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At NYU Stern on November 26, 2002, a distinguished panel gathered to discuss the Argentinian crisis and its implications. It included: Domingo F. Cavallo, the Henry Kaufman Visiting Professor at NYU Stern, who served as Minister of Finance for Argentina from 1989 to 1996 and was the architect of the currency board; Mario Blejer, a former governor of the Central Bank of Argentina and currently Director, Bank of England Centre for Central Banking Studies; and Nouriel Roubini, associate professor of economics at NYU Stern, and a former senior economist for international affairs at the White House Council of Economic Advisers. NYU Stern Economics Professor Paul Wachtel moderated the discussion. PAUL WACHTEL: Should Argentina have left the currency board? DOMINGO CAVALLO: When a domestic currency has to compete with foreign currencies you have to create some credibility so you need a tutor. Most modern currencies had gold as a tutor during the gold standard period. More recently, it s been the dollar. And we thought that using a tutor for a while would be important. The time to exit the currency board and abandon the tutor is when your currency has become credible. Argentina could have exited the currency board in 1997 after having averted the devaluation forecasted at the time. The currency was growing very fast and there was a significant inflow of capital. If the Central Bank had let the peso float, it would have appreciated vis-a-vis the dollar. That s what happened with Singapore in the 1970s, and they started to have a strong currency. But Argentina didn t abandon the currency board for a very simple reason. As part of the competition for the presidency in 1999, the government was trying to finance very large deficits of the provincial governments. [Then-President] Carlos Menem would call the private banks and get them to provide financing to the provinces. This fiscal management, which stemmed from the political competition, prevented the government from taking the natural opportunity to exit the currency board. WACHTEL: Let me ask Mario about that, and more generally, whether emerging economies should maintain currency boards? MARIO BLEJER: I d distinguish between the currency crisis and the crisis in confidence. Governments were clearly afraid of abandoning the one-to-one peso to dollar peg. In 1997, the main constraint was the cost. They didn t want to have the risk of having the currency first appreciate and then depreciate. The IMF put out a paper that concluded you should exit currency boards when things are good. This is appealing academically, but it s not practical advice. It s like saying you should have a divorce when the marriage is going well. The crisis really stems from the inconsistency between fiscal policies and the saving investment balances. The sharp increase in the government s fiscal deficit brought a very high increase in the interest rate spreads. The convertibility of the peso to the dollar helped bring down hyper-inflation in Argentina, but this rigidity imposed certain constraints on the conduct of macro-economic policy that were not respected. NOURIEL ROUBINI: I'd like to put Argentina in the context of other emerging market crises we ve seen in the last decade in Mexico, Thailand, Korea, Malaysia, Indonesia, Russia, Brazil, and most recently in Turkey. One of the lessons we've learned from all these episodes is that capital markets tend to collapse. And when this happens, emerging markets tend to move either toward flexible exchange rates or toward hard pegs. Until recently I think people categorized dollarization and currency boards as among the hard pegs. But after what happened in Turkey and Argentina, we realize that if your policies are not consistent, even a currency board can collapse.
In each crisis, fixed exchange regimes collapsed and there was some overvaluation of the currency. That led to current account deficits, which led to an accumulation of foreign debt or foreign liabilities. When you have a current account deficit, you can finance it either by equity inflows, or in the form of debt. These countries all had too much debt and too little equity. And eventually that means the banks are going to be in trouble. Argentina met most of these conditions. Two thirds of Argentinian bank assets were in debt to households or to the government, which was borderline insolvent. How can countries be less vulnerable to financial crisis? First of all, you need sound macroeconomic and fiscal policy. And if you're an emerging market, you have to overachieve. Countries like this should have debt ratios that are lower than those of developed countries. Having a sustainable exchange regime means either you pay the cost of dollarization and few countries are truly willing to do so or otherwise go to a floating regime and maybe use inflation targeting or some other anchor as a way to stabilize inflation. You can use regulation to reduce the currency mismatch by encouraging more equity investment. And if you have periods in which hot money is flowing in, some controls on inflows of capital may be useful. WACHTEL: So, Domingo views the dollar as a tutor, Mario views the dollar as not being responsible, and Nouriel views the dollar as being a monster that helped create the crisis. Perhaps we can turn our attention back to the present situation in Argentina, and ask what are the prospects for policy and economic reform in Argentina? BLEJER: To restore and start rebuilding confidence you need to pacify some sectors, like the foreign exchange market. I'm not talking about the need to fix the exchange rate, but the need to stop chaos. Certain types of capital control may restore that sort of confidence. The situation in January 2002 was very chaotic in Argentina: a lack of confidence in the peso, the abolition of convertibility, and