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Mckinsey Executive Roundtable Series on International Economics: The Lessons of Argentina: Crisis and Aftermath [Rush Transcript; Federal News Service]

Speakers: Eduardo Aninat, Former Minister of Finance, Chile, and Manuel Hinds, Former Minister of Finance, El Salvador; Author, Playing Monopoly With The Devil: Dollarization and Domestic Currencies in Developing Countries
Presider: Benn Steil, Senior Fellow and Director of International Economics, Council on Foreign Relations
December 6, 2006
Council on Foreign Relations


BENN STEIL: All right. Good morning, ladies and gentlemen. We’re going to start our session now. I’d like to welcome you all here this morning to our discussion on “The Lessons of Argentina: Crisis and Aftermath.”

This meeting is part of the McKinsey Executive Roundtable Series in International Economics, which is co-sponsored by the Council’s Maurice R. Greenberg Center for Geoeconomic Studies and our corporate program.

I’d like to remind everyone that this meeting here this morning is on the record. And as always, I’d like to remind everyone to turn off their electronic noisemaking devices, so we’ll have as quiet a room as possible for our two excellent speakers here this morning.

You know, it’s not always the case that a Latin American finance minister has a happy and successful tenure, but I think I can say that in this case we have two that had extremely happy and successful tenures: Eduardo Aninat, who was finance minister in Chile from 1994 to 1999; and on my right, Manuel Hinds, who was a visiting fellow here two years ago, who was finance minister in El Salvador from 1995 to 1999.

I’m going to kick off the discussion for about the first 35 to 40 minutes or so. There are three subjects I’d like to get through, and then we’ll open up the floor for discussion.

The first thing I’d like to discuss is exchange rate/monetary policy in Argentina in the decade before the crisis. Then I’d like to move into the crisis period, discuss a little bit about the reaction of the international community—particularly the IMF—and what lessons we may have learned; and then we’ll talk a bit about what’s been going on in Argentina since 2002 and the devaluation. And we’ll resolve all those issues very easily in 40 minutes and then we’ll try to think of something left to discuss—if there is anything.

Okay, gentlemen, let’s go back to the decade before the crisis. Latin American has pretty much experimented with every exchange rate regime known to mankind in the 1990s. Chile, by and large, ran a form of managed float. El Salvador, of course, dollarized in 2001. Mexico in the first half of the 1990s had a currency peg. And Chile had something that was often called a currency board, but it wasn’t quite a currency board. It was something in between a hard currency board and a currency peg.

Eduardo, let me start with you. Help put the Chilean exchange rate and monetary policy regime in the context of other things that were going on in Latin America at the time. And looking back, what lessons have we learned from what they tried to do?

EDUARDO ANINAT: Well, I think it’s a very relevant question for the discussion one minute later, because you’re mentioning in passing that Chile did experiment with a fixed exchange rate. It had none of the convertibility features of the Argentinean system, but between 1979 and 1982, the micro system was run at 39 pesos to $1.

In spite of the very good economic reforms that the Chicago team at the time did for Chile—many of them have lasted throughout decades—I think that was a clear main error and a huge mistake, because it hindered the economic system in terms of competitiveness, and it gave a false feeling to the people in terms of the consumption spree and ease of spending, which was not realistic at all and which had to encounter, later, the severe crisis run by the Mexicans with their default on the debt in the early ‘80s. So that’s on my side.

Now reflecting more on the Argentinean side, why, one would have had some sympathy for their convertibility system. And while we have to acknowledge that it was a more structured thing, as said by Menem and Cavallo in the early 1990s, then the Chilean peg or other pegs that have been run—all with no success in Latin America, let me add.

One has to acknowledge to them more benefit of the doubt, at least at the beginning of the ‘90s, in one sense: They were providing an (answer ?) to the economy in an otherwise very (politic ?), very variable micro-fiscal situation.

So in the sense of the answer, I think at the beginning it did serve Argentina well in answering expectations and allowing the first government of Menem to provide reforms that were much needed.

I’ll stop there, because I know this is debatable.

MR. STEIL: Well, I’m going to press you a little further before I turn to Manuel, because he will agree that it’s debatable.

But if we move into the late 1990s, particularly around ‘97, Cavallo has recently written that he felt that that was an optimal time for Argentina to have floated the currency when it was strong. What do you think Argentina should have done in the late 1990s—in which direction should they have gone?

MR. ANINAT: Well, since I’m on the record, I have to be careful in how I tell you an anecdote—(laughter)—so you can have the derivative of my anecdote. (Laughter.) And only by personal way I can give you more details later. But I had the honor—after I left the first—(inaudible)—government of Dr. Aylwin, 1990—Patricio Aylwin, very successful government in Chile—I was probably one of the (fastest ?) debt negotiators of the time in Latin America. So I ended up my job in the first year of that government, which was lasting four years.

Not least to the good effort of our lawyer there, Robert Palmas (sp), whom I’m meeting today—always the lawyer of the Chilean government, still today, I think. And therefore, I was left without the job because my position and my recommendation was abolished after have successfully, and for the last time ever in history, hopefully—at least it has proven right for the next 25 years—the position was abolished, official debt never paid. So what did I do? Well, Cavallo was recently named as minister of economy during Menem in the early ‘90s. And he called me to Santiago. We had been classmates at Harvard. He said, “Would you want to come and give us ideas about the forthcoming debt negotiation of Argentina?” And I said, “Gladly so; I’m out of a job.”

So I spent two or three months in Buenos Aires back and forth working with him and the central bank governor at the time and trying to set different options, traditional options—nothing very strange for people sitting here.

