When I first met Carlos Menem in 1989, he had just been elected president ofArgentina and was promoting a program to liberalize its sick economy.Menem’s problem was hyperinflation. Until it was killed, his reforms wouldremain on hold.
What to do? Argentina had already tried almost every hyperinflation antidotein the book, and all had failed. By mid‐1990, Kurt Schuler and I hadproduced a sound money blueprint, Banco Central o Caja de Conversión. Itcalled for an orthodox currency board regime that would put Argentina’scentral bank in a straitjacket.
Menem embraced the idea in late 1990. To make it happen, he moved hisforeign minister, Domingo Cavallo, over to the Ministry of Economy. Cavalloand his team quickly drafted a convertibility law. And on Apr. 1, 1991, thecentral bank was put into a loose‐fitting straitjacket. It did the trick.Annual inflation, which was 1,345% in 1990, fell like a stone. Tradebarriers were reduced, and in 1993, YPF, the national oil company, wasprivatized in what was then the largest initial public offering ($3 billion)in the history of the New York Stock Exchange.
The lessons learned from Argentina’s experience are clear. During the glorydays of reform (1991–94), Menem maintained a unified command of thepolitical scene. The reforms—which were developed without the IMF’s guidinghand—were simple and implemented with speed in large packages. The resultsin the 1991–94 period were spectacular. GDP per capita measured in dollarsincreased by 72.8%.
In the wake of the 1995 Mexican tequila fallout, Argentina’s reform agendalost momentum. Even though Argentina pulled out of the tequila crisis andGDP grew at a 7% clip in the 1996–97 period, the reform agenda didn’t regainits former vigor as it should have. Menem’s second term was winding down andlosing altitude fast as the 1999 presidential elections approached. To makematters worse, the economy was slumping in the aftermath of the Braziliancurrency crisis of 1999.
Armed with an IMF austerity program, Fernando de la Rúa was installed aspresident in December 1999. Alas, de la Rúa had forgotten nothing andlearned nothing. By late last year, his economic game plan was in ashambles, and the economy was sinking further into recession.
In February events occurred that threatened to loosen the linchpin ofArgentina’s reforms, the convertibility system. A bad situation turned intoa crisis.
It started with what appeared to be a banking scandal. Two enterprisingdeputies—Elisa Carrio and Gustavo Gutierrez—claimed that two banks withcorrespondent relationships with Citibank had been involved in moneylaundering. With the aid of staff people to Democratic senators inWashington, D.C., the Argentine deputies brought their allegations to theSenate government affairs subcommittee. This set off a firestorm in BuenosAires. The governor of the central bank, Pedro Pou, found himself at thecenter of it. Since the alleged money laundering had occurred on his watch,powerful politicians wanted his head.
A Pou‐bashing frenzy ensued. Pou’s enemies wanted a replacement who wouldloosen convertibility’s straitjacket. Carlos Ruckoff, the mayor of BuenosAires, made this clear when he demanded that none other than Domingo Cavalloreplace Pou at the central bank. As it turns out, Cavallo had raised thepossibility of making the convertibility system more “flexible” at J.P.Morgan’s winter conference. The Feb. 8 issue of J. P. Morgan’s EmergingMarkets Today spells out what Cavallo had in mind. According to him,convertibility could be made more flexible by switching the peso’s anchorfrom the dollar to a basket of currencies.
The markets connected the dots pretty fast. They saw the basket for what itis, an exit strategy for convertibility and a possible peso devaluation.This prospect set the speculators in motion. The peso’s discount in theforward markets widened. And Argentina’s credit risk as measured by thespread between dollar‐denominated Argentine bonds and U.S. Treasurysincreased in lock step with the peso’s currency risk. No surprise there.With an increased probability of a peso devaluation, the probability of adebt rescheduling or default increased. With these market moves, Argentinawas engulfed in another crisis.
Cavallo is ironically once again Argentina’s economic czar. His task isenormous. He must not only regain his sound money credentials but also unifythe political forces behind his competitiveness proposals. The best way forhim to allay the market’s fears about his currency basket would be todollarize the economy.