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Argentina's Paper-Money Mire

Mises Daily: Tuesday, March 16, 2004 by

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Argentina's descent from economic prominence throughout most of the 1990s to purgatory by the end of the decade is a miserable tale instilling heartache and frustration in all parties involved. More importantly, this tragedy underscores the inherent hazards of state participation in capital markets.

On March 8, Argentina's government averted joining these pariahs as a state in arrears to the International Monetary Fund (IMF) when it indicated the country would shell out the $3.1bn due to the multilateral lender. Besides evading complete ostracism from international capital markets, the moves pave the way for a resumption of Argentina's access to Fund lending later this month, the impetus for the apparent quid pro quo.

The tentative reprieve comes on the heels of escalating bitterness between Argentina and its private and multilateral creditors. Tensions have burgeoned since Jan. 28 when eight out of the IMF Executive Board's 24 members, including the trio appointed by Group of Seven (G7) countries Britain, Japan and Italy, abstained from endorsing a $350m disbursement of the Fund's 3-year, $13.5bn accord with Argentina. The withdrawal of support testifies to the deep-seated reservations some countries harbor about continuing to extend credit to the debt-ridden government in Buenos Aires.

The skepticism is in large part prompted by the combative stance Argentina's president, Nestor Kirchner, has taken to restructuring billions of dollars of defaulted principle and interest due to holders of the country's sovereign debt. Not only do domestic and foreign bondholders wish to be indemnified but also multilateral lending organizations, ultimately bankrolled by governments, would like Argentine authorities to honor the terms of the loans these institutions so lavishly heaped on the country over the past decade.

From boom to bust

In 1990, with the county in the throes of another bout of economic and political turmoil, the incoming administration of Carlos Menem faced the daunting task of subduing inflation, which at that time was running at 150% per month. After inaugurating his tenure by transferring interest-bearing bank certificates into government bonds—effectively pilfering the savings of depositors—Menem appointed Domingo Cavallo to apply market-oriented austerity measures to the economy[i].

At the center of Cavallo's reform package was the "convertibility law," which pegged the peso one-to-one to the dollar, thereby limiting the Argentine government's ability to create money.

In nearly a single stroke, Argentina's battle with hyperinflation subsided, as the annual figure plunged from 4000% at the advent of the convertibility law to 4% by 1994. Concurrently real GDP growth exceeded 5% per annum each of those years.

Another consequence of the quasi-dollarization of the Argentine monetary system was the influx of foreign investment. Emboldened by the IMF's endorsement of Cavallo's reform package, which implicitly constituted a rescue pledge by the multilateral lending body, international creditors returned in droves to derive their fortunes in another emerging-market economy.

Akin to the East Asian countries that were also fashionable investment venues throughout the 1990s, the Argentine central bank's coffers filled with dollars from abroad, enabling the institution to expand the country's monetary base. Additionally, the country's private firms deposited loan disbursements from foreigners into domestic banks, further swelling the money supply.


The twin financial scourges of fractional reserve banking and a central bank abetted fiat currency pervaded the Argentine economy, making a boom and bust possible.

Thanks to the financial chicanery of central and fractional reserve banking, Argentina's money supply burgeoned at an average annual rate of 60% between 1991 and 1994. Notwithstanding Mexico's tequila crisis in 1994 and 1995, which prompted Argentina to post negative GDP growth in the latter year and nearly scotched the convertibility law, M1 money growth was still positive at 5% in 1995 and increased by 15% and 20% in 1996 and 1997, respectively[ii].

By 1998 the accretion of money in the economy had taken its toll, exacerbated by neighboring Brazil's—Argentina's largest trading partner—currency devaluation. Foreign capital infusions petered out as a hopelessly overvalued exchange rate, brought about by rising domestic prices and Argentine authorities' devotion to the one-to-one, peso-dollar peg appeared unshakeable. The heady boom of the 1990s, where GDP growth averaged 4.5% between 1990 and 1997, turned to bust as the Argentine economy lurched into recession.

Borrow and Spend

Argentine politicians' propensity to borrow and spend accelerated in tandem with the country's GDP and money supply growth during the 1990s. Unable to reside within the limits of a balanced budget the government tapped domestic and international capital markets to plug the shortfall in tax revenues vis-à-vis spending.

National government borrowing sprees were matched by the indefatigable spending tendencies of Argentina's provinces, which benefited from a constitution that permitted subnational authorities to splurge relentlessly, with a correspondingly feckless central government stuck footing the bill.