But I still remember one conversation later through that period where I asked him at his home—we are very close friends and still are—whether he would think of a timing period where the convertibility issue, the one-to-one, would be changed for a different scheme in managing exchange rate policy in the central bank system. And basically, I think at his home at the time we discussed in a bit of detail the idea to going to a basket of currencies that were more akin to the export/import composition of Argentina’s trading structure and not just to the American dollar one-to-one. The U.S. has never been a large exporter or importer to Argentina and vice versa, so that made sense.

But to my dismay, later on—I saw him many times at the IMF or in Argentina or in Chile—I think he tended to forget about this idea. So in a way, convertibility was overextended in time. As much as it was useful at the beginning, it became as a symbol or the cathedral or the sign that kept stability on. And therefore, by the end of the ‘90s even all the U.S. bankers, European bankers and Japanese bankers would go to Argentina, do a lot of business—let me remind you—but always say and ask, “and I hope you don’t change the convertibility factor,” because it became like a (self-accompli ?) later disaster policy.

So in a way I think this overextended the life of the exchange rate policy and blurred the most demanding task for Argentina, always, which is mend the fiscal house, redo the provisional government tax and spending system, redo the central government tax and spending system, and walk to an equilibrium and even to a small surplus like we have done in recent times. So this—the overextension of this very inconvenient convertibility system by the end, in a way, killed the opportunity for more drastic reforms on the fiscal side, whereas they had been doing very good other reforms in the capital markets, social security, agricultural policy, science, so forth and so on.

MR. STEIL: Before I turn to Manuel, I’d like to give a plug for his new book that we’ve got outside, called Playing Monopoly with the Devil, on dollarization in developing countries. This book Manuel wrote while he was a visiting fellow here two years ago.

So Manuel, I think you have a slightly different perspective on what Argentina did and should have done during the—

MANUEL ENRIQUE HINDS: Absolutely! (Laughter.)

But actually, you know, there is one thing in which I agree absolutely with Eduardo—that the currency board is the worst of all worlds, you know, because you have all the rigidities and you don’t have any of the flexibilities.

So you know, if you are going to have an exchange rate regime, get away from that. You either go for floating, or, I would argue, you should go for dollarization, because that is a completely different thing. When you totally abolish the possibility of devaluation, that creates a completely different new market.

But then I would like to go to the page number three in these things that I gave you.

MR. STEIL: There will be a quiz on this as soon as the session is done.

MR. HINDS: I’m so sorry that—you know, for some reason the numbers are not here. You know, but this is—what you see here is the rate of growth of the Argentine economy during the last 30 years. Okay? And you only see that it goes from plus-10 to minus-15 percent, just like this, you know.

And throughout this time, they had what they called the tablita (sp), you know, which was a fixed first derivative of the exchange rate, okay, which is, you know, we will devalue at the set rate that was here in the 1970s. Then they had floating. Then they have the—and you cannot define here when did they float, when did they have a fixed exchange rate, when did they have a currency board. They were—the economy (moved crazily ?) you know, throughout.

So the problem—I think that we have to understand that the problem is not necessarily exchange rate—okay?—in Argentina. It’s a—the following one you have the numbers corresponding to this graph. And then, you know, what I want to say is—I don’t know if I want to go a little into the crisis, you know, because, you know, there is this idea, this very common idea of how is it that the crisis in Argentina developed.

And people tend to think, well, in 1998 Brazil devalued the currency. And because of that, Argentina became instantly uncompetitive. They could not compete with Brazil so their imports—their exports went down, and because of that, you know, there was a depression in the economy and then everything led to the devaluation—ultimate devaluation of the peso.

But if we go and we take a look at the different graphs that you see here, also there was the appreciation of the dollar against the euro. You remember that. So I started with the euro here. Was the euro determinate? And this, you know, here you have the different exchange rate of the peso—real exchange rate against the euro. Okay? And here you have exports, and you see no relationship—none at all. There was no relationship.

So you know, you could say, well, maybe, you know, we were talking about the exports to Europe, but then that’s not really the point. The point is, if you are going to have a crisis it is because the exchange rate is affecting all your exports. There’s no relationship between the real exchange rate with the euro and exports.

And after the crisis, we have a very funny graph, you know, that the more you value—the devaluation is this direction. So the more you devalue the currency, the less you exported. You know? So, you know, there is no relationship here.

The problem was that Brazil devalued—the same thing here; you know, no relationship between these two things. And after the crisis, there’s no relationship here. So, you know, the problem was not that. Of course, you can think that, you know, if the problem was the exchange rate between the real and the Argentine peso, and Brazil devalues—why did Brazil devalue? Brazil devalued because it wanted to import less. Okay? That was—they have a problem that their current account had become too wide—okay?—the deficit. So they wanted to export less. So Argentina devalues.

What would Brazil have done in that circumstances? They will devalue further. And then Argentina will devalue farther, and then they will go back to the 1930s story, you know, of these competitive devaluations, because the point is not the devaluation itself; the point is the flows of trade that you want. So if Brazil really wanted to reduce imports from Argentina, they could do it one way or the other.

Now the other—in the next graph, you can see who adjusted faster in the trade balance, you know. And you have Argentina adjusting much faster than Brazil. Brazil with a devaluation; Argentina without a devaluation. So the problem was not there. The problem was not in the (current ?) account. It was not that Argentina was importing more than it was exporting. The problem was the capital flows.

In the next graph you see this dotted line is the capital flows. And you see how the capital flows became very negative very rapidly. So the problem was that people were taking the money out of Argentina. So that—the problem was not that the exports were down, that the imports were up; it was that the people were taking the money out of Argentina. And why did they have—why were they taking the money out of Argentina?

