Don’t Give ‘em a Cent

January 30, 2002 • Commentary
This article originally appeared on National Review Online on January 30, 2001.

Many people — including economists who should know better — claim the crux of the Argentine crisis was an overvalued peso. Supposedly, the peso’s link to the strong U.S. dollar in 1991 made the peso overvalued. This rendered Argentina uncompetitive, and caused exports and the economy to slump. The facts don’t support this story, however. Argentina’s exports increased every year in the past decade except 1999, when Brazil, its largest trading partner, suffered a currency crisis. Exports during the first 11 months of 2001 were about 3.2% ahead of exports during the same period in 2000. Considering that estimated real growth in world trade was only 0.9% last year, Argentina’s export performance was relatively strong. Indeed, the export sector has been one of the few bright spots in the Argentine economy. If the rest of the economy had been growing as fast as the export sector during the last two years, Argentina would not be in a recession and Argentina would not have defaulted on its debt.

Never mind. Those who embraced the uncompetitiveness story used it as a cover to argue the Argentine peso needed to be devalued to get the economy moving again. After all, they confidently asserted, a devaluation in Argentina would be no different than the devaluations in Mexico, Russia and Brazil.

This claim — like the uncompetitiveness story — doesn’t hold water. Under the Convertibility Law of 1991, Argentina employed a parallel currency system in which the peso and the dollar both legally circulated in Argentina and traded at a peso‐​dollar rate of one‐​to‐​one. On Jan. 6, the Convertibility Law was repealed and the peso devalued. What set Argentina’s devaluation apart from other devaluations is that it involved what Frederic Bastiat (1801–50) termed legal plunder. That’s when a law is passed that takes from some persons what belongs to them and gives it to others to whom it doesn’t belong.

The Convertibility Law gave a peso holder the right to freely convert a peso into a U.S. dollar. Argentina’s redemption pledge was credible because the central bank was required by law to hold foreign reserves to fully cover its peso liabilities. This right of redemption made the convertibility system unique and distinguished it from typical fiat money systems. Accordingly, Argentina’s devaluation was like no other.

With the repeal of the Convertibility Law, the redemption pledge was thrown to the winds and the peso holders’ claims on foreign reserves held at the central bank were revoked. Consequently, Argentina’s devaluation represented a great bank robbery, one in which the rights to US$17.8-billion in foreign reserves were abolished by the government.

For the government of Eduardo Duhalde, that was just the beginning. Indeed, the government has passed a string of new laws that trample on property rights and make a mockery of the rule of law.

As the Argentine government continues a seizure of private property worthy of the Bolsheviks, Argentina’s Foreign Minister Carlos Ruckauf is making the rounds in Washington on a mission of breathtaking audacity. He is passing the begging bowl to the U.S. government, the International Monetary Fund, the World Bank and the Inter‐​American Development Bank, demanding an aid package of $15‐​billion or more. Argentina should not receive one cent.

Duhalde has taken the difficult situation he inherited and made it much worse. The Law of Public Emergency and Reform of the Exchange Rate Regime, passed on Jan. 6, gives Duhalde powers that are almost dictatorial in scope until his term expires in December, 2003. Duhalde has moved swiftly to use the new powers. On Jan. 6, he devalued the peso to an official rate of 1.40 per dollar. In the free market the peso has traded around 1.75 per dollar, with the central bank intervening repeatedly to prevent the market rate from depreciating to more than 2 pesos per dollar. In addition to wiping out the claims that peso holders had on foreign reserves at the central bank, this step immediately wiped out 30% or more of the 31‐​billion pesos in paper money and bank deposits that Argentines held at the time.

Argentina’s long history of monetary instability has led its people not to trust the peso, even when its exchange rate against the dollar had remained stable for almost 11 years, as was the case until the devaluation of Jan. 6th. Consequently, most bank deposits and loans in Argentina are in dollars. Duhalde announced that dollar loans up to $100,000 would be converted into pesos at the old rate of one peso per dollar. Dollar deposits, on the other hand, were to remain payable in dollars, though withdrawals would remain limited.

Moody’s estimated that the conversion would cost Argentina’s banks up to three times their $18‐​billion in capital. Nearly half of the deposits in Argentina’s banking system are in foreign banks owned by such big names as Citigroup and FleetBoston, Spain’s BSCH, Britain’s HSBC and Canada’s Scotiabank. They immediately began considering walking away from Argentina, leaving the government to pay the difference of up to $36‐​billion between bank liabilities and the bank assets the government’s policies are gutting.

A bailout of such magnitude would be equivalent to the government’s annual revenue. The government backpedalled and to reduce the sting of the “pesofication” of dollar loans, it announced a “pesofication” of dollar deposit liabilities at 1.4 pesos per dollar. Taking into account the market rate for the dollar is about 1.75, the implied loss is at least 20% — more than $9‐​billion out of total dollar deposits of $47‐​billion as of Jan. 6th. (A depreciating peso would, of course, translate into more losses.) The details still are not clear because Duhalde is trying to avoid being rousted out of office by angry depositors.

The government has also prohibited Argentine companies from using dollars to settle their foreign debts in dollars. It has nullified the contracts it made with U.S. and other foreign companies when it privatized Argentine utilities. Consequently, these companies will no longer be able to base their charges on the dollar; rather, they will be forced to charge in pesos. It is near to passing a bankruptcy law that declares a moratorium on mortgage foreclosures for 180 days, further worsening the quality of bank assets. In addition, this law, if passed, would be prejudicial to foreigners.

The Duhalde government is robbing banks, bank depositors, corporations, and the man on the street who holds pesos‐​in short, everyone it can find. Tax‐​paying Americans (and Canadians) should not support a government that robs foreign investors. As long as Duhalde’s government follows its current policies, the Bush administration should refuse to offer any direct aid and should veto any proposal for the International Monetary Fund, the World Bank and the Inter‐​American Development Bank to lend money to Argentina. Fortunately, the U.S. government is required to do just that. Title 22, section 2370 of the U.S. Code, provides for suspending U.S. assistance to any country that seizes ownership of property owned by U.S. citizens or corporations or nullifies contracts with them.

The Bush administration should also advise Duhalde on what Argentina needs to do to succeed. The administration has said nothing publicly beyond bland statements that Argentina should develop a “sound” and “sustainable” program. It’s time to get specific.

Argentina needs to stop trampling on property rights and start encouraging economic growth. In contract law, it needs to reverse the steps it has taken under the law of public emergency. In monetary policy, Argentina should eliminate the peso and replace it with the dollar. Dollarization would allow the elimination of exchange controls and, after a short period, restrictions on bank withdrawals. In tax policy, Argentina should cut its top tax rates drastically. Thanks to three large tax increases in 2000 and 2001, many Argentine rates are much higher than those in the United States. Respect for property rights, a sound currency, and reasonable tax rates are a time‐​tested recipe for producing economic growth.


Government seizures of private wealth since the Jan. 6 law of public emergency :

- Confiscation of foreign reserves: $17.8 billion

- Devaluation of the peso: $9 billion or more

- Losses to banks from “pesofication” of dollar loans: $18–54 billion

- Losses to depositors from “pesofication” of dollar deposits: $9 billion or more

- Losses to companies from exchange controls, suspension of contracts, and other measures: unknown, but billions more.

Note: Argentina’s GDP was $271‐​billion and shrinking, even before the devaluation of the peso.

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