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Home , Domingo Cavallo, Economist

And the Kept Rolling In (And Out)

Wall Street, the IMF and the Bankrupting of

by Paul Blustein Public Affairs © 2005 278 pages

Focus Take-Aways

Leadership & Mgt. • Argentina's hyperinfl ationary economic chaos ended in 1991, thanks to a system of Strategy strict 1:1 convertibility between the peso and the U.S. dollar. Sales & Marketing • Against all expectations, Argentina achieved monetary stability. Corporate Human Resources • Argentina's boomed. Foreign investors poured capital into the country. Technology & Production • International and brokerage fi rms hyped Argentine bonds. Small Business • As Argentina's levels of indebtedness grew to unsustainable levels, confl icts of & in fi nancial institutions led them to promote Argentine bonds even more. Industries & Regions Career Development • Argentina was reluctant to abandon the peso's 1:1 with the dollar. Personal Finance • Regulators who might have forced discipline on Argentina – most notably the Concepts & Trends International Monetary Fund – failed to do so. • Instead, they kept extending fi scal rescue packages. • Eventually, the game was up. By 2001, Argentina hit economic and political chaos. • Although Argentina's is most directly responsible for the country's plight, international banks and international regulators contributed greatly to Argentina's fi nancial fi asco.

Rating (10 is best)

Overall Applicability Innovation Style

9 n/a 8 9

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What You Will Learn In this Abstract, you will learn: 1) How Argentina’s economy revived; and 2) How it then crashed again, as the country snatched fi nancial failure from the jaws of victory.

Recommendation This is a very readable, lively presentation of the story of how Argentina overcame decades of monetary mismanagement and put itself on the path to during the early 1990s only to descend again into economic chaos. getAbstract.com recommends this book to those interested in international fi nance, although it suffers slightly from a moralistic tone, as author Paul Blustein points an accusing fi nger at international banks and brokerage fi rms. One might also have hoped for a bit more insight into what happened to the billions of dollars that fl owed into Argentina during its brief boom years. But Blustein’s expert analysis (organized around metaphorical references to the musical Evita) says much about the dark side of and points to some severe, apparently recurring problems in the international fi nancial system. Most instructive is his observation that elements of Argentina’s experience are now apparent in the fl ow of funds to emerging markets newly favored by international investors. Therefore, this book unfortunately may be a harbinger of things to come.

Abstract

“Globalization’s Big Bust” “The collapse The story of Argentina’s bubble is one of euphoric optimism, reprehensible greed, of the Argentine economy…was irresponsible regulation and tremendous suffering, including children dying of one of the most malnutrition and losing everything as their banks collapsed. spectacular in modern history.” Major international banks and brokerage fi rms collected about $1 billion for their services underwriting Argentine bonds from1990 to 2000. With that much money at stake, banks had no incentives to publicize doubts about whether these bonds were truly sound . As was the case in the U.S.’s corporate stock scandals during the same period, security analysts whose pay depended on keeping stock salespeople pros- perous painted too rosy a picture of the investment quality of Argentine bonds. But confl ict “In a country of interest was not the only factor driving Argentine investments. The that inves- like Argentina, (Economy tors use to measure money managers’ performance encouraged imprudent investment in Minister Domingo) Argentina because it gave the most weight to the country that borrowed the most money. Cavallo believed, Thus, the more indebted Argentina became, the more important it was for money manag- monetary was a dangerous ers in emerging markets to buy additional Argentine bonds. But the Argentine fi nancial instrument, a fi asco was not entirely the fault of bankers and brokers. The Argentine government failed view effectively to exercise fi scal discipline, and international regulators proved excessively indulgent. endorsed by the Argentine public, The eventual Argentine economic collapse, stemming from fi nancial events in 1999 and which by and 2000, had severe consequences for the people of Argentina and for the world as a whole. large came to see convertibility as a For many years, the International Monetary Fund (IMF) had pointed to Argentina as the contract locking case study for sound fi nancial and the benefi ts of globalization. The fact that a its undisciplined favored darling of the international capital markets could come to such an ignominious end government into acting sensibly.” provides ample ammunition for the anti-globalization movement. But what actually went wrong? A timeline of the Argentine collapse shows plenty of blame to go around.

And the Money Kept Rolling In (And Out) © Copyright 2005 getAbstract 2 of 5 “Show Me the Money:” The Argentine Boom At the debut of the twentieth century, Argentina was one of the world’s wealthiest countries “The Argentine and seemed to have a brilliant future. However, the country squandered its opportunities. authorities chose In 1991, after the country underwent decades of hyperinfl ation and poor economic not to confront performance, Argentina’s new Economy Minister Domingo Cavallo adopted a radical enough powerful to ensure new system to force fi nancial discipline on the country. The essence of “the convertibility the adoption of system” was to remove Argentina’s discretion over its by fi xing the exchange a more prudent rate at one Argentine peso to one U.S. dollar. Despite numerous doubters and skeptics, this fi scal policy.” convertibility system made it possible to tame Argentina’s hyperinfl ation from 1991 to 1994, and to establish the monetary foundation for economic growth.