Here we can go to page 14, 15, you know. We have two possibilities, you know. One is that you’re afraid of the devaluations, and the other one is that you are afraid of the bank solvency. Most people think that the people were taking the money out because the banks were insolvent. No way! I’m going to show you this.

The problem was that people were afraid that the peso was going to devalue, you know. Everybody was talking that, you know, the peso eventually would have to devalue. And that is a very bad problem when you have a currency board as opposed to a dollarization. People never discuss this (inaudible)—okay?—but this in Argentina. You have a case of—and you see here, this is dollar and peso deposits in Argentina up to the year 2000. And you see, these are the dollar deposits. They were going up and the peso deposits stabilized. And the year of the crisis was 2001.

Now see here—I’m so sorry; these things didn’t come out. But here we are June 2001—this is by month. And you see that the peso deposits up to 2001—June 2001—were very much higher than the deposits at the beginning of 2000. And actually, they were higher—they were above the same level as the deposits in January 2001. By June—and the collapse was in December. Now, look at the lower graph—those are the deposits in pesos. You see how people were running away from the pesos and into dollars. Even, you know—you have this other graph here. This is the year of the crisis and this is the dollar deposits increasing in the financial system—the savings deposits. And the peso deposits were going down.

So the problem in Argentina was a—the problem was that people were afraid that the currency was going to devalue. And actually, I have worked in all financial crises, you know, directly or indirectly, either during the crisis or assessing the problems caused by the crisis—including Chile. That’s when Eduardo—(laughs)—I met Eduardo back 25 years ago. And there is no one crisis where the problem has not been, you know, the exchange rate—that the exchange rate for some reason became too overvalued.

Why is it that this became overvalued? It became overvalued because of the currency—of the monetary policies of the central bank before that. And you know, and then the crisis came when people decided the currency’s going to devalue and they start taking their money out. So you know, I think that this was the problem in Argentina. And unfortunately, you know, the actions that the government took during the crisis bring forth the idea in the Argentines that they should have their money out of Argentina. That’s the only safe way of which you can have your savings in Argentina, outside the country.

MR. STEIL: Eduardo, you wanted to respond, briefly, because I’d like to move onto a few other issues.


On exchange rate policies—on the first part of the graph Manuel was showing, while I basically agree with him on the general content of his conclusions of stay away from pegs and convertibility doesn’t work, at least in the Argentina case, I would like to point to three complications, only to be rigorous.

Number one, aggregate export figures never show something which was more important from the policymaking, domestic point of view of the Argentineans and the Brazilians, which was (intra- ?) trade between Brazil and Argentina. And if you look at what was going on in the late ‘90s and in the early part of this century, Argentina and Brazil are extremely tied in because of export-import flows between themselves. For Argentina, Brazil is 40 percent of the market. And we should take account of that in terms, at least, understanding the political economy of what was going between those two countries after Brazilian devaluation.

Second, Argentina has a very difficult, paradoxic situation, which I don’t see mentioned anymore through the decade, and which was the creation—I don’t know whether if it was—(inaudible)—but certainly his small famous book of a great Latin economist. Well, unfortunately, he died very young—Carlos Diaz Alejandro, full professor at Yale.

Basically, he researched—and I recommend you to search for this book; it’s a wonderful book on micro, micro policies in a developing country. Basically, he says what happens in a country where the main private consumption goods by household, the staple is beef, and at the same time, that commodity is the largest export by far of the country and it has huge comparative advantages. There you would find another link with the problem of exchange rate policies because of the inflation issue and real wages issue. I don’t have time to go over this again, but in order to have a clear account, we should reread Carlos Diaz Alejandro’s book.

And finally, it’s very important that Manuel has reminded all of us of something which I learned as a very young assistant professor in the early 1970s by two eminent economists. One passed away, Paul Rosenstein-Rodan; the other Paul Samuelson—two Pauls—at one of their houses. And they were discussing and I was just taking notes and listening in the living room, a wonderful discussion about how the world had changed severely in the ‘70s as away from the ‘50s and ‘60s. And it was much more important to look at capital inflows and capital outflows and capital movements throughout the world, balance of payment issues rather than pure trade issues—export, import—to look at the exchange rate. And I think Manuel did acknowledge that, and that is something we should look further in order to understand the Argentinean crisis—not only exports.

MR. STEIL: Manuel, let’s move on into the crisis period. I want to talk a little bit about the reaction of the IMF and the U.S. Treasury, and perhaps the interaction between the two.

Now between 2000 and 2001, the IMF put together three big loan packages for Argentina. It’s debatable whether those loan packages would ever have gone forward without support, heavy support, from the United States—interestingly enough, during a period in which our own Treasury secretary claimed to be violently against bailouts.

What lessons can we learn from that two-year period where the IMF and U.S. Treasury were trying desperately to prevent a devaluation in Argentina?

MR. HINDS: Don’t do it. That’s the first lesson. Don’t do it. When you have a situation like this, when you have an attack on a currency—I think this comes from the—even during the ‘70s. Do you remember when the—(inaudible)—system collapsed and the floating of all international currencies came about, there were episodes in which the British tried to defend the pound, in which the Swedish—the Swedes tried to defend the krona and so on, and they always lost. And this was the case in Argentina, you know.

But you know, the point is, which is extremely interesting, you know, it is that the money that went out from Argentina was more than the monetary base in Argentina in one year. Okay? This means that all the currency in the hands of the population plus all the deposits of the banks in the central bank, all of this went out.