From 1993 to 1998 Argentina's entire public sector posted an increase in its indebtedness-to-GDP ratio from 29.2% to 41.4%. The rapid clip at which loans were accumulated was altogether more substantial considering that throughout the 1993 to 1998 period—save during Mexico's tequila crisis—GDP growth and the attendant cyclically spurred upsurge of tax receipts were impressive. At the same time, the central government was engaged in privatizing moribund state firms and assets, which supplemented the treasury's revenue intake. In sum, Argentine authorities could not run budget balances even amid robust economic growth and one-off collections of privatization proceeds.

As one would expect, the necessity of borrowing to sustain public spending in even the best of economic conditions portended fiscal travails for Argentine politicians as recession beset the country in 1998. Declining tax revenues coupled with rising demands for social spending (the other side of the cyclical coin) made fiscal consolidation more difficult to enact.

By late 2000, with one out of every five emerging market bonds worldwide issued by Argentina and its economy tanking, international investors began to question whether the country's mushrooming public debt would continue to be serviced.

Notwithstanding two last gasp attempts spearheaded by the IMF (discussed below)  in January and August 2001 to ward off an impending default, the political unfeasibility of fiscal tightening amid a protracted bust phase generated by fractional reserve banking proved too much for Argentine officials to surmount.

Faced with rising public discontent over a protracted recession, escalating interest rate spreads over US treasuries, and overwhelmed by rampant bank runs, Argentine officials abrogated the convertibility law and terminated regular payments on its domestic and external debt obligations of over $132bn—the largest sovereign default in history.

Settling Up

After nearly a decade of consistently positive GDP growth, privatizations and trade liberalization, Argentina was again a financial leper. After another year of penury in 2002, when GDP contracted by 11.2%, the economy grew by 8.4% in 2003 (the second highest rate in the world after China). Higher commodity prices, a revival in domestic consumption and an upswing in manufacturing stoked by a sharply devalued peso prompted the resurgence[iii]. GDP growth for 2004 is expected to remain vibrant, albeit slightly lower, from 4 to 6%.

The political picture has become more stable, relative to the raucous 1990s, as the former governor of the Patagonian province of Santa Cruz, Nestor Kirchner, has stamped his authority on the presidency since assuming office in mid-2003, taking to task the political actors that helped precipitate the country's boom and bust.

Corresponding to the revival of the country's economic fortunes, Argentina's tax take posted a 32% augmentation over 2002, with the government's revenues as a percentage of GDP back to its pre-recession level of 20%.

Despite the unanticipated resilience of the Argentine economy during 2003, the country's GDP is still 14% smaller than it was five years ago. Foreign financing of domestic firms is scarce, typically short-term in duration and subject to punitive interest rates. As private firms absorb the available stock of indigenous capital equipment and surfeit labor, these enterprises will become increasingly reliant on foreign lending to sustain the expansion.

With securing outside financing becoming imperative and the central government awash in tax revenues, the time for restructuring the approximately $100bn of total debts and $700m of interest in arrears accrued monthly has come to the fore.

Mutual Recriminations

On March 10, Argentina's cabinet chief reaffirmed the government's negotiating position, unaltered since it was first unveiled in September 2003. For every dollar (or foreign currency equivalent) worth of defaulted bonds held, Argentina will exchange it for a new bond with a face value worth approximately a quarter, bearing a coupon of one to two percent and maturity of 20 to 40 years. Put succinctly, Buenos Aires has demanded a write-down of approximately 92% of the obligations' net present value. Compensating lenders beyond these terms would not come at "the suffering and hunger of the Argentine people," according to President Kirchner.

Foreign creditors have responded to Kirchner's hard-line bargaining position with dismay and obstinacy, rejecting the offering outright and countering it by advocating a net present value write down of a more modest 50 to 60%.

Despite efforts to consolidate bondholder representation, including the January 12 announcement of the Global Committee of Argentina Bondholders (GCAB) and its steering group, which has brought aggrieved institutional investment firms and hundreds of thousands of European, East Asian and other retail investors together, the restructuring task remains acutely complex. Indeed, the existence of more than 100 separate bonds originating in eight jurisdictions and denominated in seven different currencies testifies to the daunting nature of the world's largest debt restructuring ever[iv].