a lack of confidence in the government. The supposed outcome at that point would have been hyper-inflation, and the total collapse of the financial sector. We ve avoided that so far. You have to intervene in the foreign exchange markets, provide liquidity to the banking sector, and have a very active and aggressive monetary policy with very high interest rates. These are the preconditions for a turnaround. The question is if the turnaround can be sustained. The problems are daunting, because the foreign and domestic debt has not been negotiated, wages are frozen, and inflation is 40 percent. CAVALLO: For economic growth, you need strong institutions. And for that, you need a well-functioning political system. The historical problem was that Argentinians in general did not consider paying debts as something that you had to do. In a sense inflation was a reflection of that attitude. The government would print money to finance its deficit, and would permanently devalue the currency to soften its domestic debt. Of course in a country in which nobody honors their debt, there is no credit. In the 1990s, the convertibility law not the currency board but the convertibility law, made the difference. So did the decisions to have savings protected by dollars and the emphasis we put in legislation on honoring obligations and fighting tax evasion. Our development in the 1990s was really financed from domestic savings. And that permitted the incredible expansion of the banking system, from $10 billion up to $80 billion, and the creation of the pension funds. This modernized much of the economy and created an increase in productivity, particularly in traditional export sectors like agriculture.
As for the next decade? If the old ideology that destroyed savings, prevented investment, and generated inflation in the past, rules the day, then the first decade of the new century will be a lot like the 1980s. The 1980s started with a default, and we struggled with foreign creditors. Eventually, it will wind up in the complete collapse of the monetary and financial system through inflation. Argentina has realized that the rules of the game of the 1990s were much superior to the previous rules. The recent rule changes did not come about because the markets forced them. They were created by big private sector debtors associated with the governors and with some politicians. Building institutions is a very difficult political task. But I think these problems will be fixed, because fortunately we have a republic. I think the judiciary will force the executive and the legislative power to reverse many of the decisions that were adopted. The functioning of the constitutional system is more important than any question related to the exchange rate system. ROUBINI: There's no disagreement that institutions matter. But compare Hong Kong and Argentina. They both had a currency board. Hong Kong in 1998 had a major shock. But there was no budget deficit, no public debt problem, a very dynamic economy, and high productivity growth. They cut wages by 15 percent and that's how you achieve the real devaluation. In Argentina, you have a large public debt, a large budget deficit, a current account deficit, and rigid labor markets. When you have a bunch of shocks, eventually the regime collapses. So institutions mattered, but having also some policies mattered as well. On convertibility, I'll be really blunt. I think they lived under the delusion that one peso was one dollar. You know these currencies tend to collapse, so one peso is worth much less than a dollar. What s more, the peso-based assets were loans made to a government that was bankrupt. So the idea that a dollar in a Buenos Aires bank is the same thing as a dollar in Miami or New York was a false idea. CAVALLO: I d argue that the illusion that Argentina had that we were saving dollars is exactly the same illusion that people in Texas had that they were saving in dollars after the collapse of the price of oil in the late 1980s.
ROUBINI: But that's why all those savings and loans and oil companies went bankrupt in Texas. CAVALLO: But they went bankrupt in spite of the fact that the dollar was the American currency. If relative prices go down like if the price of oil plummets of course all the sectors whose income is tied to those prices will have a problem. You can t solve that with any monetary regime. BLEJER: Saved in pesos, in dollars, or in chewing gum, the banking crisis would have happened because the government was crowding out the private sector. The government was pushing bonds into the banking sector. And this has nothing to do with the exchange rate. CAVALLO: He s right. We created the climate for getting a lot of financing from our citizens, because they were convinced that they were saving dollars and that their savings were protected. They left their savings in the country and that generated credit. But if this facility for credit simply allows the government to raise funds, and the government wastes those resources and accumulates debt, of course it s bad. The question is how to keep the savings and create credit while also protecting property rights of the people. The answer is to impose discipline on the fiscal sector to prevent the misuse of those savings. BLEJER: Without macro-economic stability you are not going to have investment and growth. Argentina has paid a tremendous high price for this crisis, no doubt. Today more than 50 percent of the population lives below the poverty line, 25 percent are below what's called extreme poverty. Unemployment is 22 percent. I think that there is basic agreement in the fact that one needs to rebuild a different framework, but at the same time one has to be very careful to implement macro-economic policies that are conducive to the recuperation of confidence of credibility.
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