History Senior Thesis Advisor: Professor Martha Howell
Second Reader: Professor Pablo Piccato
The ‘Maradona’ of the Economy
The Rise and Fall of Cavallo’s Integrated Argentine Economy
By Lucas Federico Servideo
Acknowledgments
I want to thank Professor Howell for her support and patience. Almost midway through my
project when I was completely lost she told me to have faith and push on. Hesitantly I did and, as
per usual, she was right.
To Professor Piccato, thank you for your continual support as my second reader. To Oliver and
Julia thank you for the countless edits, conversations, and laughs. To Professor Chang, a last
minute savior, I am truly thankful.
Últimamente me gustaría agradecer a mis amigos, a mi familia, y a Irene. Gracias por aguantar
un año de solo escuchar sobre Domingo Cavallo, las privatizaciones, y la deuda externa.
2
IntroductionArgentina’s Anti-inflationary Tango: Convertibility 4
Chapter ILa Guarda Vieja: Overview of Argentina’s Political Economy 12
Borrowing 12Privatization 15Antecedents 17Stability 18Recession 24Crisis 27
Chapter IIEl ‘Lunfardo’ de Cavallo: The Minister’s Words 33
Lessons from Argentina’s Privatization Experience, 1997 33Period I: Brady Plan Agreements 37Period II: Borrowing for Convertibility 40
Chapter IIIBehavioral Economics as Model For Cavallo’s Argument 45
Chapter IV La Retórica Se Vuelve Realidad: Debt Used in Privatizations 52
ConclusionEl Ultimo Paso: What Does All This Mean? 59
Epilogue Guardia Joven: Contemporary Significance 63
3
Introduction
Argentina’s Anti-inflationary Tango: Convertibility
“At the end of every seven years you must cancel debts. This is how to cancel debt: Every
creditor is to cancel what he has lent his neighbor. He is not to collect anything from his
neighbor or brother, because the Lord’s release of debts has been proclaimed.” – Deuteronomy
15:1
About 24 years ago, two years before I was born, both of my parents travelled from
Buenos Aires to Miami. They had both just finished university and, perhaps a little foolishly,
they decided to do some shopping. They paid for the majority of their purchases, as well as their
meals, and their stay on credit cards. Probably all of us have made similar bad decisions at some
point in our lives – we’ll figure out how to pay this later. Unfortunately, the concept of paying
later was a risky one in Argentina in the late 1980s and the early 1990s. The annual inflation rate
for the year that they travelled was around 3000%. This meant that when they returned, the value
of the austral (the Argentine currency at the time), in which my father earned his salary, had
been substantially diminished. The bills, however, had to be paid in dollars. Luckily, my mother
convinced her boss to determine her salary on a dollar basis for one more month, allowing them
to avoid defaulting on their credit card debt. Their story ends well, but they were the exception,
not the rule.
Inflation plagued Argentina throughout the decade of the 1980s. It had been customary
for people to sell their property and put their earnings in a bank, but during this period, money
would become worthless within two months, leaving them literally homeless. There was no trust
in the value of the national currency; those who could do so put their savings in dollars. Perhaps
this episode was not as memorable as the inflation suffered by the Weimar republic, acutely
4
captured by the pictures of men carrying wheelbarrows of money or children using cash as toys,
but it was just as bad, and possibly even worse.
In early 1991, ten years before Argentina defaulted on its international debt and devalued
its currency, an effort was made to address the economic crisis caused by runaway inflation. The
subsequent decade, that is the years after 2000, saw the failure of the policies then put in place
and marks one of the most tragic periods in the country’s economic history. During the 90s, the
country underwent ‘neoliberal’ market reforms centered on open trade and access to capital
markets, fiscal responsibility, and a stable currency.1 According to Joseph Stiglitz, a Nobel Prize
winner in the field of economics and author of Argentina, short-changed: Why the nation that
followed the rules fell to pieces, the policies implemented during the 1990s were doomed to fail.
The most influential piece of the policy reforms was the convertibility law, which equated the
Argentine peso with the US Dollar.2 Maintaining this exchange parity was of the utmost
importance to the country at the time and depended on two measures: the sale of state assets and
international borrowing.
In this thesis I will study the relationship between these two policies through an analysis
of Domingo Cavallo’s account, Argentina’s economic minister from 1991 to 1995. By
examining his speeches, articles and interviews, and by studying the process of selling state
assets in it of itself, I argue that the minister believed that privatization made access to capital
markets possible. The story I am telling and my analysis of it obviously have a deeper history
that is essentially social and political, but this thesis does not try to place the policies or Cavallo
1 Neoliberal in quotation marks because at first the IMF, and other neoliberal organizations, did not support Argentina’s radical fixed exchange policy. Instead, they insisted on fiscal discipline, they argued that the elimination of taxes on imports and the fixed exchange rate were not conductive to Argentina having a budget surplus. In other words the country was not being fiscally responsible as it policies indicated it was going to spend more than it was going to earn. 2 The peso was the Argentine national currency that replaced the previous currency, the Austral, at the time that the convertibility law was passed. This will be further described in Chapter 1 in the section titled Stability.
5
himself in that history except by implication. Instead, I am focusing on the monetary and fiscal
history itself: how privatization worked, how it made it possible for Argentina to borrow in
international markets; to the extent possible from published data, I am also assessing the extent
to which the combination of privatization and borrowing actually worked to restore fiscal health
– and when it no longer did.
