In February 1989 Argentina was suffering one of the hottest summers on record. The electricity system in Buenos Aires struggled to cope. People grew accustomed to five-hour power cuts. Banks and foreign exchange houses were ordered to close as the government tried to prevent the currency's exchange rate from collapsing. It failed: in the space of just a month the austral fell 140 per cent against the dollar. At the same time, the World Bank froze lending to Argentina, saying that the government had failed to tackle its bloated public sector deficit. Private sector lenders were no more enthusiastic. Investors were hardly likely to buy bonds with the prospect that inflation would wipe out their real value within days. As fears grew that the central bank's reserves were running out, bond prices plunged. There was only one option left for a desperate government: the printing press. But even that failed. On Friday 28 April Argentina literally ran
out of money. Tt's a physical problem,' Central Bank Vice-President Roberto Eilbaum told a news conference. The mint had literally run out of paper and the printers had gone on strike. 'I don't know how we're going to do it, but the money has got to be there on Monday,' he confessed.
By June, with the monthly inflation rate rising above 100 per cent, popular frustration was close to boiling point. Already in April customers in one Buenos Aires supermarket had overturned trolleys full of goods after the management announced over a loudspeaker that all prices would immediately be raised by 30 per cent. For two days in June crowds in Argentina's second largest city, Rosario, ran amok in an eruption of rioting and looting that left at least fourteen people dead. As in the Weimar Republic, however, the principal losers of Argentina's hyperinflation were not ordinary workers, who stood a better chance of matching price hikes with pay rises, but those reliant on incomes fixed in cash terms, like civil servants or academics on inflexible salaries, or pensioners living off the interest on their savings. And, as in 1920s Germany, the principal beneficiaries were those with large debts, which were effectively wiped out by inflation. Among those beneficiaries was the government itself, in so far as the money it owed was denominated in australes.
Yet not all Argentina's debts could be got rid of so easily. By 1983 the country's external debt, which was denominated in US dollars, stood at $46 billion, equivalent to around 40 per cent of national output. No matter what happened to the Argentine currency, this dollar-denominated debt stayed the same. Indeed, it tended to grow as desperate governments borrowed yet more dollars. By 1989 the country's external debt was over $65 billion. Over the next decade it would continue to grow until it reached $155 billion. Domestic creditors had already been mulcted by inflation. But only default could rid Argentina of its foreign debt burden. As we have seen, Argentina had gone down this road more than once before. In 1890 Baring Brothers had been brought to the brink of bankruptcy by its investments in Argentine securities (notably a failed issue of bonds for the Buenos Aires Water Supply and Drainage Company) when the Argentine government defaulted on its external debt. It was the Barings' old rivals the Rothschilds who persuaded the British government to contribute £1 million towards what became a £17 million bailout fund, on the principle that the collapse of Barings would be 'a terrific calamity for English commerce all over the world'. And it was also the first Lord Rothschild who chaired a committee of bankers set up to impose reform on the wayward Argentines. Future loans would be conditional on a currency reform that pegged the peso to gold by means of an independent and inflexible currency board. A century later, however, the Rothschilds were more interested in Argentine vineyards than in Argentine debt. It was the International Monetary Fund that had to perform the thankless task of trying to avert (or at least mitigate the effects of) an Argentine default. Once again the remedy was a currency board,this time pegging the currency to the dollar.
When the new peso convertible was introduced by Finance Minister Domingo Cavallo in 1991, it was the sixth Argentine currency in the space of a century. Yet this remedy, too, ended in failure. True, by 1996 inflation had been brought down to zero; indeed, it turned negative in 1999. But unemployment stood at 15 per cent and income inequality was only marginally better than in Nigeria. Moreover, monetary stricture was never accompanied by fiscal stricture; public debt rose from 35 per cent of GDP at the end of 1994 to 64 per cent at the end of 2001 as central and provincial governments alike tapped the international bond market rather than balance their budgets. In short, despite pegging the currency and even slashing inflation, Cavallo had failed to change the underlying social and institutional drivers that had caused so many monetary crises in the past. The stage was set for yet another Argentine default, and yet another currency.
After two bailouts in January ($15 billion) and May ($8 billion), the IMF declined to throw a third lifeline. On
23 December 2001, at the end of a year in which per capita GDP had declined by an agonizing 1 2 per cent, the government announced a moratorium on the entirety of its foreign debt, including bonds worth $81 billion: in nominal terms the biggest debt default in history.
The history of Argentina illustrates that the bond market is less powerful than it might first appear. The average 29 5 basis point spread between Argentine and British bonds in the 1880s scarcely compensated investors like the Barings for the risks they were running by investing in Argentina. In the same way, the average 664 basis point spread between Argentine and US bonds from 1998 to 2000 significantly underpriced the risk of default as the Cavallo currency peg began to crumble. When the default was announced, the spread rose to 5,500; by March 2002 it exceeded 7,000 basis points. After painfully protracted negotiations (there were 152 varieties of paper involved, denominated in six different currencies and governed by eight jurisdictions) the majority of approximately 500,000 creditors agreed to accept new bonds worth roughly 35 cents on the dollar, one of the most drastic 'haircuts' in the history of the bond market.6 8 So successful did Argentina's default prove (economic growth has since surged while bond spreads are back in the 300-500 basis point range) that many economists were left to ponder why any sovereign debtor ever honours its commitments to foreign bondholders.
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