Argentina’s recent currency devaluation and debt default have stolen money from its own citizens and undermined the country’s long-term economic prospects, according to former finance minister Domingo Cavallo.
“The idea that default is good comes to the mind of populist leaders because, they say, ‘The creditors are foreigners. We Argentineans are debtors,’” Cavallo told an audience at Wharton’s Latin America Conference Nov. 15. “But most of the creditors are Argentineans, people who saved and kept their savings in Argentina,” rather than abroad.
As finance minister from 1991 to 1996, Cavallo was the architect of a plan, called the convertibility law, that pegged the value of Argentina’s peso, one-for-one, to the U.S. dollar. In devaluing the peso, the government abandoned the peg, which many had credited for a burst of economic growth in the early 1990s. “Without convertibility, there will be neither investment nor productivity growth because there will be no credit,” Cavallo noted. “The domestic market may recover but investment will not recover for a long time. Investment requires local financing – savings – and rules of the game that provide protection for savings.”
Cavallo, a visiting professor at New York University, chastised his country’s media for creating a culture where it was acceptable to shirk debts. He accused media outlets of acting out of their own self-interest as debtors. “They took on debt to purchase the cable TV networks, to purchase as many newspapers as they could. Now they have been using their influence, trying to invoke a culture of ‘You don’t have to pay.’ That’s a terrible culture. If you have a country like that, it’s a country that will never be able to recreate credit.”
During Cavallo’s speech, a group of protesters gathered outside the hall and made it clear they blamed him, not the media, for Argentina’s economic ills. In addition, one member of the audience who identified herself as Argentinean challenged Cavallo during the question-and-answer portion of his talk, noting that “You have presented yourself like a victim. What was your role? What did you do wrong in your 10 years in government?” Cavallo’s response: “I made many, many mistakes. All I did, I did thinking I was working for my country …”
Cavallo, a Harvard-trained economist, was once heralded as the father of prosperity on account of the dollar peg and other reforms. In the early 1990s, he was lauded for taming the runaway inflation that had dogged the country for decades. And he oversaw the sale of the country’s inefficient state-owned industries. But in 1996, he left the government after a falling out with then-President Carlos Menem. Two years later, the recession began. Many Argentineans now believe the dollar peg exacerbated the downturn by making the country’s exports too expensive. In 1999, Cavallo ran for president as a third-party candidate and got 10% of the vote.
In an attempt to revive the economy and reassure Washington and Wall Street, then-President Fernando de la Rua brought Cavallo back as finance minister in March 2001.
Cavallo improvised furiously but by then Argentineans had tired of his bitter economic medicine. As one professor told The Washington Post, the tonic had become toxic. Cavallo pushed an unpopular plan for cutting government spending, insisting that his country not default on its foreign debt.
In December 2001, he froze Argentineans’ bank accounts to prevent a run on the banks. During the rioting that followed, he resigned. A few weeks later, the government abandoned the dollar peg, devaluing the currency. In April 2002, Cavallo was arrested on charges of arms dealing, then released two months later when the charges – viewed by many as a vendetta by political opponents – were overturned by an appeals court. He later joined the faculty at NYU’s Stern School of Business.
His speech at Wharton, titled “Argentina: Where the Attempt to Set the Right Prices Destroyed Property Rights,” began with an explanation of the law that he believes was his country’s economic salvation.
Besides pegging the peso to the dollar, the convertibility law recognized the right of Argentineans to enter into contracts denominated in dollars and made those contracts legally enforceable. Subsequent reforms, such as selling off the country’s bloated state enterprises, depended on that, he said. The financial guarantees in contracts would have meant nothing unless the parties believed they would be paid in a stable currency.
Cavallo insisted his reforms ushered in a prosperity that Argentina, which was once Latin America’s richest country, hadn’t seen in decades. In the 1990s, the country’s gross domestic product grew at an average of 5% a year, compared with a 1.5% annual shrinkage during the 1980s, he pointed out. Its exports rose an average of 8% a year, compared with 4% during the 1980s. And productivity, which had been negative during the 1970s and 1980s, increased. “Why were we able to increase our exports with a fixed exchange rate? Because there was a significant increase in investment,” he said.
The catalyst for this investment, Cavallo suggested, was increased saving. That created credit, which allowed businesses to expand. “When foreigners saw that Argentineans were keeping their money in Argentina, they also started to look there for opportunities.” Previously, Argentineans harbored their money abroad.
But the dollar peg required prudent fiscal management. Argentina didn’t have that in late 1990s, Cavallo said. At the time, then-President Eduardo Duhalde was competing with Menem for their party’s presidential nomination. To win votes, both of them encouraged higher spending by provincial governments. Banks were willing to finance that spending “because they were charging high interest rates, and the loans were guaranteed by federal taxes.” Trouble is, the borrowing crowded out private borrowing and hampered economic growth.
Then came the devaluation of Brazil’s currency, the real, and the depreciation of the euro vis a vis the dollar. Most Argentinean exports go to Brazil and Europe. With the peso tied to the strong dollar, the country’s exports got too expensive for its main trading partners.
At the time, Argentina could have saved its economic gains by either allowing its currency to float again or by tying it to a combination of the dollar and euro, Cavallo said. Either step, he added, would have been legal under the convertibility law and would have lessened the value of the currency and revived exports.
“We should have said that the peso could float between the dollar and the euro. It’s a way of moving gradually from a fixed exchange rate to a flexible one.” But politics, Cavallo said, thwarted what economics demanded. “If the government had let the peso float in 1997, that would have stopped the inflow of capital. And the inflow of capital was necessary for the financial system to provide financing to the provinces.”
Elected leaders muddled along until, in 2001, de la Rua, in desperation, invited Cavallo back into the government. Cavallo set about implementing a tough austerity program to cut government spending and entered into negotiations to restructure its hefty debt.
But he also imposed the measure that has made him a lightning rod for his fellow Argentineans’ frustration and despair – the bank-deposit freeze. “Many people say that I was responsible for the deposit freeze. That is absolutely false. What we introduced Dec. 1 was a typical exchange control that would be introduced in most episodes of crisis.” It was supposed to be temporary, lasting no more than about 90 days or until the government had restructured its debts, he said.
But the freeze continued after Cavallo’s resignation. (It was only recently relaxed.) And then the government abandoned the dollar peg and transformed dollars into pesos at a below-market rate. “That, of course, violates any concept of legal security and makes the law inferior to any other law that provides protection to savings,” Cavallo said.
“That is why I say the measures adopted to set the right prices – to get rid of the currency overvaluation and to give incentives to exports – destroyed the property rights of the savers, not of the rich people but the people who brought their money to the banks and wanted their savings to be in dollars.”