Traditional treatments of Argentina’s economic policies during the 1990s, in particular
those studies dealing with the convertibility law, have considered privatization and borrowing
important, but parallel, ways of maintaining exchange parity, not as necessarily interdependent
policies. As economist and historian, Joseph Halevi put it, the only way that Argentina could
stimulate the capital inflows essential to maintaining its convertibility scheme was by “[…] (3)
privatization of public activities such as utilities where a steady flow of rents is always
guaranteed; [and/or] (4) borrowing on international financial markets.”3 In brief, as he and many
others understood it, the Argentine central bank needed to ensure it had sufficient dollars in
reserves to backup the pesos in circulation, a necessity it could fulfill through either borrowing,
or privatization, or through a combination of both, as policies working in parallel to one another.4
IMF publications during this decade explained the policies similarly. They were, in the IMF’s
view, two separate initiatives, which independently influenced Argentina’s dollar reserves,
allowing the country to maintain convertibility. In this logic, privatization would attract foreign
investors because it demonstrated Argentina’s commitment to liberal economic policies; once
privatized, these industries would be well run, generate profits, and pay taxes. Those few
observers who have specifically acknowledged that privatization attracted foreign lenders
3 Joseph Halevi, The Argentine Crisis: Monthly Review, 3. 4 This is a simplistic version of a complicated mechanism that Argentina implemented in 1991 to make sure its national currency was equal to the US Dollar. Chapter 1 will explain the details of this mechanism, as well as the reasoning behind it at length.
6
themselves, not just investors expressing faith in liberal economic principles — principally
Steven Darch, former head of J.P. Morgan’s office in Buenos Aires — have only made brief
references to the link between privatization and international borrowing and have tended to treat
the connection casually, making statements like, if Argentina “wants to be part of the
competitive international markets, it has to sell off [state assets]”, and “how can you have a
phone system that doesn’t work and expect to attract foreign investment?”5
It is important to stop here and define the terms of the preceding paragraph that will be
employed throughout the rest of the thesis; they will be helpful to understand the privatization-
borrowing relationship. ‘Investors’ refers to individuals/institutions that bought a stake (debt or
equity) in privatized Argentine assets. ‘Lenders’, in contrast, refers to four types of people or
institutions: (1) individuals/institutions who purchased debt or equity in Argentine companies
that had never been nationalized (2) individuals who purchased government debt; (3)
‘institutional lenders’, that is international organizations such as the IMF, the World Bank,
among others, that bought government debt (4) ‘past speculators’, financiers who held defaulted
Argentine debt from the 1980s and were allowed to exchange this for equity in the newly
privatized companies.
Unlike most observers who commented on the monetary and fiscal policies put in place
in the 90s, Domingo Cavallo understood that privatization was very directly linked to
Argentina’s ability to attract the dollars necessary to sustain convertibility; it was not just a
supplement to borrowing, but an essential part of it. An analysis of his rhetoric demonstrates that
the minister believed that privatization actually attracted international lenders by not just
building up market confidence. With Argentina being cut off from international markets as a
result of defaulting on its debt during the 1980s, in fact privatization allowed it to receive support
5 Steven Darch in New York Times article: The Big Push Toward Privatization in Argentina. Dated 06/09/92.
7
from the IMF and the United States, because the seized assets (industries), when sold and the
funds added to the Argentine treasury, helped the country achieve a budget surplus. Both the
IMF and the US were adamant that countries wanting to reenter the international debt markets
needed to have a strong fiscal position. Thus, privatization was crucial to garnering their support,
which was in turn critical to the country’s campaign to be allowed to become part of capital
markets once again, a goal it achieved in 1992.
The actual process of privatization under Cavallo’s ministry reflects this understanding.
Many of the assets that had been previously seized by the state as part of the nationalization
efforts of the early 1990s were sold in exchange for outstanding debt that was trading at a deep
discount (around 15 cents on the dollar), in what is referred to as debt-to-equity swaps.6 Thus,
individuals and corporations that had invested in Argentina’s bonds during the 1980s (past
speculators) and had then seen their portfolio radically decline in value as the country failed to
meet its debt obligations, were able to exchange their devalued bonds at face value (full value)
for equity in the assets being privatized. In accord with the logic Cavallo expressed, which will
be explored more fully in this thesis, this plan was designed to restore the value of the previously
discounted bonds and in the process recuperate market confidence in Argentina, which would
allow future borrowing. This also had an effect on the still outstanding Argentine debt, for it now
seemed more attractive to lenders, given that the government was making a concentrated effort
to pay back its loans. Hence, from the beginning of the privatization policy in the early 1990s,
the debt-to-equity swaps created a direct relationship between privatization and borrowing.7
Interestingly enough, some investors/lenders, not economists, picked up on this phenomenon,
6 Argentina’s Privatization Program (The World Bank, 1993), 13. 7 Argentina had defaulted on its debts in the 1980s after many years of struggling with hyperinflation under the newly elected democratic government. Prior to this default, Argentina had been under military dictatorial rule. The former government had extended the country’s total amount of debt, leaving an unfavorable economic situation for the democratic government.
8
and I will use them in the body of the thesis to support my argument that this connection was a
self-conscious part of Cavallo’s plan. There I will consider Cavallo’s speeches and writings,
paying careful attention to the way he acknowledges the privatization-borrowing pairing.
Additionally, I will seek to expose their relevance to Argentina’s actual economic experience
during the decade. The organization of my chapters follows this chronology.
Chapter one begins with a section devoted solely to explaining both of these initiatives at
length, both in general terms and with respect to Argentina’s case. It continues by providing a
historical sketch of Argentina’s economic experience from 1983 when the country reclaimed its
democracy, up to the default and devaluation that took place in 2001. It describes Argentina’s
long history with inflation, the early successes of the convertibility program, and its eventual
failure. In a sense it condenses and simplifies a relatively complex economic history in order to
foreground the ensuing analysis of Cavallo’s speeches and publications. Furthermore, in
providing this long economic overview, chapter one shows how others have described
privatization and borrowing.
