Argentina Financial Collapse

During the period of 1998 to 2002, the Argentina economy underwent a massive financial crisis. This was nothing unheard of, if economic experts were to be believed. Argentina had suffered severe bouts of hyperinflation in the preceding years. However, the Argentinean politicians had somehow found a way to navigate through two major financial crises without any significant damage.

This time, the issue became much more severe. The Argentinean crisis blew out of proportion. In fact many compare it with the Great Depression claiming that it has put Argentina behind by several decades and has ended up wiping out the existence of the Argentinean middle class. In this article, we will explore the events that lead to the crisis as well as the consequences of this massive crisis.

Military Causes

For several years prior to the 1998 crisis, Argentina had been a country that was embroiled in multiple wars. Also the fragile political atmosphere at home had created a situation of a civil war like situation at home as well. Argentinean political class was composed of several warring factions, the objective of each of them was to gain control over the nation.

Therefore, Argentina was in a constant state of emergency in those years. Fighting wars wrecks havoc on any country’s economy and Argentina was no exception. The billions of dollars of debt that later became a bone of contention were borrowed during this period with wartime emergency being the pretext used for such massive borrowing.

Economic Causes

The economic causes of the Argentinean crisis were very similar to the Mexican crisis. Firstly, they had incorrectly pegged their peso to the dollar on a one to one ratio. The peg overvalued Argentina’s currency to begin with. To add to it, the Argentinean government continued to inflate their currency unchecked. The average inflation rate in Argentina during the 1990’s was 10% per month. On an annual basis, this translated to close to 200%. Hence, the peg of the peso with the dollar that inflated at around 5% created a significant anomaly in the markets. The exchange rate was completely artificial and hence bound to fall out.

As a result of this bizarre exchange rate situation, Argentina found it extremely cheap to simply import goods. However, their exports were unnecessarily expensive. This caused a massive trade deficit. The trade deficit was being financed by hot money inflows i.e. by “portfolio investment”. This, as we know by now, is an unstable way to finance deficits since this money can be taken out of the country in a matter of minutes. That is precisely what happened. As the Argentinean currency crisis took off, investors pulled off their money immediately causing a 50% decline in the Argentinean Forex reserves within a few days.

Lastly, Argentina had a significant amount of dollar denominated debt. Therefore, if it simply devalued its currency against the dollar, it would end up multiplying its debt! Argentina therefore faced a severe currency mismatch on its balance sheet.

Effects

The Argentinean crisis of 1998 caused massive outrage the country. It was one of the first times in modern history when regular people took to the streets and started protesting economic policies

Bank Freeze: The Argentinean population had lost confidence in their local currency. They believed that the value of their local currency was about to be significantly devalued. Hence, they would lose money if they simply let it sit in their bank accounts. As a result of this widespread belief, people started queuing up outside banks trying to withdraw their cash. Once they got their hands on the local currency, they would sell it in the Forex markets and buy the United States dollars causing further fall in their currency value.

In order to prevent this, the Argentinean government took some desperate measures. One such measure was to freeze the bank accounts of the general population and they were not allowed to withdraw cash. This further gave credence to the people’s fears that the government is on the defensive. As such, the black market transactions skyrocketed and the local currency continued to lose its value rapidly despite government attempts at preventing such a decline.

Unemployment: The Argentinean crisis is often compared to the Great Depression. Often, economists refer to it as the Great Depression of South America. This is because of the large scale unemployment that it caused. The official figures of unemployment during that period were 25%. This meant that on an unofficial note, close to half the population was either unemployed or underemployed. Since there was so much uncertainty about the currency, local businesses were hesitant to borrow any money and expand their businesses. In fact, they were paying off their debt as fast as they could in order to avoid the risk. Also, the foreign trade was completely disrupted during that period due to wildly fluctuating Forex rates further exacerbating unemployment.

Devaluation: The final effect of the Argentinean crisis was breaking the peg between the United States dollar and the Argentinean peso. The peso faced rapid devaluation as the market adjusted itself. Also, the peso faced speculative attacks as traders tried to take advantage of the negative market sentiment against the peso to make a quick buck.

Vulture Funds: The courtroom battles between the vulture funds from the United States and the Argentinean government continued long after the crisis was over. Many of the vulture funds had purchased the debt far below its face value and stood to make a lot of money even if Argentina paid off its debt partially. Some funds stood to gain over 1000% if the Argentinean debt was completely paid off. As a result, the government of Argentina requested some of these funds to accept partial payment of debts. However, they refused and the matter was brought to the United States Supreme Court where the ruling was given out in favor of the vulture funds. The vulture funds gained a lot of negative publicity during that period.


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