Consistent with the hardened quality of his inaugural restructuring offer, Kirchner's administration had refused, until March 8, to recognize the legitimacy of the recently constituted GCAB. The dispatch of an Argentine official to attend the 24 February meeting of the bondholder organization in New York City as a mere observer had demonstrated the government's unwillingness to seriously engage a body collectively comprising $37bn in defaulted debt. The GCAB subsequently reciprocated the gesture by withdrawing from the consultative mechanisms instituted by Buenos Aires, thereby aggravating already rancorous relations.

Before Argentina's recent recognition climb down, the GCAB and other shortchanged lenders have resorted to and will likely continue to pursue two avenues utilized by creditors to extract payments from deadbeats: reliance on the court system to seize assets and calling on strongmen to exact payment.

Earlier this year, U.S. courts froze Argentine assets in Maryland and inside the Beltway, at least opening the door for lender confiscation. But as Thomas Griesa, one of the judges adjudicating these legal maneuvers observed, seizing Argentine assets in America or in any other country is largely ineffectual, saying, "I do not imagine that the Republic of Argentina has a lot of commercial activity in the United States." 

Bereft of a fighting force capable of appropriating government assets, Argentina's creditors have increasingly relied on the financial muscle of the IMF to intervene in the dispute, assertively, if necessary.

Disciplinarian or enabler?


The only means to exorcise the debt demon is to deny government access to credit, namely by repudiating all outstanding obligations to multilateral and private lenders alike.

Throughout almost the entire period spanning the advent of the convertibility law to the present Buenos Aires has been subject to Fund assistance and oversight. From the outset the relationship can best be portrayed as one between an alcoholic and bartender, with the latter (the IMF) unwilling or unable to temper the former's (Argentina) zeal for binge drinking (borrowing).

 In 1995 when government borrowing began to exceed stipulated targets, the Fund lifted the fiscal deficit ceiling rather than penalizing its errant pupil. During the episode of rapid economic growth (1995 to 1998) Argentina's consolidated budget balance breached quarterly targets more than half the time, despite being revised upward more than once in the country's favor and swelling tax coffers. The Fund did little more than pardon the transgression officially with a waiver, or simply turned a blind eye to the indiscretions[v].  

This permissiveness was duplicated in late 2000 and early 2001 as the ongoing economic recession continued to take its toll on commercial activity and the government's fiscal position. Again, the central government's habitual failure to meet even lax deficit targets in that quarter was ignored by an equally incorrigible IMF. On January 12 the Fund released $3bn (the first tranche of a revamped $14bn Stand-by package) in what was seen as the last internationally supported package designed to help Argentina avoid sovereign default, a possibility that had been openly discussed since the autumn of 2000.

However, the Fund caved in again in August as the first last-ditch bailout faltered. This time a $6bn check from a multilateral lender found its way into the hands of the Argentine government. The transfer was achieved through a fait accompli orchestrated by none other than Domingo Cavallo (who had been recalled from America's Ivy League to rescue the economy and subsequently resigned prior to the default), which enabled a sovereign borrower to dictate the amount and timing of Fund support, a first in IMF history.

What is so chintzy about this feat is that the debt default that occurred in December of 2001 was already inevitable: $6bn in internationally-lended (taxpayer-funded) assistance was wasted on an abortive undertaking.

Over the past two years the spineless bartender-binge drinker analogy—notwithstanding the most recent events—has been reinforced. After effectively blackmailing the Fund in January 2003 into rolling over Argentina's defaulted debt to multilateral lenders through August 2003 by deliberately suspending a payment to the Inter-American Development Bank, the economy minister, Dr. Roberto Lavagna, wielded the metaphorical broken bottle again in September of 2003. Refusing to stump up $2.9bn owed to the Fund—the largest nonpayment of a loan in that organization's historyLavagna and his boss, Nestor Kirchner, won another deal on extremely generous terms.

Besides refinancing $21bn in debts to multilateral lenders, Argentina committed to run a modest primary surplus (tax revenues before interest payments) of not more than 2.5% of GDP in 2003 (which Buenos Aires has easily exceeded) and only 3% in 2004. After clinching the deal, Kirchner magnanimously countenanced rescinding the suspension of the $2.9bn repayment.

Clashing interests

Presently Argentina owes the IMF approximately $16bn (15% of total Fund lending outstanding) along with another $18.3bn and $1.9bn to the World and Inter-American Development Banks, respectively. As if Argentina's debt, far exceeding the cumulative borrowing limit member states are permitted to access under Fund rules, was not enough, Buenos Aires's principally implacable and mean restructuring offer to private lenders may breach its commitment under September's IMF Letter of Intent to negotiate in "good faith." 