The second chapter focuses exclusively on Cavallo’s publications. It is divided
chronologically, beginning with those narratives that deal with Argentina prior to it being
allowed to borrow in 1992, and finishing with Cavallo’s thoughts after the country was actively
borrowing in capital markets. In the midst of this analysis, this chapter not only demonstrates the
minister’s conviction that privatization enabled borrowing – it did not just accompany borrowing
– but also his understanding of how the relationship worked. Beyond analyzing Cavallo’s
thoughts on the matter, the chapter also highlights data that proves the feasibility of his
argument. Demonstrating the plausibility of the link between privatization and borrowing.
9
The third chapter utilizes behavioral economics to give an analytical framework to
understand Cavallo’s argument. Through the use of psychological tools, specifically feedback
loops, it explains how the minister’s account could be understood. In doing so it does not make a
claim about the plausibility of the argument, merely demonstrates that if it were taken as true it
could fit within this discipline of economics.
The final chapter takes an in-depth look at how many of the sales of nationalized assets
were actually carried out. It turns out that several of the state assets, as was briefly mentioned
earlier, were bought with debt forgiveness. That is to say, debtors forgave Argentina’s
outstanding debt in exchange for equity in these newly formed private companies, which were
previously state assets. This chapter looks into the significance of this operation, starting with the
historical relationship between debt and privatization, and moving on to the effect that such
operations had on individual and institutional lenders. Again, we see Cavallo’s policies in action.
In short, we can now see very clearly that the country was able to attract foreign investors not
only to companies being privatized, but also that these operations increased confidence in the
country so that other companies and the nation itself appeared to be credit-worthy. This
influenced lenders who, in turn, primarily bought governmental debt, playing an important role
in maintaining the country’s convertibility scheme.
Thus far, historians have paid little attention to Cavallo’s understanding of the necessary
link between privatization and borrowing, leaving out the commentary/opinion of the minister
who implemented these reforms. By showing how they were related and how Cavallo explained
their relationship, this thesis seeks not only to illuminate an aspect of the country’s economic
history during this tumultuous period, but also to help show why these policies were doomed to
fail.
10
Chapter 1
La Guarda Vieja: Overview of Argentina’s Political Economy
11
Preface
At the end of 2001, Argentina suffered an unprecedented economic collapse accompanied
by social and political unrest. The collapse was preceded by negative GDP growth from 1998
onwards and was followed by a debt default of US$ 155 billion, the largest in history. In this
section I will outline the economic and political history that led to this event with the goal of
providing the background to my analysis of Cavallo’s thoughts on privatization and borrowing.
This overview covers the years 1983 to 2001 in order to capture a full picture of
Argentina’s economy during the years prior to the crisis and is divided in four distinct,
chronological, subsections: Antecedents (1983-1991) – the aftermath of the military dictatorship,
and Argentina’s struggles with hyperinflation; Stability (1991-1998) – implementation of
neoliberal polices and their success; Recession (1999-2001) – the moment negative GDP growth
began showing the inadequacies of the system; and Crisis (2001) –the economic collapse that
ensued.8 9 Firstly, however, I will provide two detailed sections on borrowing and privatization
given their importance to this thesis.
Borrowing
International borrowing is an important macroeconomic tool used by most modern
economies to finance long-term projects or government deficits. Emerging economies have
customarily used this initiative to facilitate investments in infrastructure and other expensive
ventures and have done so because it gives them access to easy capital that they cannot produce
endogenously. These countries generally do not have a budget surplus and usually run trade
deficits, as they are still developing their export industry.
8 These subsections are partially based on Ronaldo Munck’s paper Argentina, or the Political Economy of Collapse. 9 This 20-year range is deliberate. In 1983 Raul Alfosin was democratically elected, ending Argentina’s military dictatorship. In 2001 Argentina officially defaulted on its debt and devalued its currency. These politically significant moments also encompass equally significant economic turning points for the country.
12
Latin American countries have historically followed this route. Notably, Buenos Aires
provides an example. The city obtained financing to build its port, Puerto Madero, in 1881 with
Barings Bank, an English merchant institution. Although this was a successful example, Latin
America has not always been so lucky with borrowing. Another more recent and relevant
instance is the one that led to the Latin American debt crisis of the 1980s. During the 1960s and
the 1970s many of the region’s countries, notably Brazil, Mexico, and Argentina, borrowed
unprecedented amounts of money in international capital markets to develop their
industrialization programs, resulting in an increase of Latin American external debt from $75
billion to $315 billion between 1975 and 1983. This amount equaled 50% of the zone’s GDP.
When the world went into a recessionary phase during the 1970s and 1980s, many of these
countries suffered a liquidity crunch – the moment when nations need additional borrowing to
cover their interest payments. Customarily, many of their debts would be extended, but under
unstable macroeconomic conditions debt holders were unsure of the countries’ ability to repay its
loans, so they cancelled the refinancing. Like its neighbors, Argentina was having serious
difficulties covering its interest payments and in 1982 it had to approach the IMF for financial
assistance. Eventually, it was cut off from the capital markets.