And then you say, you know, how is it that this money could go out from Argentina? And then please go on to page 20 and you will see something that happened in the year 2001. You remember that the rule of the monetary board is that, you know, the central bank will never trade money on its own; it will just—if you want pesos, you have to give up dollars. If you are going to convert dollars into pesos, you do the opposite, you know. But the currency board doesn’t have any possibility of giving credit to the government or trading pesos on its own. It has to—that’s why—(inaudible)—exchange the monetary board. It’s just exchange.

And then you see here the net foreign assets of these. The rule should be that the amount of money in circulation should be exactly equal to the net foreign assets of the central bank. You know, it’s just because it’s one peso for one dollar and the other way around. And you see it going down like this. Why? Because in 2001 the central bank of Argentina began to act not as a currency board but as a central bank, and it started financing the government. And then the money that it was created was then used to buy dollars and take the dollars out of the country. That’s how this happened. And, of course, in December of 2001, as you can see here, reserves came to zero. There was no way the central bank could keep on creating money, and it had to devalue the currency.

So, you know, we had that even, you know, at the very end in Argentina, what happened was that Argentina itself violated its own currency board rules. And, of course, the IMF knew this, you know. So the IMF knew that by giving more money to Argentina, more dollars to Argentina, what it was doing was providing the dollars through a revolving door. You know, the money will go into Argentina and immediately it will go out from Argentina.

Now, many people, you know, with this conspiracy theory, will say that this was the international bank pressing the IMF to provide the currency so the international banks could take the money out of Argentina. But actually, if you see the detailed accounts in the balance of payments of Argentina, you will see that the last to understand what was going on in Argentina was the international banks.

The international banks kept on pumping money into Argentina, almost at the same time as the IMF. You know, they kept on pumping money. They thought that this was not going to happen. And actually it was all the Argentine deposits—it was the Argentines who were taking the money out of the country, because they didn’t trust the peso. And they were right.

MR. STEIL: Eduardo, those who are a little kinder than Manuel to IMF interventions might point to the Mexican crisis in ‘94 and ‘95. How do we distinguish between the two in terms of determining when it’s worthwhile for the IMF to come in with these large loan packages?

MR. ANINAT: Well, it’s a very good question. And, in fact, I think you were reading my notes. (Laughter.) I had written, while Manuel was speaking, not only Mexico but also Turkey, Indonesia and others.

I think to understand the rationale behind the IMF staff and IMF management, and particularly IMF board, you should read the statements of the board members at the time of all countries. It’s an interesting story.

One of the explanation factors is the fact that the world has gotten a bit used to large packages. I don’t remember when they started, but they certainly got enhanced with the Mexicans’ large package, as funded also by the U.S. Treasury and the IMF and several other multilateral institutions after the big crisis in ‘82-‘84 there, and then later on at the Tequila crisis in particular in 1994. And that package worked, and Mexico is in a very different shape today, or was five or six years ago, as compared to the other case we are discussing.

Indonesia might be the wrong example, but Turkey is a good example, so forth and so on. So basically there is some point, in studying further, why the world was pushing at the political and banking and financial level for large packages. These had to do with confidence, confidence rebuilding, and the time to get your economy back on track, especially the economic institutions.

Another thing to understand better, the rationale where the spillover effects. And on this point I wish to defend the IMF as a whole, on this particular point of the spillover effect. The world was just emerging initially from the Asian crisis, and none of you were finance ministers of the Asian crisis. I was.

MR. HINDS: I was.

MR. ANINAT: Oh, you were. (Laughter.) Sorry. I thought you were much older than that. (Laughter.) You said we had met 35 years ago—(inaudible).

Anyway, and in the Asian crisis, I think the world, without perceiving it—and we still have no good report in my own particular view—financial institutions everywhere were a bit shaky, including the U.S., let me say, because of leverage institutions and confidence crisis, to some extent. And therefore, as the IFIs have just managed now, with the good help of many treasuries around the world, including an excellent U.S. Treasury team at the time, they were worried that another event, a la Russia, a la Argentina, could—(inaudible)—for the world, not in Argentina but in many of the neighboring countries, including Brazil, which is the largest country in South America.

And, therefore, perhaps—and I—(inaudible)—the extension of larger packages and the refusal to stop had something to do with giving more time to important neighboring countries, Brazil and Mexico among others, Colombia as well, to have time to prepare for what was basically a foreseen story at the end. (Convertibility ?) would not work.

And finally, there is an important point. I will not excuse myself; I was part of the management team, and I didn’t veto any of the packages. But, of course, I will not tell you here the internal discussions we had. The leadership in the Argentina case was always held by Stan Fischer first and—(inaudible)—later. But the benefit, I would also say, that it’s very hard when you have an ongoing member that is current at the IMF that (believes ?) he is doing part or most or several of the reforms on the conditionality that’s being discussed, because here Manuel did not discuss one minute about the conditionality imposed on those packages, however large they were. And they’re also an important part of the picture.

In terms of assessing the damage on institutional and social fabric you have in the country, you will be the (detonator ?). And I agree with all of you that this was a foreseen end—a foreseeable end. Sorry for my English. But once you have to vote in a board and you have to decide whether you will be the catalyst or others will be the catalyst on the structural, social and political fabric, that’s a whole different discussion we’re not thinking of here, which would take us many years to discuss.

And finally, I think finally it’s a bit still too recent, because we need to collect more evidence, both on Argentina’s domestic issues, on South American issues, spillover on the institutional part, before rewriting history. It’s always easy to rewrite history back, but you need a bigger perspective in order to be more fair.

And, yes, I share the fact that the last packages were very polemic, but I am not in a capacity to provide a very definitive cost- benefit analysis as is being done here at this stage, today, in December 2006. We need more evidence, more discussion and more facts before doing that, because when you do it, you have to be present at that board voting. And it’s a whole different ball game, in my view.

