislation would grant Duhalde special powers to ease the peso's decade-old one-to-one peg with the dollar, reform the banking system, control prices and protect local industry and jobs". It marks a sea change in economic policy, shifting Argentina away from a fixed currency regime and unbridled free market practices. Although the bill did not specify a new peso rate, government officials have indicated there would set a fixed rate of around 1.4 pesos to the dollar for finance and business transactions. Ordinary Argentines would have to buy hard currency on the open market, probably at a higher rate. Ordinary Argentines would have to buy hard currency on the open market, probably at a higher rate."Subsequently, Argentina's government fully uncoupled the peso from the U.S. dollar as exchange houses overflowed with anxious Argentines seeking U.S. dollar". The free-floating peso posed a key test of the caretaker government of President Duhalde who took office under pressure to ease Argentina's worst economic crisis in decades.

The Duhalde government cut some tax rates but raised others, especially on export products. Argentina's banking system is recovering after a disastrous year in 2002. Its long term health will depend on whether th economy is able to grow anew rather than simply rebound from the depression. Argentina's prospects of partly repaying the government debt on which it has defaulted also depend mostly on whether the eco no.