During the 1980s Argentina attempted, and failed, to reenter the borrowing market; the
country’s unsuccessful bids to renegotiate its loans with commercial banks marked the decade. A
major breakthrough came in 1992 with the Brady Plan. Proposed by Nicholas Brady, the US
Treasury Secretary at the time, the plan consisted of a market solution for “emerging market”
debt. Instead of commercial banks providing “new lending to give countries time to grow out of
their debt-servicing difficulties,” the Brady plan provided “permanent relief through market-
based debt and debt-service reduction for countries adopting strong economic reform
13
programs.”10 The key innovation behind it was the introduction of Brady bonds, which were
dollar-denominated bonds issued by emerging economies. These bonds were made up of
converted bank loans that had defaulted in the 1980s, which allowed commercial banks to
exchange their claims/debts on developing countries into instruments that could be traded — the
Brady bonds. This translated into banks removing the bad loans from their balance sheets. More
importantly, it meant that Argentina and other emerging economies were once again capable of
tapping international capital markets for financing. The conditions to be eligible for this program
varied on a country-to-country basis, but they were generally centered on adopting strong
policies to guarantee debt reductions.11
Argentina signed a deal with its bank creditors on December 6th, 1992. The deal consisted
on the exchange of bank loans for different options of Brady bonds. The IMF calculated that the
whole operation was equivalent to buying back the existing debt at 38% of its original value.12
Argentina’s acceptance into the Brady bonds program was dependent on free market reforms. As
one IMF official put it, “we believe that the sweeping market-oriented economic reforms that are
being implemented are exactly the sort of policies we had in mind when the international
financial community endorsed Secretary Brady’s proposals for debt and debt-service
reduction.”13 Argentina also received loans from the IMF, and other international monetary
institutions, as a result of the country’s adoption of free market reforms. Note that in saying so, it
becomes clear that for the institutional lenders privatization was only one policy within a set of
other equally important policies that demonstrated the country’s reforms, which ultimately paved
10 John Clark, Debt Reduction and Market Reentry Under the Brady Plan (FRBNY: Quarterly Report), 38. 11 John Clark, Debt Reduction and Market Reentry Under the Brady Plan (FRBNY: Quarterly Report), 41. 12 Five Fat Years: Recovery from the Debt Crisis, 1990-94 (The IMF and Emerging Markets), 419. 13 Five Fat Years: Recovery from the Debt Crisis, 1990-94 (The IMF and Emerging Markets), 420.
14
the way to the country’s reemergence in the capital markets. Cavallo’s accounts challenge this
position; I will demonstrate this from page 33 onwards.
By the mid 1990s, Argentina was once again fully integrated into international capital
markets. Lenders were as confident as the international organizations in the country’s prospects,
which allowed Argentina to once again obtain loans at an unprecedented rate during this decade.
From 1991 onwards the country’s external debt grew at a rate of 12% per year. By 1999 the
balance totaled roughly 50% of the country’s GDP.14 Argentina, unlike in previous decades, was
predominantly utilizing the capital from these operations to finance its convertibility scheme.15
By 2001 the debt and interest obligations were too much for the country to meet timely
payments, leading to a default on its international debts.
Argentina’s recent borrowing history moved from one extreme to the other. Either the
country amassed unfeasible debts, engaging in intense borrowing, or it was cut off from the
international market after defaulting on its debts. In any case, it can be said that borrowing was
central to Argentina’s political economy. What is truly remarkable about the country’s
experience during the 90s is how effectively it was able to return to borrowing, a phenomenon
that I will address later.
Privatization
Latin America underwent a period of intensive privatization during the 1980s and 1990s,
following the Western neoliberal economic ideology. State companies, which had been acquired
during the previous two decades’ wave of nationalizations, were sold to private investors faster
14 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 414. 15 As Halevi explains in his article.
15
than anywhere else in the world. Overall, more firms and larger ones, raising more proceeds,
were privatized in Latin America than in the rest of the globe.16
Argentina was the crown jewel of privatizations in the region. The sales began in 1989 —
before the Menem administration — and by 1996 every state asset that could be put on the
market had been sold. The country was selling at a rate of US$555 million per month.17 The
initiative was aggressive enough to catch the attention of the international press. A 1992 New
York Times article, “The Big Push Towards Privatization in Argentina,” was just one of many.
Argentina’s 1990s privatization history is much simpler to explain than its borrowing
trends, though both policies played an equally fundamental role in the country’s political
economy during this decade. To maintain convertibility Argentina needed an inflow of dollars —
recall that every peso in circulation had to be backed up by a dollar held in the central bank. The
country, historically, had only a small trade surplus. Convertibility, however, made export
surpluses almost impossible, as Argentine goods were more expensive than goods from countries
with lower value currencies — a result of the fixed exchange rate. Thus, dollars or other strong
currencies were not entering the country in significant amounts through commerce; rather, it was
the reverse as Argentinians bought from foreign suppliers. The convertibility policy was in a
sense based on contradictory logic. On the one hand, it needed dollars to be maintained, but on
the other it limited the inflow of dollars into Argentina by making export surpluses unlikely. The
solution to this problem was instead on privatization and borrowing: the country utilized the
capital from its privatization program, as well as continuous debt issuances, to have a steady
supply of dollars. In turn, this growing reserve allowed the government to maintain the peso-to-
16 John Nellis, Rachel Menezes, Sarah Lucas. Privatization in Latin America: The rapid rise, recent fall, and continuing puzzle of a contentious economic policy (Center for Global Development Policy Brief, Jan 2004), 1. 17 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 337
16
dollar parity. If the government had been able to keep dollars flowing in, Argentina may have
never devalued its currency, as it did in 2002.
This section has explained Argentina’s economic history, particularly borrowing and
privatization at length because it is a crucial step in order to comprehend the country’s
convertibility model. The peso-to-dollar parity put the country in a situation in which it needed to
either borrow or privatize, and traditional historiography has generally treated both of these
initiatives as separate if related. The remainder of this chapter will utilize the understanding of
both policies to explain Argentina’s long economic history.