MR. STEIL: Okay, do—no, because I want to use my few minutes remaining to move on to the post-crisis period, okay?

MR. HINDS: One minute.

MR. STEIL: One minute max.

MR. HINDS: One minute.

MR. STEIL: Okay.

MR. HINDS: Okay, the difference—I just want to point out the big difference between the packages in Mexico and all the successful packages in Argentina. These were provided after the valuation. That’s a completely different ball game. You know, the countries—the value then you provide. But before the valuation, you just feed the speculation.

And the other point is, you know, it is true that there was, I believe, through the Tequila crisis and this—and actually El Salvador is an investment-grade country. We became investment-grade during that time precisely, you know. And we never had a problem, you know, in the international markets to float even 30-year loans. It was—

MR. ANINAT: Can I take the—(off mike)? (Laughter)

MR. HINDS: But then, you know, the other thing is precisely this—I agree that the problem was the problem, you know. And the IMF was in the case of the central bank, and this happens, you know, in countries also when you have a currency—when you are going to have a crisis, a financial crisis, you know that all the banks—(inaudible). But then you are afraid that if you say so, the banks will go bankrupt and everybody will say, “It was you guys.” And then I think this was the problem in the IMF. They didn’t want people to say that this was going to be the IMF crisis. And because of that, they kept on maintaining it until it collapsed by itself.

MR. STEIL: You can have 17.2 seconds.

MR. ANINAT: Just one thing. I’m not going to again make the case for the IMF. I have already made it. But I think I want to—

MR. STEIL: His former employer.

MR. ANINAT: Yes, of course, and I’m proud of it. Let me unveil only one point, because we are now going to move to the short-run policy in Argentina today, and I don’t want my dear friend Manuel to escape from something.

I see he is extremely wise and forthcoming in one point, which we share—(inaudible)—and that—(inaudible)—has a lot of damaging effects to the aftermath and to disguising the real problems of Argentina at the time.

What is very discussable—and this is what I want to unveil—where dollarization is a better alternative, I think it’s a very good alternative for small countries like Salvador or Ecuador, and under very particular scenarios. But I would certainly not recommend dollarization for big countries such as Brazil, Argentina or Mexico. I didn’t want him to escape with that.

MR. STEIL: Okay, I am going to move on to the last part of the discussion, what’s going on in Argentina now; a little bit of historical context which I think is very interesting and relevant. In the early 1930s, when the last vestiges of the gold standard were crumbling away, economists were debating what was going to happen in this brave new world when we no longer had commodity money.

And I came across a fascinating lecture that Hayek gave in 1937 when he talked about this. First, he and many other economists were very concerned about what would happen with short-term capital flows. During the gold standard, they were very, very stabilizing, because gold tended to flow back into countries that were hit by crises because the market knew that the gold parities were going to be restored. But now economists said, “Well, without this anchor, capital flows are going to have the opposite effect. They’re going to become extremely destabilizing.

And Hayek took it further and he said, “Well, when countries start demanding the right, governments start demanding the right to set interest rates completely irrespective of interest rates in the global market,” essentially dollar rates today, “the amount of intervention that would be required would be utterly enormous, probably ceaseless.”

He said, “First we would have to introduce capital controls to stop people from interfering with domestic credit condition, then price controls.” And then he wrote, “We’d have to go further.” He said, and I’m quoting, “Exchange control designed to prevent effectively the outflow of capital would really have to involve a complete control of foreign trade, since, of course, any variation in the terms of credit on exports or imports means an international capital movement.” He wrote that in 1937.

Let’s look at what Argentina has done since 2003. It was exactly as predicted in the 1930s. In 2003 the Argentine government introduced its first capital and domestic price controls. In 2004 energy sector controls were extended to include first export taxes, then outright bans on the exports on oil and gas.

In 2005 rules were imposed forcing companies to convert most foreign proceeds into pesos and limiting the amount of foreign currency that individuals could acquire to invest abroad. And earlier this year President Kirchner, in an effort to stop the rise of inflation much beyond 1 percent per month, demanded what he called voluntary price freezes on about 300 products. Interestingly enough, he targeted all the component products of the official consumer price index and expanded his export bans to beef and other products. So he’s doing exactly what Hayek said we would need to do.

So my question to you, Manuel, is where do we go from here? How does Argentina get back to normality?

MR. HINDS: Well, you know, that would be impossible. (Laughter.) But you know what happens is, you know, first let’s position what we are talking about, you know, because first we have to understand that we—Eduardo pointed out, you know, we are moving from a world—(inaudible)—when capital flows happen just to settle trade flows. Okay, that was in the 1950s, 1960s.

Now we are living in a world where actually these capital flows that determine almost everything, including here in the United States. In the United States people say, you know, “We have this current account deficit because we have a fiscal deficit,” forgetting that the current account deficit started when the country had a very strong surplus. Here what is happening is that the capital flows—because of the monetary and financial globalization, capital flows determine almost everything in the world.

And then, you know, this changes completely the vision that you should have regarding your monetary system, you know, because in the 1950s you had—the system was you separate from the rest of the world; you have your own little currency, okay. And then also you will have protection. So you will have your own little corner of the world, and you want it to be away from the rest of the world.

Actually, monetary policy—the advantage of monetary policy was that you will be able to separate from the rest of the world. Now to separate from the rest of the world is absolutely crazy, you know, because the financial globalization is such that, you know, the services—everything that you have there are determining the progress all over the world, you know. Money is flowing throughout the world.

