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Objective of the New Government Depleted, the BCRA Again Expanded Credit Lines Lehigh Preserve Institutional Repository The Debt Crisis Comstock, Art 1995 Find more at https://preserve.lib.lehigh.edu/ This document is brought to you for free and open access by Lehigh Preserve. It has been accepted for inclusion by an authorized administrator of Lehigh Preserve. For more information, please contact [email protected]. THE DEBT CRISIS Art Comstock Introduction which largely reflect the ineffective past politi­ cal and economic policies of the government. In Aprill982, Argentina declared default on I then analyze the effects of the crisis on the the servicing of its foreign-denominated-debts. Argentine economy and the current attempts This event has been called "one of the most trau­ to rebuild and restructure. Finally, I examine matic episodes in the history of world financial proposed solutions to the crisis and the poten­ crises on account of its intensity and length." tial effectiveness of each. (Montanaro, p. 73) Its effects on Argentina and the rest of the world still linger today. Origins of the Argentine Debt Crisis The Argentine debt continues to limit the nation's quest for development. Rather than A financial crisis can be defined as a momen­ investing in its future, Argentina continually tary lack of liquidity. It is usually caused by the pays for its past spending. Until recently, eco­ inability of financial institutions to make debt pay­ nomic progress has been slowed while scarce ments. Then, a "snowballing" effect occurs as resources are sent abroad to pay the debt. In investors panic, removing their funds from the order for Argentina to develop further, a solution system. A dangerous financial collapse ensues. must be reached; but the country cannot do it However, countries in the intermediate alone. The United States must make every effort stage of their industrialization process (like to help alleviate the crisis and create a mutually Argentina) often have very different underly­ acceptable solution. Mter all, the United States ing reasons for a financial crisis. In such has not only a financial interest, but also a polit­ instances, the main contributing factor can ical and a future investment interest in the res­ often be classified as a structural insolvency of olution of the Argentine debt crisis. the foreign sector. The situation evolves from In order to develop a solution, it is crucial a sustained growth in foreign debt due to cer­ to understand the nature of the crisis and the tain characteristics in the economic system. changes in the Argentine political structure These countries generally have a primary and that have occurred up to the present. In this an industrial sector which are distinct from article, I review the origins of the debt crisis one another. The primary sector is highly pro- 33 ductive and efficient, but the industrial sector (Montanaro, p. 73) The Argentine financial sys­ is immature and undeveloped. tem began with a policy of "financial repres­ For instance, in the Argentine case the pri­ sion" which forces a transfer of savings towards mary sector- farming- has been successful the protected sectors of the manufacturing due to the fertile land of the pampas. But, the industry, thus promoting an import-substitut­ industrial sector's relative productivity lagged ing industrialization. The newly established behind to such an extent that it could not com­ Banco Central de la Republica Argentina pete internationally with industries of more (BCRA) implemented such a structure, which developed countries. This inefficiency created brought about a period of temporary econom­ problems due to the exchange rate. In order to ic growth. The BCRA took upon itself all be competitive, the Argentine exchange rate responsibility for the government's decisions in was set at a level which allowed what was pro­ the financial sector, in the cost of credit, and it:J. duced in the agricultural sector to be exported the reward for saving. It imposed high reserve competitively. Thus, the exchange rate was set requirements and interest rate restrictions on on the basis of the competitiveness of the pri­ loans. Taken together, these factors created a mary sector, without recognizing the ineffi­ system that rewarded productive investments ciency of the industrial sector. In other words, and punished the accumulation of liquid assets. Argentina created a pampan dollar that could (Montanaro, pp. 73-74) not be sustained by the underdeveloped indus­ Over a period of about thirty years, this trial sector. (Wionczek, p. 236) model managed to sustain a stable and efficient As Argentine industry began to grow, how­ financial structure. Its success was mainly a ever, it required more and more foreign result of this government encouragement of exchange for importing raw materials and cap­ savings through investment in the economy. ital goods. But, because of the protective tar­ Such a trend in savings is often a necessary iffs established to make industrial products ingredient for the economic growth of an more competitive on the international market, underdeveloped