Antecedents
In 1983, Raul Alfonsin became Argentina’s first democratically elected president after
years of military dictatorship. He had campaigned on the slogan, “with democracy one can eat,
be educated, and be cured of illness,” however, he could not make it a reality, for his government
became plagued by economic distress suffering from the legacy of the military dictatorship.18
“The most pressing economic issue that the new democracy needs to face,” as one commentator
flatly put it, “is the external debt, “totaling US$ 45 billion in 1983, 70% of the country’s GDP.”19
20 Being unable to repay it, the country lost the right to borrow in the international markets, and
the ensuing credit crunch was accompanied by hyperinflation.21 22 Inflation had to be reduced if
18 Omar Sanchez, Argentina’s Landmark 2003 Presidential Election: Renewal and Continuity (Bulletin of Latin American Research, 2005), 460. 19 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina (Rosario Santa Fe: Pueblos del Sur, 330) – free translation. 20 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina,352.21 External debt is anything owed to foreign creditors. This includes governments (USA), international economic institutions (IMF), and private institutions (banks). 22 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 330 – free translation. Quote: “the new democratic government had inherited an unsustainable inflationary situation, and an administrative disorder”.
17
Argentines themselves were to regain confidence in the economy, while foreign investment
necessary for economic recovery depended on price stability.
During his first year in government, Alfonsin took measures to improve the country’s
economy. As a democracy, Argentina was able to obtain an extended IMF loan to foster its
recovery for example, but this success was short lived, for in 1985 the country suffered a
hyperinflationary outburst, with levels of up to 672.2%.23 24 The situation worsened and
Argentina fell into a spiral of hyperinflation that “bedeviled and liquidated the Raul Alfonsin
presidency (1983-1989) six months before the end of its constitutional term.”25 Under the new
president,Carlos Menem, hyperinflation continued despite his commitment to neoliberal
measures — notably the deregulation of the economy, and some privatizations of state assets. It
was only in 1991, with the Convertibility Law (described below), that inflation was finally put to
rest.
Stability
The eight-year long financial crisis had severe social effects. Sustained, and at times
exponential, increases in the prices for goods and services did not coincide with growth in
earnings, which affected the lower classes in particular by making them effectively poorer.26 27 28
Additionally, average people who had their savings in the national currency found themselves
with a considerable decline in purchasing power. Wages were only adjusted at the end of the
month, whereas goods such as groceries were adjusted on a daily basis. This meant that the
general population had to very carefully select when to purchase their groceries and, as a means
23 "I.M.F. Loan To Argentina." The New York Times. January 24, 1983.24 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 341. 25 Omar Sanchez, Argentina’s Landmark 2003 Presidential Election: Renewal and Continuity, 455. 26 "Inflation: What Is Inflation?" Investopedia.27 Real value represents the ability to purchase goods. Different to nominal value which is expressed in currency. 28 James Brooke, “For Argentina, Inflation and Rage Rise in Tandem.” The New York Times. June 03, 1989.
18
of survival, desperately search for stores that had still not adjusted their prices.29 This
phenomenon resulted in economic chaos and consequently social chaos followed. The figures
below show the runaway inflation, peaking in the years of 1989 and 1990. These numbers,
however, only suggest the suffering that Argentinians experienced.
Annual Inflation Rate for Argentina from 1983 to 1990:30
Year Inflation rate (%)1982 164.81983 343.81984 626.71985 672.21986 90.11987 131.31988 343.11989 3079.51990 2314.1
Menem’s government only began to successfully slow inflation down in 1991, with the
implementation of the Convertibility Law instituted by the new Finance Minister, Domingo
Felipe Cavallo — a neoliberal economist with a PhD from Harvard University. Cavallo took
office on the February 1st; by March 27th he had received congressional approval to enforce his
Convertibility Plan, which consisted of fixing the peso to the US dollar on a one-to-one basis.31
“From then on,” Ronaldo Munck has established, “domestic money creation would have to
match the available US dollars, in order to avoid the money-printing syndrome of the
inflationary past.”32 This meant that the Central Bank could only print pesos that were backed up
29 Interview with Fabiana Stella Maris Frias. Conducted on December 20th, 2013. 30 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 341.31 The peso was the new currency established in 1991 to replace the austral. Technically, the convertibility was firstly done for the austral that was then converted to the peso. US$ 1 = 10,000 australes. 10,000 australes = 1 peso. So, US$ 1 = 1 peso. 32 Ronaldo Munck, Argentina or The Political Economy of Collapse, 73.
1982 1983 1984 1985 1986 1987 1988 1989 19900
500100015002000250030003500
164.8 343.8626.7 672.2
90.1 131.3 343.1
3079.5
2314.1
Argentina Inflation
Year
Infla
tion
Rat
e (%
)
19
by dollar reserves and that the Argentine monetary system would become inherently dependent
on its ability to accumulate dollars, resulting in the stabilization in the price of the peso. Indeed,
for nine years Argentina had no inflationary concerns, a welcomed relief. The data attest to this,
truly an astonishing feat when compared to the inflation of the previous decade. Inflation was
reduced to single digits within the first three years of the program.
Annual Inflation Data for Argentina from 1991 to 2000:33
Year Inflation rate (%)1991 171.71992 24.91993 10.61994 3.91995 1.61996 0.11997 0.31998 0.71999 -0.12000 -0.2
In order to maintain convertibility, which controlled inflation, Argentina needed to
guarantee the balance between the net inflow of dollars and domestic monetary creation. There
are two principal ways to do so: “(a) large surpluses in the current accounts (exports greater than
imports) or (b) net capital inflows of other kinds.”34 Surpluses increase the Treasury’s dollar
supply both directly and indirectly. Some exports are paid for in dollars and these go directly into
the Treasury, other goods are paid for in pesos, which can be used to buy dollars in foreign
exchange markets – indirectly increasing dollar supplies. This, however, was not a reality for
Argentina. The reasons as to why have been covered in the previous section (page 16). For their
part, capital inflows “could be stimulated by […] privatization of public activities such as
33 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 381. 34 Joseph Halevi, The Argentine Crisis: Monthly Review, 3.
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000-50
0
50
100
150
200171.7
24.910.6 3.9 1.6 0.1 0.3 0.7 -0.1 -0.2
Argentina Inflation
Year
Infla
tion
Rat
e (%
)
20
utilities where a steady flow of rents is always guaranteed; and/or borrowing on international
financial markets.”35 Argentina followed these two policies extensively during the 1990s.