Now, this is true for all countries. It is true even for the United States. The United States cannot afford to get out from the world. (Inaudible)—big Latin American economy, which is more or less, you know, between (that avenue ?) which we choose, you know—25 or 50 (percent ?)? You know, the biggest Latin American economy, which is Brazil, is about the size of the economy of Manhattan. This is what we are talking about here, okay, just the financial system of Pittsburgh is bigger than the financial system of Brazil, okay.

So this is the kind of things that we are talking here. And when we say that, we can say that two-thirds of the economy in the world works very well under three currencies, which is, you know, the dollar, the euro and the yen. And the rest of the world’s economy works under 150 currencies, you know. So you say, you know, “What are we talking about here? You know, are we really talking about big economies?” It’s about the size—the biggest in Latin America is the size of Manhattan.

So going back to the problem of Argentina, looking at least from the point of view of Argentina, if Argentina wants to have its own peso, okay, then it has the—(inaudible). It can devalue its currency so that its soybeans could be cheap enough to export them to China. But then whenever you devalue the currency, you lower the value of the savings of the people. People try to (escape ?), so you have to impose capital controls on that.

Or you can see it from another point of view, you know. There is something called fear of floating, you know. If you have a floating currency, you say, “I’m choosing”—I said before, you know, that you could choose between dollarization and floating. Now, you know, if you are going to float your currency, then, you know, a professor comes and says, “You have to value your currency, because your soybeans are becoming less competitive in China.”

You have—you’re very afraid of doing that, because by devaluing your currency, your capital outflow will be faster. So we’ll have to impose even more capital controls. You will be more detached from the globalized world, which is driven by financial forces.

So why are you going to have a currency if you aren’t going to move it? And if you move it, you are going against your integration with the globalized world. So I think that, you know, Argentina is now in a condition in which it will impoverish itself. Why? Because looking at soybeans and devaluing the currency because they want their soybeans to be competitive, they are forgetting that there is another way of adjusting. You know, the other way of adjusting when your income is too high for the profits providing—of the value added provided by a commodity, you should move to another kind of production which will be enough to pay for your higher salary. And this is the way which Japan, Great Britain, the United States, every country in the world has developed. It is you start producing cheap things.

But then, you know, when you become successful at that, you have to move up to the next stage where you can pay higher wages to your people rather than devaluing the wages of your people so they can keep on competing with soybeans.

MR. STEIL: It’s interesting that you bring up the issue of soybeans, because after the export bans were put in on beef, I read that a lot of ranchers, rather than sell their beef domestically, which is what the government hoped would happen, started converting their fields to soybean production, which the government obviously hadn’t anticipated.

Eduardo, as briefly as you possibly can, because I want to give people plenty of time to ask questions.

MR. ANINAT: Let me give you another perspective, although I share Manuel’s worries on this issue in particular.

Let’s look at some short-term numbers for Argentina this year. Industrial production—all my numbers would be year-on-year, 12 months—July, 8.8 percent growth; August, 7.3 percent growth; September, 7.7 percent growth; supermarket sales, 8.2, 12, 16 percent; imports, substantial growth, so forth and so on.

Prediction for the end of the year: Annual growth rate this year, 8.5 percent; 2003, they grew at 8.8; 2004, at 9; they will grow again at 9.2. The estimate for next year hovers around 6 percent, the most pessimistic.

So, at least in terms of short-term, very short-term recovery, Argentina has already accumulated about 40 percent of added more growth as from the bottom, when they fell in 2002. Part of that is, of course, a recovery.

What is the problem ahead? I think the problem ahead has to do with where we started at this meeting—volatility, the big variance in all of the accounts in such a country.

If you take a long-term perspective, let’s take, say, 1976 to 2005—and compute what Manuel was giving you in the first graph, the variance of the rate of growth in real terms, GDP growth rate for almost 30 years, the variance is 5.9 percent per year and the average growth rate for that period was 2.6 percent. So the variance deviates almost two times or more than two times as much as the average growth rate they actually have in the long term. So basically in my view, Argentina is pulling off rather well of their big downfall in 2001 and 2002, but has a big question from 2008 onward because of what Manuel was pointing out. The microeconomic policies still carry a lot of distortions inside them. They’re facing huge energy constraints for the future, and that may come in perhaps earlier than 2008.

And as Manuel was explaining, the central bank is not allowing the peso to float freely but intervenes on it mainly, in my view, on inflation fears. Inflation is under control but at a high rate. The official inflation indexes are reading at 10, 11 percent per year, and that is high for a country that does not want again to damage wages and to damage the investment setting and has to recover still ahead.

And therefore, in my view, Argentina looks well this year, looks well next year, but has question marks in 2008 on because of this allocations-of-resources issue that Mr. Hinds was pointing out.

MR. STEIL: Okay, great.

If you’d like to ask a question, put up your hand, wait for the microphone to come around, then tell us who you are and what institution you are coming from. Who would like to ask the first question? Sergio.

QUESTION: Thank you. Sergio Galvis from Sullivan & Cromwell.

The big elephant in the room is politics. And as I listen to the discussion and compare, say, El Salvador or Panama to Mexico, or compare and contrast, and compare to Argentina, the contrast is choices that the political actors made.

So how do you view the intersection between a dollar-based economy and the politics that are likely to flow from that if there is such a connection, or a floating-rate economy and the politics that are to flow? Does the choice of currency affect the political choices and the political dynamics of a particular country, and therefore drive toward greater or lesser success?

MR. HINDS: This is a very interesting question, because it just happened, you know, in Ecuador. The candidate that won the presidency ran initially on the idea that he was going to abolish dollarization and go back to Ecuadorian something. He had to drop his intentions, you know, because he realized that this was going to be almost impossible to do. It is very difficult for people to give back dollars for monopoly currency.

