Argentina's Crisis Explained

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Looters steal merchandise from a supermarket on the outskirts of Buenos Aires Sixteen people have died in Argentina in the last 24 hours in violent protests against the government's austerity measures, and most of the cabinet has resigned. Attempts to deal with the economic meltdown appear to have rendered the government untenable, and investors fear the international repercussions of the country's apparent inability to meet its debt burden. How did this volatile situation evolve?

Peter Katel: Three distinct crises have converged in Argentina at the worst possible time, given what's happening in the world economy. The first is the fact that the Argentinean peso was legally pegged to the dollar, on a one-to-one basis, a decade ago by Economy Minister Domingo Cavallo. He'd hoped the move would end hyperinflation, but what that meant in practice was that when Brazil devalued its real in 1999, foreign investors and buyers found their dollars could buy more in Brazil than in Argentina. So Argentina's foreign investment and exports dried up — buyers of Argentine beef or wheat or anything else the country produces could get more for the same price in other countries, particularly in neighboring Brazil.

The second crisis results from the extensive borrowing done by the government of Carlos Menem in its second term, before the election of current President Fernando de la Rua. Menem's government acquired a lot of debt, both domestic and foreign, and that sent domestic interest rates up. The more the government was borrowing, the more expensive credit became for businesses. And that forced many companies to close.

A wave of privatization in the 1990s under Menem had already thrown a lot of people out of work, and because many of the privatized companies were utilities, prices for such basic services as electricity and phones spiraled upwards. So Argentina's recession had started three-and-a-half years ago, and it grew steadily worse as domestic demand went into a downward spiral as companies lost business and were forced to lay off even more people.

The downward spiral increased the debt burden, because the government's tax revenues were shrinking. And the IMF made clear they were not inclined to bail Argentina out by making an advance payment on a previously agreed loan to allow it to make its next debt payment.

The three crises converged to the point that a few weeks ago, people started believing that their pesos would be devalued and rushed to the banks to convert them to dollars at the one-to-one rate. Cavallo made a proclamation limiting withdrawals to $1,000 a month in order to avoid draining the banks, but that sparked a wave of uncertainty and anger throughout the country, and last weekend in the provinces poor people began looting supermarkets. The riots had spread to the capital by Tuesday.

President De La Rua on Wednesday night declared a state of siege, but he failed to offer any prescription for dealing with the crisis. And that sent people straight back into the streets of Buenos Aires last night — not only the unemployed people who'd been looting supermarkets, but middle class people hit hard by financial restrictions. Five thousand gathered outside Cavallo's apartment building, banging on pots and pans, and after an hour of that he resigned, taking the whole cabinet with him overnight.

To whom are the protestors looking as a savior? It had been suspected after the last election that Menem would eventually seek to make a classic Peronist comeback on a wave of mass protest against austerity measures?

Yes, but Menem can't return until a full term has passed since he left the presidency. And it's far from clear that they're looking to him in their hour of need. Argentina's entire political class is pretty much in disrepute. Traditionally in such moments the protestors on the streets have turned to the Peronistas. But this time, there doesn't seem to be one clear beneficiary.

The IMF's position appears to be to let Argentina fail, that it's too far gone and that any contagion can be contained. Are they underestimating the danger?

What you hear from people in international financial community is that the problems are so deep that simply throwing money at Argentina would ultimately only extend the crisis and delay an inevitable collapse. The immediate danger, of course, is that Argentina defaults on its debt and creates a crisis in the international financial system. That would certainly hurt investor confidence in emerging markets, particularly during a global slowdown or recession. But the other view is that this crisis has been so long in the making that it constitutes a special case with characteristics that don't apply to other cases. I think the jury is still out on this one. It's simply too early to tell.

So where does the De La Rua go from here?

That's the question of the hour. Whether alone or in some form of coalition, he urgently needs a plan to cope with the immediate impact of the crisis — ensuring that people are not going hungry, for example — and restore economic growth. The problem is that in order to ease the burden of the crisis on the poor, the government has to spend millions of dollars on providing food and other basics. And that could leave them in formal default on their debts. Something has to give. People in the financial community saying for weeks that a default is inevitable. Cavallo had been trying for months to renegotiate the terms of that debt, to avoid calling it a default. But now he's gone and the crisis remains.