Meanwhile, to address other problems that had stymied economic progress, the Argentine government deregulated industry, removed barriers and privatized government enterprises. Notwithstanding some problems with corruption in the program, and some serious shocks to groups that had benefi ted from the previous protectionist regime, on the whole the new economic order seemed to succeed splendidly. It passed “Today, remorse runs deep at a diffi cult test in 1995, when a fi nancial crisis in Mexico tainted all emerging markets the IMF on this investments. Argentine fi nancial markets suffered but quickly rebounded. point, and many economists’ Cavallo was a national hero, and foreign investors were eager to pour funds into the postmortems Argentine success story. In 1997, the IMF (whose ranks included many people who agree: was one had been skeptical about the convertibility program) gave its blessing to Argentina by of the crucial establishing a “precautionary” program to provide the nation with emergency monies junctures where if needed. But little evidence indicated that Argentina would ever need the emergency Argentina went wrong.” funds; it seemed safe and sound. Notwithstanding the Asian fi nancial crisis that erupted that year, investors continued to buy Argentine bonds. Unfortunately, investor avidity for those bonds made it easy for Argentina to incur beyond prudent levels.

As Argentina’s -to-GDP levels climbed, IMF analysts began to raise troubling questions about the country’s long-term solvency. In April 1998, IMF offi cials warned fi nancial markets that a meltdown could occur. The market shrugged off the warning. Later that year, the IMF prepared to deliver an ultimatum to Argentina: reform the labor market or “Argentina had face the withdrawal of IMF support. However, the Russian and the collapse of a skirted around a major hedge fund put the entire global fi nancial system in jeopardy. Rather than exacerbate squall – the crises uncertainty by confronting Argentina, the IMF backed away from its ultimatum. Instead affl icting Asia and Russia.” of disciplining Argentina, global fi nancial regulators invited Argentine President to address the annual meeting of the IMF and World .

The Argentine or “This May Not Be Paradise” In 1999, Brazil precipitated a crisis by devaluing its . Since Brazil was a major export market for Argentina, its made Argentina’s exports considerably more expensive. Argentina’s exports fell – just as one would expect. Meanwhile, worldwide commodity also were falling, cutting Argentina’s hard currency earnings from “But the place in wheat and other agricultural exports. At last, international investors began to worry about which it had taken Argentina’s ability to service its debt. Argentina found itself trapped in a vicious cycle. shelter was about to be struck by The recession led to bigger budget defi cits, which led to more market skittishness, which wave after wave led the markets to demand higher interest rates on Argentine bonds, in turn leading to an of bad news.” even deeper recession. Argentina’s country risk surged. A new president replaced Carlos Menem, who left under a cloud.

And the Money Kept Rolling In (And Out) © Copyright 2005 getAbstract 3 of 5 In January 2000, the new government took aggressive action to cut spending in a bid to reduce its budget defi cit. However, reducing reduced national demand, worsening the recession. As Argentina’s (GDP) fell, its “The crunch put debt-to-GDP ratio climbed. Since debt to GDP is a critical measure that foreign investors Argentina in a use to assess country risk, the international investment community was growing more position analogous to that of an skeptical about Argentina. Their skepticism intensifi ed in October when the leftist individual with a vice president resigned to protest the government’s aggressive defi cit-cutting measures. hefty credit card Political instability coupled with the rising debt-to-GDP ratio made foreign investors balance who more nervous. suddenly fi nds the credit card In December 2000, the International Monetary Fund agreed to lend Argentina $14 companies no longer willing billion to help shore up confi dence in the country, and to give the government some to offer low breathing room to sort out its diffi cult problems. The IMF approved the controversial promotional in January 2001. One IMF director noted that Argentina’s exports were only interest rates on 20% of its debt, and said debt service would consume all the hard currency that those their cards.” exports generated. Clearly Argentina’s debt burden was unsustainable. Experts seriously questioned Argentina’s ability to stay the course of fi scal discipline – and worried that even if it did stay the course, it would not be able to generate enough economic growth to improve its debt-to-GDP ratios. The skeptics proved to be prophets. Under attack for budget discipline, the new “Needless to government’s Economy Minister resigned within months. His successor lasted three say, members weeks. Somewhat in desperation, the new president reappointed Domingo Cavallo, who of the fi nancial had worked an apparent miracle by engineering Argentina’s prosperity during the early community were not pleased about 1990s. Cavallo was confi dent to a fault. Notwithstanding his earlier success, this time this trend.” his confi dence was not contagious. Investors continued to be wary of Argentina, and Cavallo’s apparent disrespect for IMF offi cials did not build goodwill in that important offi ce. By late spring of 2001, Argentina concluded a “megaswap,” in which bondholders accepted new bonds in exchange for their old bonds, agreeing to stretch out Argentina’s payments, but at a high cost to the nation. Contrary to Cavallo’s hopes, the swap did not reduce Argentina’s country risk. As Argentina’s country risk rating climbed, so did its borrowing costs. “The country’s debt burden was That summer, Cavallo implemented a so-called “zero defi cit” program that cut deeply simply too large, into Argentine government salaries and welfare payments. By summer’s end, the IMF its economy had offered another fi nance package: $8 billion – including $3 billion to facilitate debt too torpid, and restructuring. But this new IMF facility was even more controversial than the earlier, $14 its chances for escaping its trap billion fund. By now, almost everyone involved clearly saw that Argentina’s situation was too remote.” unsustainable. It had borrowed more than it could repay, and would have to restructure its debts. However, the U.S. Treasury Secretary opposed involuntary restructuring and insisted that the new $8 billion package include $3 billion to support a voluntary restructuring (if Argentina could reach such an arrangement with its lenders). The Argentine economy continued to weaken. For a long time, the IMF had urged Argentina to abandon its convertibility system, which effectively locked the country into a fi nancial straitjacket. The strict 1:1 exchange rate made it impossible for Argentina “The wait for full-fl edged to respond to the recession with an accommodating . But no matter panic would how onerous the convertibility system became, ending it would be neither simple nor not be long.” straightforward. Many had incurred debt in dollars, confi dent that their peso income was as good as dollars. These debtors would suffer greatly if the peso fell against the dollar. Moreover, the convertibility system had been a cornerstone of Argentina’s