To meet this requirement the Fund has asked that Argentina acknowledge the GCAB as a de jure interlocutor, lift the acceptable threshold of investor participation rates and formally ink the investment banks tapped by Kirchner to negotiate on the government's behalf. In addition, Fund paymasters, the G7, have stipulated that debt repayments owed by Argentina to the multilateral lending institutions take precedence over reimbursing private creditors.

In spite of repeated bouts of intransigence, Buenos Aires seems willing to comply with G7 strictures, for paying off debt owed to the IMF and the other multilateral lending organisations, only 20% of Argentina's total debt burden, rankles private creditors, sewing discord between the Fund and the bondholders it has been called on to assist. After all, the more Argentina earmarks to the Washington D.C.-based organizations, the less it has to offer everyone else.

By pledging to pay the IMF $3.1bn in obligations due, acknowledging the GCAB as a legitimate emissary, and agreeing to constructively negotiate with all creditor groups by the end of March—enshrined in a letter of intent inked on March 10—Argentina has conveyed mixed intentions to rival creditors, likely driving a wedge between multilateral and private lenders.  

Blame game

Who then is to blame for the current state of affairs, where a country's populace—50% of Argentina's 36m inhabitants dwells in poverty—is recovering from a protracted recession, bank failures and political upheaval? Where should accountability be allocated when private lenders are not receiving timely payments of interest and principle and taxpayer contributions the world over were squandered by a spendthrift government ultimately bankrolled by other states?

The obvious answer is the Argentine government itself. Despite nearly uninterrupted economic growth, a burgeoning tax take and supplementary income from privatizations, the country's public sector (both central and provincial) could not match expenses to revenues.

The twin financial scourges of fractional reserve banking and a central bank abetted fiat currency pervaded the Argentine economy, making a boom and bust possible. Taken together, excessive borrowing during the expansionary years obviated Argentine authorities capacity to service the massive debt, which became irredeemable as tax revenues dried up amid the recession.

The IMF was well aware of these perilous trends throughout the 1990s but did little to admonish, let alone take action, to discipline the prodigal politicians in Buenos Aires. Institutional impediments, the Fund's area departments' remit includes cultivating relationships with the borrowers they are charged with monitoring, as well as image concerns—the IMF took flak throughout the late 1990s about its performances in East Asia and Russia—prevented the Fund from chastising one of its success stories.

Furthermore, the multilateral lender's approval of Argentine policy since 1990—lax surveillance throughout and a propensity to continue lending regardless of adherence to program targets—emboldened private foreign entities to maintain lending and investment activities in Argentina even as government finances unraveled.

For its part private creditors should have known better than to bankroll a government and economy as ill starred as Argentina's. Frequent changes of government, alternating between civilian and military since 1930 coupled with a parallel rise of state intervention in the marketplace, have sharply attenuated Argentine capital formation and savings. From 1960 to 1994 the economy averaged an annual inflation rate of 127% and received between 1980 and 1994 15 ineffectual adjustment loans from the IMF and World Bank combined[vi].  

Like the Fund, international and domestic investors blithely dismissed the rapid accumulation of debt by Argentine authorities and continued to lend on generous terms even as government debt dynamics began to appear unsustainable. Allured by the high-yielding bonds on offer in the Americas, especially after the East Asian "miracles" succumbed to contagion, undaunted, risk-tolerant creditors were willing to redirect capital to Argentina, the star of the emerging-market debt arena.

All too eager to accommodate investors, Buenos Aires managed to float a sizeable amount of debt in late 1999 through early 2000, notwithstanding a severe economic contraction.

Taken together, profligacy, carelessness and the inability or refusal to say no, conspired to produce the miserable situation the troika of Argentina, private lenders and the IMF confront today.

Abolishing sovereign finance

Of course the licentiousness and pliant stance towards reckless lending and borrowing are mere symptoms of the root cause of Argentina's tragedy. The ability of governments to borrow enables politicians, bureaucrats and the constituencies that receive succor at the public trough to live beyond the means they seized from taxpayers, knowing full well that the exploited, productive class will also foot the bill due to investors keen on purchasing government bonds.

In the case of Argentina, the only means to exorcise the debt demon is to deny government access to credit, namely by repudiating all outstanding obligations to multilateral and private lenders alike.

To the casual observer this suggestion is anathema for it violates the sanctity of contracts. However, as Murray Rothbard correctly explained, there is a fundamental distinction between private and public debt[vii].