Ensuring a steady inflow of dollars into the economy, these measures translated into a growing
monetary base, which in turn led to economic stability.
During the process of privatization, as previously covered, the state sold a number of its
public assets to private companies, both foreign and national, to generate financial profits
(rents).36 Cavallo did not invent this policy, for it had begun for key industries such as railways,
airlines, telecommunications, and petroleum prior to his ministry. Indeed, “a portion of
Telefonica, Telecom, and Aerolineas Argentinas had already been sold” when he took office.37
After Cavallo began his term, however, the pace accelerated. As one expert summarized it:
“Privatizations were accelerated, by December of 1992, important companies, such as Entel, Segba, Aerolineas Argentinas, Somisa, Gas del Estado and Obras Sanitarias had been fully or partially sold. […] Soon after came the privatization of the petroleum companies Bahia Blanca, Encotes and of the airports. From the beginning of the privatization process up to 1999, it had been estimated that US$ 35,000 million (US$ 35 billion) had been raised.”38
The selling of state assets led to an inflow of capital into the Argentine economy and improved
the country’s economic conditions. As one commentator put it, “privatization and budgetary
austerity attracted capital, thereby expanding domestic monetary creation and leading to a
euphoria that, between 1991 and 1995, generated a growth rate in excess of 4 percent per year.”39
In tandem with privatization, the Argentine government increased its debt by borrowing
in the financial markets. Part of this came from loans issued by the IMF and prolonged
throughout the 90s, as the process of privatization continued and gave the IMF further evidence
35 Joseph Halevi, The Argentine Crisis: Monthly Review, 3. Note: the steady flows of rents led to public activities being in demand by investors looking to purchase state assets. 36 Joseph Halevi, The Argentine Crisis: Monthly Review, 5. 37 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 57 – free translation38 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 337 – free translation39 Joseph Halevi, The Argentine Crisis: Monthly Review, 4.
21
of Argentina’s commitment to free markets. The other part originated from “international
financial companies [that] were pushing loans” onto the country’s local capitalists.40 The key
tenant for this to happen was the signing of the Brady Bonds that I covered in the preceding
section. In the end, total national indebtedness increased eleven-fold from 1991 to 2001.41
Accordingly, rising indebtedness was made possible by all of the reforms undertaken by the
country. As has already been touched upon, for IMF officials the Brady agreements came to be
as a result of Argentina adopting market oriented reforms, of which privatization only played a
small role. In the case of lenders who purchased Argentine debt, they were also influenced by all
of the reforms. In subsequent sections of this thesis I will show how Cavallo’s accounts
challenge this perception – he believed that privatization was at the center of the country’s
borrowing policy/ability, not just attendant to it.
The combination of capital inflows, a growing money supply and price stability set the
foundation for economic growth. At a domestic level, the dollar to peso parity gave Argentines
increased purchasing power because they now earned in “dollars.” The improvement of services
through privatization meant that demand for amenities was also rising. Private companies tend to
provide better services than state companies because they are subject to competition and
experience higher risk of default, while state companies act in a monopoly in which customers
have no choice of service provider. The latter can also be unprofitable — as the state has to cover
losses — resulting in low levels of investment in infrastructure, leading to bad services. A
quotidian example of this phenomenon is the implementation of phone lines. Prior to the selling
of the state telephone company for example, families had to wait for years to get working lines.
After privatization they could have the service within a week.42 At a macro level, the stability
40 Joseph Halevi, The Argentine Crisis: Monthly Review, 4. 41 Ronaldo Munck, Argentina or The Political Economy of Collapse, 74.42 Interview with Gaja family. Conducted on 21st of December, 2013.
22
achieved with the convertibility law contributed to accelerating capital investments from
industrialized economies. This stimulated consumption, which in turn stimulated the Argentine
economy.43
Indeed, the results were positive. GDP rose from 1990 to 1998, with only one year of
negative growth during Mexico’s financial crisis in 1995. Moreover, what economists sometimes
call the misery level (= inflation + unemployment – GDP growth) declined during this period.
Argentina was also being hailed as the exemplary case of success in the developing world.
International publications praised the country and Latin Finance Magazine named Cavallo
economist of the year.44 For a period, it seemed as though convertibility had solved the country’s
problem, returning Argentina to a level of prosperity that had only been experienced in the late
1800s.45 46
Misery Level (in %, see above for definition) for Argentina from 1990 to 1998:47
Year Misery Level (%)1990 2312.41991 169.31992 23.31993 13.9
43 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 400 – free translation. 44 "Harvard Newsletter." Newsletter.45 Up to this point, Argentina’s political economy has been presented in a generally positive manner. I have chosen to ignore some of the flaws of the policies. These, as well as their consequences, will makeup the latter section of this overview. 46 Roberto Cortes Conde, La Expansión de la Economia Argentina entre 1870 y 1914 y el Papel de la Inmigración. (France: Presses Universitaires du Mirail, 1968), 67. 47 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 396.
23
1994 6.91995 23.71996 13.01997 7.11998 9.7
Gross Domestic Product Annual Variation (in %) for Argentina from 1990 to 1998:48
1990 1991 1992 1993 1994 1995 1996 1997 19980.1
8.9 8.7
6.3
8.5
-4.6
4.3
8.1
3.9
GDP (Annual Variation %)
Year
GD
P C
hang
e
Recession
Toward the end of the decade, however, Argentina’s economy began to show signs of
strain, mostly caused by the convertibility program. Roque Fernandez had replaced Cavallo as
Finance Minister in 1996, but “the difference between them was primarily in style,” not in
48 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 383.