financial structure into a devel­ the industrial sector did not export. All gener­ oped financial structure. However, these polit­ ation of foreign exchange was then left to the ical decisions throughout this period limited primary sector, which was growing much more the overall growth of the Argentine economy. slowly than the industrial sector. Eventually, Due to this financial repression policy of gen­ the primary sector could no longer supply the erating economic growth through import -sub­ foreign currency needed by the industrial sec­ stitution, the Argentine economy remained tor, and the foreign exchange reserves were closed to foreign investment and dependent exhausted. In order to continue its economic solely upon government institutions for pro­ activity and pay its foreign debt, the govern­ ductivity and growth. The domestic industry ment thus resorted to attracting foreign capi­ was sheltered from competition, due to the pro­ tal and credit. Of course, these funds only cre­ tective tariffs mentioned earlier; and as a con­ ated more debt payments that went unpaid as sequence Argentina experienced low growth as the cycle continued. And as the crisis in the compared to other developing countries. balance of payments progressed, more foreign Furthermore, as a result of the structural insol­ indebtedness was incurred to finance expendi­ vency of the foreign sector as mentioned earli­ ture in foreign currency. The end result was a er, the balance of payments crisis worsened; and growing accumulation of foreign debt and peri­ the government unwisely chose to increase the odic crises in the balance of payments. money supply in order to service the interest This structural insolvency of the Argentine payments on the foreign debt. As a result, infla­ system may have been the underlying cause of tion began to rise steadily in the middle 1970s. its foreign indebtedness, but ineffective politi­ In fact, in 1976 the annual rate of inflation was cal and economic policies further increased the about 382 percent, compared with an average structural difficulties. In fact, the financial his­ of only around 25 percent between 1960 and tory of Argentina beginning in the 1940s can be 1974. (Montanaro, p. 76) termed as one of "backward development." The new government regime that took 34 control in 1976 hoped to alleviate the inflation opportunities between the official and the effec­ problem by freeing the economy and increas­ tive rate of exchange, the plan failed. Market ing productivity in the government-owned investors recognized the discrepancy between industries. A plan of financial deregulation, the position held by the monetary authorities along with the abolition of foreign trade laws and the true position of the peso in the market, which previously hampered international and they continued to profit from it. exports, was also implemented. The plan's Furthermore, due to the discrepancy intention was to stimulate competition through between the crawling peg exchange rate and the a laissez-faire approach. Soon afterwards, the true rate, a banking "euphoria" erupted in the Banking Act of 1977 allowed banks to have late 1970s. The Argentine financial system and direct control over interest rates on deposits, the number of banks expanded rapidly. In fact, yet still called for a 100 percent guarantee by deposits grew by 86 percent and credit grew by the government of domestic deposits. In other 110 percent over the three years preceding the words, the act allowed the banks, investors, and crisis (1979 to 1981). Also, the spread between market competition to determine the going bank rates on loans and deposits increased sig­ rates. As these and other deregulatory measures nificantly. This difference showed the inexpe­ continued, an increase in M2/GOP 1 from .12 to rience of a banking system which had never had .245 followed in the next year. (Montanaro, the opportunity for correct risk evaluation due p. 77) This increase in the money supply rela­ to thirty years of financial repression. tive to GOP growth showed the inability of the Along these same lines, foreign speculation economy to grow at a rate equal to the increase further accentuated the debt problem. Financing in the monetary base, which was a result of the in pesos became the primary method by which money expansion freedom suddenly given to to acquire financial assets to use as collateral for banks. By allowing interest rates to float freely, dollar debts. This speculation was caused both the government opened the financial market by the greater profitability available due to the for product innovations in investments such as high differential between interest rates in time deposits and acceptance certificates of Argentina and those rates on the dollar, and by deposits; and so investors concentrated on these the overvaluation of the peso as stated above. For new short-term, profit-making opportunities. these reasons, between 1979 and 1981 the for­ However, this shift towards other investment eign currency debt obligation expanded from $19 opportunities only furthered the decrease in billion to $35.7 billion.
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