In the former case, where a low-time preference creditor lends money to a high-time preference borrower in exchange for repayment plus interest, to repudiate one's debts is tantamount to depriving the lender of his property, which is indefensible.

In regard to public debt, governments do not pledge their own assets, but taxpayers' instead, with creditors cognizant that the principle and interest will be paid through the involuntary confiscation of private property—taxation. In effect, both sides are complicit in the violation of property rights of a third party in the future, which scarcely deserves to be acknowledged as a contract.

Beyond the dodgy status of sovereign borrowing, debt repudiation is beneficial in two respects. Immediately it alleviates the citizenry of onerous repayments on obligations issued by previous governments. More importantly, by denying the Argentine government credit altogether, as lenders will be liable to do, it will be compelled to operate within the constraints of a balanced budget, a novel notion in that country's history.

Indeed, many of Argentina's economic ills throughout this and the past century can be attributed to politicians' insatiable appetite to borrow and spend, with the attendant annihilation of the citizenry's savings and capital as the central bank's printing press has often been utilized to ameliorate substantial government debt burdens.

A harsh, but necessary remedy

Initially, private Argentine firms will likely suffer rebukes from international capital markets due to government debt repudiation. However, when the citizenry is relieved of massive tax-funded repayments on these obligations and no longer saddled with a credit-worthy government, foreign lending will return to invest in promising private enterprises. Likewise, indigenous capital formation can emerge as the profligate public sector is reined in. Fortunately, Argentines are estimated to have stashed close to $100bn of savings abroad, hopefully a substantial portion can be repatriated.  

With respect to private creditors, as shameful as the blatant deprivation of the funds loaned to Argentina may be, such arrangements clearly infringe third-party property rights and are an affront to liberty. Hopefully Argentina's debt repudiation will serve notice to prospective lenders that states, the only entity in society—save criminals—that exist at the expense of others, are parasitic and wasteful consumers of capital undeserving of investment.

Alternatively, as Rothbard suggested, a government mulling unilateral cancellation of its debts may at least partially allay creditor contempt by selling state assets and channeling the receipts to servicing its obligations. The plight of small investors in Italy (450,000 people, including pensioners, hold $12bn-worth of Argentine bonds), Japan (40,000 possessing $3.02bn) and elsewhere is especially dire and may merit such attention.

Concerning the IMF, debt repudiation would be a fitting lot for an entity culpable in precipitating Argentina's boom, bust and default. The Fund was instrumental in engendering Argentina's present woes through lax oversight and an implicit bailout guarantee, which was actualized when Buenos Aires's fiscal fiasco became insurmountable.   

Essentially a nascent central bank charged with rescuing feckless governments and the private international financial institutions that underwrite sovereign debts, the IMF accomplishes its mission by funneling member state contributions (quotas) to distressed borrowers, in the process imbuing moral hazard in both parties.

In other words, this international organization lends contributions supplied by governments, whose quotas are met via the involuntary confiscation of property (taxation), to recipient states in order that the beneficiaries continue to service public debts to private lenders, also a nefarious compact that entails violating the property rights of a third party. This facet of the international financial architecture is nothing more than systematic pilfering.

As a lender reliant on stolen goods as its source of its capital, the IMF warrants scant recompense for its haphazard lending practices, let alone deserves precedence over other creditors. At least private institutional and retail lenders staked their own fortunes, however imprudent, when investing in the Argentine government, an inherently loss making proposition.

In sum, Argentines would be wise to petition the politicians in Buenos Aires to repudiate the public debt—though perhaps compensating small retail investors via the sale of government assets—ultimately divesting the state of the prerogative to borrow.   

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Grant M. Nülle is a Research Fellow at the Council on Hemispheric Affairs in Washington D.C. He can be reached at grantn007@yahoo.com. See his archive and discuss this article on the blog.



[i] Skidmore, Thomas E. and Peter H. Smith. Modern Latin America. 5th ed. Oxford UP, 2001.

[ii] Salerno, Joseph T. "Confiscatory deflation: The Case of Argentina."  Mises.org. 13 Feb. 2002.

[iii] "Argentina bounces back from recession."  Financial Times. 20 Feb. 2004.

[iv] "Argentina on the edge."  Financial Times. 7 March 2004.

[v] Mussa, Michael. Argentina and the Fund:  From Triumph to Tragedy. Institute for International Economics, 2002.

[vi] Easterly, William. The Elusive Quest for Growth. MIT Press, 2002.

[vii] Rothbard, Murray N. "Repudiating the National Debt."  Mises.org. 16 Jan. 2004.