And the Money Kept Rolling In (And Out) © Copyright 2005 getAbstract 4 of 5 hard-won fi nancial credibility and was the foundation of Cavallo’s reputation. He was understandably reluctant to abandon it. The Argentine story moved with tragic inexorability. By late autumn 2001, the situation “Like an engine that has seized was so dire that foreign fi nanciers themselves proposed that Argentina restructure its debt. up for lack of oil, Effectively, they were demanding that Argentina pay them less than it owed. Indeed, the the Argentine Argentine government responded in November with a debt-restructuring plan that would economy ground trim Argentina’s interest payments by $4 billion per year. Rating agencies answered by to a virtual halt, as additional downgrading Argentina’s bond rating. Argentina’s foreign exchange reserves fell farther. restrictions Apparently the IMF funds merely had made it possible for investors to get their money on bank out of the country. Argentines launched a run on their banks, trying to pull their money withdrawals led to a breakdown – especially their dollars – out of their accounts before the banking system collapsed. in the system by In December, the Argentine government responded with the “corallito,” severely which people and businesses pay restricting bank withdrawals and money transfers. Also in December, the IMF withdrew each other, and its mission chief and announced that it could not disperse additional funds to Argentina. the bank credit Massive protests erupted, some of them violent. By the end of December, the presidency that companies need for day-to- was a revolving door – four presidents took offi ce and resigned within 10 days. By January day commerce 1, the fi fth president stepped in; that month, he ended the peso convertibility program. dried up.” “Don’t Cry for Them, Argentina” An irresponsible Argentine government failed to exercise prudence and discipline. Greedy international investors hyped Argentine debt and encouraged unsustainable borrowing. International fi nancial regulators lost their backbone. The innocent suffered. What are the deeper lessons of the Argentine experience? The fi rst is that nations need to be extremely cautious in accepting offerings from global fi nancial markets. The markets that suddenly make investment capital available can withdraw it just as abruptly. The rapidity with which funds move from place to place generates tidal forces in the fl ow of capital. These forces are strong enough to knock out the fi scal foundations of developing countries. Perhaps international fi nancial markets need to slow the fl ow of capital to minimize the potential for damage to fragile . Several such proposals are on the table, some based on taxing capital fl ows, some based on developing a sort of “It could happen “bankruptcy court” for nations. here…The United States has shown Argentina’s experience holds lessons for lenders and regulators. Most notably, the every sign of confl icts of interest exposed in the wave of corporate scandals in the U.S. during the having adopted late 1990s and the early 2000s have parallels in the sovereign debt markets. It might be that same cavalier, incautious advisable to extend to these markets the same kind of investor protections familiar in the attitude in the stock markets. Finally, Americans can learn a particular lesson from the Argentine fi asco. fi rst few years of Like Argentina, the U.S. has become complacent about the availability of capital to fund the twenty-fi rst its defi cits. By some predictions, the U.S. debt-to-GDP ratio may be as high as 50% by century.” 2015. After that, it is only likely to grow. Of course, the U.S. is no Argentina. But could it be? The penalty for lack of fi scal discipline is severe. Argentina’s economic show some recovery, but Argentine was close to 20%, and nearly half the Argentine population had slipped below the line.

About The Author

Paul Blustein, a staff writer at The Washington Post, has written about business and economic issues for a quarter of a century. He is also the author of The Chastening: Inside the Crisis That Rocked the Global Financial System and Humbled the IMF. And the Money Kept Rolling In (And Out) © Copyright 2005 getAbstract 5 of 5