Currency devaluations, particularly in emerging market countries, have been a common occurrence during the past decade. Since 1995, the currencies in, among other places, Mexico, Thailand, South Korea, Indonesia, Russia, Brazil, Turkey, and most recently, Argentina have been devalued. The devaluation of the Argentine peso was, however, like no other. It was in a class by itself.
On January 6th, the Duhalde government repealed the Convertibility Law of 1991 which had established a parallel currency system in which the peso and dollar legally circulated at a peso-dollar rate of 1-to-1. To replace that setup, a dual exchange rate was established: a temporarily pegged rate of 1.40 pesos per dollar for certain transactions and a floating rate for all other transactions.
Just what sets Argentina’s devaluation apart? For one thing, the foreign exchange markets were closed from December 21, 2001 until January 11, 2002, an unusually long period. In addition, at the time of the devaluation, the central bank held a very large stock of foreign reserves relative to its peso monetary liabilities. But what made the devaluation truly unique and unprecedented in the contemporary setting was the fact that it involved legal plunder, something that has gone unnoticed and unreported.
To get a handle on all this, we must go back to basics. And there is no better place than in Frédéric Bastiat’s (1801-50) classic pamphlet The Law, which was published in June 1850. Bastiat was not a legal positivist. Accordingly, he did not use the word “law” to denote any decree or statute approved by a legislative assembly. For him, the word “law,” when used correctly, had to meet certain moral criteria. And the main features of that morality included liberty, justice and property.
Bastiat referred to two types of plunder: illegal and legal. The illegal type, such as theft and swindling, is dealt with by a penal code. Bastiat didn’t dwell on this type of plunder. Instead, he focused on the more complex issues surrounding legal plunder. That type of plunder occurs when a law is passed that takes from some persons what belongs to them and gives it to others to whom it does not belong.
This brings us to the uniqueness of the Argentine devaluation. The Convertibility Law gave a peso holder the right to freely convert a peso into a US dollar. That redemption pledge was made credible because the central bank was required by law to hold foreign reserves to fully cover its peso liabilities. It was this redemption pledge that made the convertibility set up unique and distinguished it from the typical fiat money system.
With the repeal of the Convertibility Law on January 6th, the redemption pledge was thrown to the winds and the peso holders’ claims on foreign reserves held at the central bank were revoked. Argentina’s devaluation, then, represented more—much more—than a garden-variety devaluation. It was a great bank robbery. Foreign reserves equal to USD 17.8 billion that were the property of peso holders were confiscated by the government.
That was just the beginning. In addition to stealing the foreign reserves from people who held pesos, the Duhalde government has passed other laws and issued regulations that trample on property rights and make a mockery of the rule of law. This legal plunder was authorized by the Argentine Congress on January 6th, when it approved the Law of Public Emergency and Reform of the Exchange Rate Regime. This law transfers extraordinary powers to the President of the Republic and allows him, in effect, to rule by decree for two years. In consequence, the government has introduced one measure after another that has taken property without compensation.
- Contracts denominated in dollars will be redenominated in pesos.
- Bank loans denominated in dollars below $100,000 will be redenominated in pesos at the old 1-to-1 rate. These include: mortgages, home improvement loans, personal loans, auto financing, small and medium sized business loans and credit card balances.
- Public utilities will be required to bill in pesos, not dollars, and will no longer be allowed to index their prices to changes in US inflation. This will alter the terms of many recent privatization agreements.
- Rents formerly paid in dollars must be payable in pesos for 180 days and then be renegotiated in pesos.
- Any “unjustified” layoffs during the next 90 days will require indemnification at a rate double that required under the previous law.
- Oil exports will be taxed at a rate up to 40%, and in principle, these tax revenues will be used to subsidize the banking system.
- Argentine companies will not be allowed to buy dollars to pay foreign creditors, unless they first negotiate a three-year extension of maturities on their loans. This will result in a forced default on a great many corporate loans.
- Farmers will receive special treatment (as yet, not specified) when they renegotiate their dollar-denominated debt.
- Contrary to an earlier pledge by the government to retain peoples’ deposits in the currency in which they were denominated, the government will redenominate all deposits into pesos.
- Any proceeds received by private pension funds from term deposits at banks will be required to be invested in government bills. Consequently, private pension plans will be required to purchase paper from an issuer that is in default.
- A bankruptcy code has been proposed that will be prejudicial to foreign creditors and companies. If enacted, this will flaunt a basic tenet of the rule of law: equality before the law.