MR. STEIL: Eduardo?

MR. ANINAT: Well, on that particular question, I agree that Ecuador must stick to its dollarized economy, and the same in El Salvador. El Salvador has been a much more successful case, thanks to reforms more than dollarization perhaps. However, in Ecuador we should not dismiss that the quality adjustment has been not very good, the different regime; and second, that dollarization does not guarantee at all sufficient growth. And, in fact, their growth record has been poor. They have not had the turmoils of the past, and dollarization has provided an answer which is, in fact, replacing a more rational and responsible fiscal policy, because they are—(inaudible). But it is not necessarily a sufficient condition for development. That would be my only point.

MR. HINDS: I would like to agree with that.

MR. ANINAT: And in any case, if I take the perspective, say, for the rest of the country, if I think of Peru, Chile, Brazil or Argentina, dollarization is not the convenient road, in my view, because either many of those countries or all of them do it or you’d better (speak out ?), because you’re having the issue of intercountry trade between them, which is large in our case, and they’re having a host of other issues, as in the case of Chile.

I think we have the most responsible fiscal policy in the world. So why would we go for dollarization if that is a very—(inaudible)—substitute for a good, responsible, institutional fiscal policy? So this is a very discussable point.

MR. HINDS: Very quickly, I want to say that, you know, definitely, you know, dollarization is a stage. You set the stage for development to take place. You can have several other stages, and this a convenient stage. But, of course, you know, if you think that dollarization will substitute for fiscal policy, that’s not the case. You know, you have to be fiscally responsible. It helps in many other ways. It integrates you immediately into the globalized world.

In the case of El Salvador, for example, you know, actually this is incredible; the (country risk ?) disappeared; you know, our banks borrowing in the United States—(inaudible). That’s because the funds—(inaudible). And, you know, only in Chile you have—in Latin America you have long-term credit for investment only in Chile, in Panama and in El Salvador, not in Ecuador, you know, because in Ecuador they don’t have the other things. But in El Salvador you can borrow 15, 20 years at 7 percent.

QUESTION: Angelo Carriero with Bank of Italy, New York office.

I was wondering, what is your assessment on the emergence of a currency unit within Latin America, looking at the medium and long term, as a way to somehow borrow stability, whereas allowing a certain degree of flexibility, certainly a higher degree of flexibility than dollarization and a lower degree of volatility of—(inaudible).

MR. ANINAT: I think the probability for the next 20 years is zero, or close to zero. And as I say that, I say very sadly, because—(inaudible)—your positive undertone on the question, I think Latin America a long time ago should have worked its way similar to the European Union or should have embraced something larger, like a Free Trade Area of the Americas, (integrated ?) much further.

We are losing incredible welfare gains, and we have still huge transaction costs in all the countries because of the lack of harmonization of policies and of union. And why am I so pessimistic? Because look at the two experiences we have on integration, even on the trade side only—Mercosur; Mercosur, which is a good idea after it was created.

It’s a continuous fight and a continuous quota bargaining and tariff bargaining between the two largest, Brazil and Argentina. They seem to be stuck permanently in an infight every time, and they don’t have institutions like Brussels is for the European Union. And look at the others; the—(inaudible)—with Venezuela in and out, with—(inaudible)—between Ecuador and Colombia or Peru, so forth and so on. And therefore, we simply have not bringed (sic/brought) our act together as Latin Americans to integrate further. And that is sad that I am giving this response.

MR. HINDS: I have an observation also. I give you two reasons why not, and the first is, like Groucho Marx, I think he said, “I will never join a club that will accept me.” (Laughter.) You know, if you look at what the central banks of Latin America have done throughout history, you say, “I don’t want to have a currency with these guys,” number one. (Laughter.)

But more seriously—no, but this is serious. But also, you know, there is another thing, you know. We have this idea—I am against the optimum currency area. I think it is a very bad piece of theory.

I think that, you know, what is interesting—you know, an optimal currency is not because you shared problems with other people, you know. An optimal currency is a currency that really gives you stability of prices, stability of interest rates, stability of conditions, financial conditions, regardless of the exchange rate with other currencies; for example, the euro and the dollar.

You know, you have seen the dollar has depreciated against the euro. It has appreciated against the euro. It has done many things. But the interest rate remains—(inaudible)—the inflation rate is. And why, you know, this is different from other places in Latin America?

When you devalue, the interest rate goes up, because the interest rate—because the standard value in Latin America is the dollar, okay. So if you devalue against the dollar, people are thinking, you know, it will be earning 5 percent in dollars plus the devaluation—this is the interest rate they have to pay in pesos. If not, I move my money to New York. So, you know, there is a big difference between what happens in an international currency when the exchange rate moves and one of these parochial currencies, I would say. In one of these big international currencies, what is the big advantage? The diversity of the economy, you know, because the fact that the dollar depreciated against the euro by 30 percent doesn’t result in an increase in the price of the Chrysler cars by even 1 percent, or any car in the United States or any hospital equipment or anything else. But if you do it in any other country, if you devalue against the dollar, of course the price of cars will go up, the price of machinery will go up, and so on.

The point is that the American economy or the European economy are so diversified that they can substitute for any imported thing. That’s why, if you’re living within an international currency, you know, it doesn’t matter if it devalues. It will help you, really, because if you’re a producer of cars in the United States and you devalue against the Europeans, probably your demand will increase. But your price does not increase.

So you need diversity. And in Latin America, we don’t have diversity. What we have is commodities, and, you know, some minor industries and so on. So if that currency will devalue, you know, then you will have increases in prices and the same thing that happens in any other place.

