Default, Devaluation and Depression: Argentina after
Javier García Fronti (Universidad de
Buenos Aires and University of
Acknowledgements: We are grateful to the
ESRC for financial support supplied to the research project “Moral Hazard and
Financial Institutions” under Grant No. R000239216. We thank Mario Blejer,
Guillermo De la Dehesa, Matthew Fisher and Daniel Heymann for discussion and
suggestions; but responsibility for views expressed is our
eliminating price inflation, the currency board system operated in
proved extraordinarily successful; but, as Krueger and Fisher (2003) ruefully
observe, “the combination of a highly dollarized banking system and a rigid
exchange rate regime can result in vulnerabilities that are difficult to
Blame for the end of the currency peg and debt default has been
attributed to the progressive loss of competitiveness of the Argentine economy
over the decade when its currency was tied to the US dollar, and on growing
doubts about long run fiscal sustainability, which together led to a “sudden
stop” in the external finance, Gerchunoff and Llach (2003), Mussa(2002), Calvo
et al (2002). But the end of the dollar peg did not simply involve a
delayed devaluation; it took the
form of a ‘twin crisis’ in which a banking system heavily exposed to the
sovereign’s unsustainable debt played a central role in precipitating and
propagating economic contraction, Blejer (2003) and Sturzenegger(2003). The insolvency of
the entire banking system was, perhaps, the crucial element in accounting for
the depth of the collapse.
was inevitable and appropriate that, when Eduardo Duhalde was appointed as
president in 2002 and the peso lost
almost half its value in terms of
the dollar, there should be a write-down of bank assets and liabilities
in dollars, i.e. some ‘pesification’ of their balance sheets. What no one
predicted was an asymmetric
pesification - in which dollar deposits were converted to pesos at the rate of 1
to 1.4 and dollar loans converted
to pesos one to one – enough to wipe out the capital of the banking
system even before taking account of the writedown of bank holdings of sovereign
dollar denominated debt. Thanks to this enforced ‘de-dollarisation’, banks which
had been long the US dollar suddenly found themselves unhedged, so the fall of
the peso rendered them insolvent and brought the financial system to a halt.
the actual process of pesification
was to prove so disastrous, why was it chosen? The only plausible reason for the
asymmetry was the government’s desire to privilege the loan customers of the
banks, Sturzenegger(2003). (After pressure from the IMF and the resistance of
the banks, the government has - belatedly - issued new bonds to recapitalise the
authors cited above provide us with a graphic history of these events, their
causes and dire consequences, involving nothing less than an Argentine Great
Depression. Our aim in this paper is first to provide an account of the
implications of devaluation-with-pesification on bank balance sheets; and then to
incorporate this in a consistent framework of analysis, which includes other key
features, particularly the severe effects of the falling peso corporate balance
sheets. After describing how the enforced pesification of the banks can – and
did - lead to insolvency, we therefore turn to ‘third generation’ macroeconomic models of crisis to show
how this can produce a catastrophic collapse of the economy as a whole. To
capture the adverse impact of high interest rates and devaluation on the on the
supply side of the economy via the balance sheet effects on businesses and
banks, we adopt the approach developed by Aghion et al (2000, 2001) and adapt it
to fit the Argentine experience. We use it to show first how pesification can,
in principle, mitigate adverse balance sheet effects(although the contractual structure was so
dollarised that this would have difficult, Galiani et al., 2002) ; but how,
mishandled, it can plunge the economy into chaos.
Finally, going beyond the positive economics of the macro-model, we offer
a simple game theoretic explanation of why the ill-starred initiative of robbing
Peter (the banks) to pay Paul (loan customers) was pursued.
P., P. BACCHETTA,
and A. BANERJEE
(2000): "A Simple Model of Monetary Policy and Currency Crises" European Economic Review, 44,
— (2001): "Currency Crises and Monetary Policy in an Economy with Credit
Constraints" European Economic
Review, 45, 1121-50.
M. (2003) “On Currency Collapses and Bank Runs: Argentine Twin
at “International Financial Crises: What Follows the Washington Consensus?” Warwick
G. A. (2002): "On Dollarization" Economics of Transition, 10,
G. (2003): "Ganadores Y Perdedores De La Crisis Argentina" Foreign Affairs En
S., D. HEYMANN,
and M. TOMMASI
(2002): "Missed Expectations: The Argentine Convertibility".Universidad de San
Andres. Departamento de Economía. Documentos de
Randall (1999) "Is it Better to Forgive Than to Receive? Evidence from the Abrogation of
Gold Index Clauses in Long-Term Debt During the Great Depression”
Randall (2002) Panel discussion of the Argentine crisis; AEA Meetings ,
A. and M. FISHER
(2003): " Building
on a Decade of Experience: Crisis Prevention and Resolution” presented at
“International Financial Crises:
Follows the Washington
P. (1999): "Balance Sheets, the Transfer Problem, and Financial Crises," in International Finance and Financial Crises:
Essays in Honor of Robert P. Flood, Jr., ed. by P. Isard, A. Razin, and A.
K. e. Rose.
P. and J. LLACH
(2003) El Ciclo de la Ilusión y el
desencanto. 1a Ed.
M. (2002): Argentina
and the Fund: From Triumph to Tragedy.
Institute for International Economics.
F. (2003) La Economía de los Argentinos.
Buenos Aires: Planeta.