24
policy.49 More importantly, the convertibility model setup by Cavallo was still in place but the
privatization program had exhausted itself. By the end of the century most of Argentina’s
industries had been denationalized, which meant that the country was solely dependent on
borrowing to feed its treasury. As Di Pietro explains, “the financing of the negative balance of
payments with foreign capital was not sustainable, this was because the movement of capital can
occur for multiple reasons.”50 For example, “an increase in interest rates in the US would rapidly
volatize foreign capital.”51 In other words, if the return on investing in American bonds were to
increase, the capital invested in Argentina would be transferred to the US in order to take
advantage of the added returns and the relatively lower risk of American securities.52 Foreign
capital was also volatile because of the “country-risk” associated with emerging economies —
the danger that the country will not be able to honor its debts. If there is speculation that this will
happen, foreign capital tends to flee. As one scholar has put it, “In the case of peripheral
countries, a persistent and rising external deficit is immediately translated into the threat of
insolvency.”53
Mexico’s 1995 economic crisis caused further worry; lenders in Argentina became
apprehensive and, according to the traditional economic explanation, a crisis was averted only
because of trade expansion within the newly created Mercosur area, a free trade market in
between Argentina, Brazil, Paraguay, and Uruguay.54 This calmed lenders as Argentina’s fiscal
49 Juan Carlos De Pablo, La Economia Argentina (Buenos Aires: La Ley, 2005), 587 – free translation.50 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 401 – free translation.Note: ‘balance of payments’ refers to the country’s annual budget, its income minus its expenditure. A budget surplus means a growing monetary base, and vice-versa. This is the overarching mechanism behind the dollar/peso conversion. A deficit has to be financed through borrowing. 51 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 401 – free translation.52 US bonds are considered risk-free because of two reasons. Firstly, the US constitution states that the country must pay its loans on time. Secondly, the US central bank is capable of printing money in order to pay its loans. This is because the dollar is the world reserve currency. 53 Joseph Halevi, The Argentine Crisis: Monthly Review, 4. 54 Joseph Halevi, The Argentine Crisis: Monthly Review, 4.
25
situation improved as exports increased. Yet the country’s GDP contracted by around 3 percent
and, worse still, the crisis exposed its dependence on foreign capital. Argentina’s vulnerability to
regional crises continued. By 1998, Mercosur was absorbing 35 percent of the country’s exports
and in the same year Brazil’s economy collapsed (Efecto Caipirinha).55 The immediate effect
was the real (Brazilian currency) being devalued by 40 percent. The devaluation of the real
meant that Argentine goods had become relatively even more expensive, thus were less in
demand. “From January 1999 onwards there was a direct [encarecimiento] of [Argentina’s]
exportable products” that led to a decline in the level of exports.56 Consequently, the country
began experiencing negative GDP growth, which lasted until 2002.
Argentina’s monetary policy was also impacted by Brazil’s crisis. First, it “put to rest any
illusion regarding long-term growth in the Southern Cone countries of Latin America,”
diminishing market confidence in the region.57 Second, and more importantly, it underlined a
fundamental truth: “real production could not possibly sustain the enormous debt and interest
burden of Argentina.”58 Undoubtedly, the country was not capable of exporting enough to
overcome the debt that had been accumulated over the past 8 years. The combination of these
two weaknesses meant that Argentina had difficulties renewing existing debt and issuing new
obligations. If they borrowed they now had to do it on increasingly unfavorable terms as lenders
feared devaluation, which would result in a significant loss in their investment. The outcome was
what one commentator described it, “an economic, not a political, debate about the necessity to
devalue the Argentinean currency.”59 The conclusion among experts was that the peso to dollar
parity could not be sustained much longer, but Argentina’s government decided to maintain the
55 Joseph Halevi, The Argentine Crisis: Monthly Review, 4. 56 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 409 – free translation.57 Joseph Halevi, The Argentine Crisis: Monthly Review, 4. 58 Joseph Halevi, The Argentine Crisis: Monthly Review, 4. 59 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 409 – free translation.
26
policy.60 As a result, its exports remained “expensive” and declined in demand, while the country
continued to borrow in the financial markets, increasing its overall debt. The recession deepened
as the GDP continued to fall, and confidence in Argentina’s credit steadily declined.
Crisis
This situation worsened in 2001. Fernando de la Rua, the country’s president at the time,
called Cavallo back to his post as Finance Minister, from which he had resigned in 1996 after
falling out with President Menem, with both men claiming that the other was involved in
corruption scandals. Under Cavallo’s guidance and the IMF’s recommendations, de la Rua’s
government undertook a series of orthodox austerity policies, including reducing public sector
wages as well as pension entitlements. In spite of these policies, international lenders did not
gain confidence and continued to flee, as interest rates on foreign debt rose further. In the end,
the country could no longer borrow and the devaluation of the peso became a certainty. By the
end of the year, lenders were withdrawing $1 billion per day. To make matters worse, it was
evident that Argentina was going to default on its foreign loans. The decline in exports meant
that the country had limited real production to generate tax revenues available for debt service.
The increase in interest rates, which had been taking place since the Brazilian crisis, meant that
the new loan payments were more expensive. The Argentine bond jumped by around 800 basis
points over the US Treasury bond in 1998.61 Finally, the unavoidable devaluation, a result of no
more privatization and no access to loans, meant that Argentina was likely to have to pay off its
dollar loans in an undervalued peso.62 The bond-spread variation can be seen below. 60 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 410 – free translation.61 "JP Morgan Market Data EMBI." Basis points are a financial measurement tool for understanding the difference between two different interest rates. Typically, the US Treasury bond is utilized as the base index, as it is considered riskless asset.100 basis points are equal to 1%. The yield of a bond is negatively correlated with its current price. A fall in price correlates to an increase in yield and vice-versa. In Argentina’s case, yields went up by around 8% compared to the US bonds, as their price fell and investors were worried about the bond defaulting. 62 The loans were originally made in dollars. With the convertibility this meant that they could be paid off in pesos, as 1 peso was equivalent to 1 dollar. With the devaluation, the amount owed in pesos would increase.