Remember that Latin America, you know, maybe is the size of the upper little corner of United States, you know, northwest or something—all of Latin America together. So, you know, I think that, you know, thinking of a Latin American currency doesn’t make sense. You really want a currency that will, you know, be diverse enough to include commodities and machinery and knowledge industries and knowledge services and all these sophistications. So that’s why I think you should move more into an international currency, which could be the euro or the dollar.

MR. STEIL: John.

QUESTION: John Mbiti from UBS.

I wanted to follow up on two points that were suggested with respect to going forward in Argentina. The first one was the suggestion to try and move away from low-end commodity exports to high-end manufacturing products. While I agree this is a long-term solution, I’m not sure this is a short-term panacea, because, to use an analogy, countries like, say, Malaysia and Singapore took over 30 years to move from, you know, commodity products like palm oil to, you know, semiconductors.

The second suggestion was dollarization. While I agree it addresses certain issues like sovereign country risk, it also—it only seems to make sense where the particular country that’s dollarizing, the economies are aligned very closely, if not the same as the United States. Take, for example, the Federal Reserve has no remit, nor would anyone suggest it should have a remit to take into account economic conditions in, say, Panama or El Salvador when considering monetary policy.

In addition, I think when you dollarize, you give up the right for the central bank to seignorage on the domestic currency.

So given these two particular issues, are there any real short-term solutions?

MR. HINDS: Well, you know, first let’s talk about the seignorage. In Salvador seignorage was 0.00—I don’t know—0.1 percent of GDP—very, very small—you know, because you have to distinguish between two things. One is the inflation tax and the other one is—(inaudible).

(Inaudible)—is the income that the government gets, because people demand money and the government is providing it, okay. And it has two parts, two components. One is cash, cash in the hands of the population. If you have an advanced banking system, which, in the case of El Salvador, you know, it is advanced by Latin American standards—we have exactly the same spread between lending and borrowing rates, as in the United States, and services and—(inaudible)—and so on.

It is a very, very, very small part of your money supply. In El Salvador it was very, very small. And then you have the deposits of the banks in the central bank. But then if you pay interest on those deposits, which was the case in El Salvador, to keep the margin low between the two rates, then that is almost zero. So in the case of El Salvador, the—(inaudible)—was very small.

You know, you can get more—(inaudible)—if you impose controls and restrictions on the financial system, but that’s bad for the country. So forget about—(inaudible).

Now, the other point is, you know, moving from low end to the high end, if you look at, for example, Japan or Germany in the recovery, you will see that the more they exported, the higher the value of their currency. It is not, of course, that they were exporting when the currency appreciated. It is that when you become successful exporting, your currency naturally appreciates. And then is when you have the problem. Then you have to make the choice; you know, “We are going to devalue the currency.” If you devalue the currency because of the problem I was talking about, the standard value, then the rate of interest will go up.

Your financial costs will go up if you say, “I’m going to keep the wages low,” all right, but then you are killing, you know, your cow milk, because you increase the interest rates and then you are not going to have the investment you need to increase the value (added ?) for your production. So in my view, it is better to keep the interest rate low so that, you know, you can have higher wages and the investment needed to give those higher wages, you know.

And, you know, then the alignment with the business cycle—you know, what would you prefer? Would you prefer to operate in an economy where you have a perfect synchronicity of the business cycle so that at the same time everything goes up and everything goes down? Do you prefer that, or to operate in an economy where some sectors will go up while other sectors will go down, so that you will have more or less—(inaudible).

I prefer the second one. So I prefer to share my currency with an economic area where I have enough diversity that some things are going up and some things are going down. For example, I would never choose a currency issued by oil-exporting countries—never, you know, because that would be to go in a (ride ?) like this. You prefer an economy where you have some things going up, some things going (up ?). Now, that is—what you said is exactly the reason why the optimum currency area theory says that you should have your own currency. The answer I’m giving you is the reason why I think the optimum currency area is not the one that they say but is the one when you have a diverse economy, that’s the optimum currency area, because you can balance the risks.

MR. STEIL: Eduardo.

MR. ANINAT: Well, basically I think the one important consideration that is being laid out here is to be keen about transaction costs and where you want to focus your efforts as producers, as exporters, as import substituters, as investors. And in that sense, joining a larger currency or a stronger currency or dollarizing at the edge can be a lot of advantages. I share that view.

On the other hand, we have to put a grain of salt here, because I think the examples that were given were very commanding and very strong. But what were to happen if the euro-dollar relation went to 1.5 instead of hovering around 1.18 to 1.13? Well, I think, to be very clear, German exporters would get diarrhea. (Laughter.) And let’s be very clear about it.

So within reasonable range of movement, things go the way Manuel is saying. But that is also under the background scenario of other remaining stable conditions—the Fed’s behavior, fiscal deficits here and in Europe, the yen situation, so forth and so on.

So I would just bring a point of caution on the background scenario, because the problem with economics is like—it’s like a—how do you call this—global? Balloon. It’s like a balloon. If you push on one side too much and overstress your point, other parts become deformed.

It’s a simultaneous equation problem. You can’t have just one (variable more ?) or two (variable more ?). Everything has to tie in together. And that’s how development here (associates ?), or in Europe or in Japan, everything moving together in a kind of harmonized, simultaneous way—(inaudible)—important that may be.

MR. STEIL: It’s 9:15, so I want to apologize to those of you who didn’t get to ask questions. We always end on time at the Council. So I’d like to ask you at this point just to join me in thanking our speakers for a very fascinating discussion. (Applause.)


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