In addition to not trusting the peso, Argentines don’t trust their banks. And for good reason. In August and November of last year, Domingo Cavallo, the former economic czar, engineered “voluntary” debt swaps in which local banks swapped liquid, relatively high yielding government bonds and bills for lower yielding illiquid notes guaranteed by earmarked tax revenue. This maneuver was designed to save the government money. However, it put a big dent into the banks’ balance sheets and rendered many banks illiquid. Due to the imposition of recent measures, the banking system has been pushed into insolvency, according to a Moody’s report of January 18th.
And given the current sorry state of affairs, a recapitalization of the banking system is probably not in the cards. What prudent banker would pour more money into what has become a legal black hole? And forget the Argentine government. It’s broke. That leaves the IMF and other multi-national outfits. Will they turn a blind eye to legal plunder and cough up the big bucks needed to recapitalize the banking system? If they do, they will be accomplices in a crime. If they don’t, the banking system will remain insolvent.
Argentines’ savings are trapped in an insolvent banking system. And if that isn’t bad enough, their dollar savings are rapidly being redenominated into a sinking peso. It is not surprising that about 80% of the population yearns for the convertibility system, and that the street violence in Argentina refuses to subside. Even though few Argentines have ever heard of Bastiat, they know legal plunder when it hits them in the face.
What makes Argentina’s devaluation so amazing is the fact that most independent economists, most of the press corps, the International Monetary Fund, the Bush administration and you name it thought, and still think, it was necessary. Apparently, legal plunder is acceptable, if not necessary, in Argentina, but not in Zimbabwe.
Why was Argentina’s devaluation necessary? The story goes like this and has been repeated ad nauseam. Under the Convertibility Law, the peso was linked to the strong dollar and became overvalued. This rendered Argentina uncompetitive, caused the economy to slump and forced Argentina to default on its debt.
Does this story hold water? The claims about Argentina's lack of competitiveness are nonsense. A classic sign of uncompetitiveness caused by an overvalued currency is declining exports. But 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 the real growth in world trade was only 0.9% (estimate) 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 the government would not be bankrupt.
In an attempt to bolster their overvaluation claims, many asserted, on the basis of taxi rides from the airport or other casual impressions, that prices were high in Buenos Aires, and that high prices were evidence the peso was significantly overvalued against the dollar. A recent Union Bank of Switzerland survey of prices in 58 of the world's largest cities found that for a basket of 111 goods and services, weighted by typical consumer habits -- including three categories of house rent -- Buenos Aires ranked 22nd, about midway between the most expensive city, Tokyo, and the least expensive, Bombay. The survey also found those taxi rides that were allegedly so expensive cost about 8% less than in Rio de Janeiro.
And there are plenty of other indicators that contradict the overvaluation story. For example, the Economist magazine’s Big Mac Index indicates that the peso, before its devaluation, was 2% undervalued. This didn’t stop the Economist from repeatedly editorializing about an overvalued peso. Even though the Big Mac Index, as well as more sophisticated estimates of equilibrium exchange rates, should be treated with skepticism, a recent careful study of the matter using data from 1993 to 1999 indicates that the peso was always within 6% of its so-called fundamental equilibrium real exchange rate.
The overvaluation story is a lie, one that created nothing but cover for the peso devaluation. Never mind. Will the devaluation get the economy going again? Let’s go through the arithmetic on the restrictive and unrealistic assumption that the devaluation is the only thing that has happened in Argentina. To stimulate Argentina’s exports by 1%, the real value of the peso (adjusted for inflation) would have to depreciate by 10%. Exports in Argentina only accounted for 9% of GDP last year. This implies that if the current devaluation of 50% (the floating peso is trading at two to the dollar) doesn’t pass through to any domestic inflation—in short, if the nominal devaluation is a real devaluation—exports will increase by about 5%. Even under these unrealistic assumptions, a 50% devaluation would only add less than a half percent to GDP. Consequently, in the best of all possible worlds the devaluation will add very little to a GDP that has, thanks to the devaluation and the new exchange-rate regime, collapsed.
Any way you cut it, there was no factual justification for Argentina’s devaluation. And given the property rights enshrined in the Convertibility Law, there was no moral basis, either. The same can be said about all the other measures in which the Duhalde government has flaunted the rule of law. All this was apparently more than the finance ministers from the member states of the European Union could bear. On January 22nd, they issued a joint “Statement on Argentina” in which they called the Duhalde government on the carpet for not abiding by the rule of law and the principles of a market-based economy. This is encouraging, particularly given that most of these ministers are members of socialist parties. Unfortunately, the same can’t be said of the Bush administration and its Trojan horse, the International Monetary Fund. Unless they reverse course, they will be accomplices in Argentina’s crime.
This article originally appeared in Friedberg’s Commodity and Currency Comments, v. 23, no. 1, January 28, 2002.