MONEY and BANKING PAPERS LOW GRAPHICS

 


T
he economic collapse of Argentina


by Heidi Mak
 

 

Is the economic collapse of Argentina at the fault of the government?
Argentina is a country with rich natural resources and abundant educated and energetic labor. Yet it fails to pull itself out of a recession that has lasted for too many years, according to its citizens. Many blame the International Money Fund (IMF), foreign influence, or political corruption for their monetary woes. However, others believe that the Argentinean government is to blame for the high unemployment rates and increased poverty. They believe that the government has spent more money than it has received; thereby, increasing the government deficit to unfixable levels, which has ultimately led to the downfall of the economy as a whole. These people are only partially correct; that is, yes the government is to blame, but not for its high deficit but for its bad decisions on monetary and fiscal policies.

Throughout history, the Argentinean government has made one mistake after another, which all eventually led to the stagnant recession the country faces today. The Argentinean government had focused on too many short-term gains to realize its true goals: long-term success. Throughout history, Argentina has faced a very unstable economy. To understand why the government has made its past choices, one must know about its past. Throughout the 19th century, the Argentina was a country dependent on its exports to foreign countries. Its grain and cattle industry were its strong exports. But foreign chaos, such as the First World War and the Great Depression, led the Argentinean economy to its own problems. Argentina soon switched from agricultural goods to manufactured good as a means to survive the new world of secondary goods. With such a huge switch, the government made all the factories and manufacturers state-own. Their goal was to provide for themselves; thereby removing any dependent problems they’ve had. Argentina became a self-sufficient country that lacked competition from foreign markets. However, due to the lack of enthusiasm and lack of profits, the economy soon returned to its downward spiral towards recession. As more debt poured into the country, more investors moved out. The rate of growth plummeted and the inflation rate skyrocketed to over 3,000 percent by 1989.

 

As a rebuttal against such economic horrors, the Argentinean government turned the state owned manufacturing factories into private owned. The goal was to end the monopolies and create competition; thereby, improving quality but lowering prices. In addition to the factory switches, the Argentinean government also deflated the peso by placing it at a one to one ratio with the American dollar. The money supply could only change if the money supply of the United States changed. Although these solutions seemed feasible at the moment, Argentina soon found out that they had made huge mistakes.

 When the Argentinean government privatized the companies, they thought that revenue and profits would occur quickly and naturally. But in reality, the state owned monopolies became private owned monopolies. Not only were they still monopolies, but also they were foreign owned. Therefore, any money gained did not end up back into the country, but rather to foreign countries. Also by fixing the peso to the dollar, the Argentinean government believed that they would have a more stable currency. This, in fact, was true. Inflation stabilized over zero percent. However, it also meant that Argentina was not allowed to pass any monetary policies to allow the economy to become flexible to any blows. Unfortunately, this was just the case.

 Around the mid 1990’s, Argentinean investors and citizens became wary of the government’s attempts to solve the economic debts. Therefore, many large investors began pulling money out of the country while citizens began to send their money to foreign banks. This was a part of the Mexican banking crisis (also known as the Tequila crisis). In addition, in the year of 2001, the IMF decided to cease their aid to Argentina. With all these factors troubling Argentina at the same time, it was no wonder that the country’s debt had reached over 52 percent of its GDP and their economy was in a deep recession with high unemployment rates and high poverty levels.

With all this said, the Argentinean government is to blame for the downfall of the economy. However, the recession is not due to the lack of responsible spending of the government; but, in fact, it is the government’s lack of ability to repay its debts. At first, the government had trouble in repaying its debt because the IMF had ceased to help Argentina with monetary aid. With such horrific news, investors were sure to pull out of the economy as fast as possible; therefore, the Argentinean economy faced even more debt. To make matters worse, the Argentinean government had to find alternative ways to pay off its debt. They turned to foreign loans. At the same time foreign lenders were wary of Argentina’s ability to repay its loans. Therefore, they raised the loan interest rates, which in turn, made the Argentinean debt even larger. With a bigger debt came a larger risk. People began to pull their money out of the country; thereby creating a smaller money supply, a larger debt, and higher loan interest rates.

 

By this time, interest rates had increased over 250 percent. This had become the vicious cycle that Argentina faced and since had not recovered from it. Throughout its history, Argentina has faced many difficult economic problems. However, they used poor judgment to solve them. They tried many “quick fix” answers without realizing the long terms affects. For example, they responded to the increase in demand for manufactured goods by becoming a self-run manufacturing country that led to high prices, few profits, and large debts. They, in turn, tried to solve this problem by changing the state-run companies into private owned. However, the problem was just worsened. What little money that was going back into the country was now going out into foreign markets. Also, as the inflation rates rose, they fixed the peso currency with the American dollar without thinking that it froze their ability to use monetary policies to allow the economy to become flexible to economic blows.

These are only a few examples of how the Argentinean government is at fault to creating a huge debt that they ultimately defaulted on. Many people have suggested solutions to Argentina’s economic problems. But few have suggested solutions that would actually be beneficial in the long run. This has been illustrated by the many presidents and economic ministers that Argentina has faced in the last few years. Even the IMF failed to realize Argentina’s true problem: their huge debt, not their deficit. Therefore, to solve their problems, they must first realize the cause: the foreign debts. To ease the strain, the IMF can renew their loan to the Latin American country to increase investments and lower risks. As people and investors become less wary of the future of Argentina, the economy will slowly stabilize with the lowering of interest rates. As more money is being invested into the country, production would increase which in turn would decrease unemployment. However, the government must be careful not to deflate the currency too quickly nor to use its newly acquired resources in some drastic action, such as the incident with the manufacturing companies in its past. Argentina would then slowly come out of its deep recession. However, the key point is slowly. As mentioned previously, short-term gains can lead to devastating long-term effects. Therefore, a slow and steady solution is one answer that Argentina should consider. The once vicious cycle can become a prosperous one.

Resources:

 “Argentina’s Economy: Why an economy with such potential is performing so poorly, and policy proposals for recovery” by Matt Hedges (April 2002) http://www.tradealert.org/view_art.asp?Prod_ID=46 http://www.csis.org/pubs/prospectus/01summer_rich.htm http://www.cei.org/gencon/019,02281.cfm

 

 

 

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