27
63
A further consequence of the foreseeable devaluation was that Argentines rushed to
withdraw all their savings from the banks. For nine years they had earned in “dollars.” If they did
not withdraw their deposits before the end of convertibility, they would effectively lose their
money, as they would not be able to exchange pesos for dollars at the parity rate. The demand for
currency overwhelmed both the private and federal banks.64 Fearing a bank run, Cavallo
implemented a “state–imposed freeze on bank accounts […], severely curtailing access to
savings,” a process called El Corralito.65
Enforced in November 2001, this measure was met with social revolt. Picture yourself
unable to withdraw money from your bank. Picture yourself knowing that the savings you had
accrued for years would most likely be worthless if you could not get them out. The result was
chaos. Argentina’s economic crisis had transformed into a sociopolitical one. People took to the
streets, ransacking supermarkets and other convenience stores in the city of Buenos Aires on the
63 "JP Morgan Market Data EMBI."64 Banks are legally bound to maintain a minimum level of reserves (currency/deposits not in use). Typically, they need to equal 10% of the total assets. This rate is supposed to cover the typical fluctuations in the demand for deposits. Nevertheless, it is not setup for extreme cases of excess demand. The Argentinean Central Bank, because of the convertibility law, was obligated to exchange pesos for dollars at a 1 to 1 rate. Their dollar reserves were limited as privatizations and borrowing had halted. 65 Ronaldo Munck, Argentina or The Political Economy of Collapse, 76.
28
19th of December. That same night President de la Rua announced a state of emergency. This led
to further revolts, with protestors famously banging pots and pans in criticism of the
government’s political economy (Cacerolazos). On the 20th of December rioters gathered outside
the Casa Rosada, Argentina’s presidential mansion, screaming “que se vayan todos,” or, all
politicians should quit. The same day protestors picketed outside Cavallo’s home, resulting in
the minister’s immediate resignation. The next day President de la Rua also renounced his post,
fleeing the Casa Rosada by helicopter after broadcasting his decision on national television.
Indeed, “under Menem [and his successors] politics were completely subdued under the
economic question.”66 When economics failed politicians had to pay.
The run on banks was not the only problem. After de la Rua’s resignation the interim
government announced that the country would default on its international debt. Adolfo
Rodriguez Saa, the acting president, claimed that Argentina was insolvent and hence would not
be making payments on its contracted debts. This was the largest debt default in history,
amounting to US$ 155 billion. In fact, negotiations regarding debt restructuring are still taking
place today. More importantly, with the default Argentina was officially and determinably cut
off from foreign capital.
With the official end of borrowing, no more privatization, and dwindling foreign
reserves, Argentina’s currency finally devalued in the first month of 2002. Because of the
corralito, ordinary citizens lost around three quarters of their savings, embodying the failure of
the economic model.67 For those who had their deposits in pesos — mostly the working class —
devaluation resulted in significant decline of their purchasing power. For those in the middle-
66 Ronaldo Munck, Argentina or The Political Economy of Collapse, 74.67 Ronaldo Munck, Argentina or The Political Economy of Collapse, 76.
29
upper class who had their deposits in dollars the loss was even greater.68 The government
converted all these savings into pesos at the new official rate, which was below the market rate.
“The dollar, once ‘freed’ rapidly went up to 1.70 pesos, and by 2002 the dollar was being valued
at 3.5 pesos and more.”69 The dollar to peso exchange rate was subject to the forces of the market
and responded to Argentina’s economic prospects. Instead of basing their conversion on the
market rate, the government instilled their own conversion metric. The government also decreed
that all deposits in dollars were to be converted into the local currency. Their metric overvalued
the peso (or undervalued the dollar), and thus resulted in immense losses for the middle class.
For instance, an average Argentine who had saved up US$100,000 would have this converted to
pesos at the official rate, which I will set at 2:1 (2 pesos = US$1) to simplify this example. In
exchange for his dollars he would receive 200,000 pesos. If he wanted to convert this back to
dollars, and put his savings in a foreign bank or buy American assets, he would need to go
through an exchange dealer. This dealer would quote him the market rate, which I will set at
3.5:1 (3.5 pesos = US$1). The Argentine would receive roughly US$57,000. In effect, he lost
US$43,000, and his savings almost halved. Furthermore, the higher (peso worth more dollars)
the government set its exchange rate, or the lower (peso worth fewer dollars) the market rate, the
more Argentines lost through this operation. The population ended up paying for the failures of
Argentina’s political economy.
Beyond the immediate causes of the crisis, such as the devaluation of the Brazilian real,
and “the world economy moving to a generally recessive phase,” the neoliberal policies of
Cavallo also played a role in Argentina’s predicament.70 At the very least, one can make the
68 During the convertibility period it was common for Argentinean’s to hold their bank deposits in dollars rather than pesos. 69 Ronaldo Munck, Argentina or The Political Economy of Collapse, 77.70 Ronaldo Munck, Argentina or The Political Economy of Collapse, 76.
30
argument that Argentina’s monetary policy imposed too much discipline on a system that needed
elasticity.71 That is to say, the peso to dollar parity was too rigid. In 1999 the peso did not
devalue with the real. This may have been out of fear of hyperinflation with an un-pegged
currency or because Argentina had contracted debts in dollars (Brady bonds were dollar
denominated), so paying them off in a devalued peso would be costly. Regardless of the
motivation, the result was that Argentina committed to an unsustainable monetary policy. Thus,
forcefully maintaining parity led to a more severe crisis — a larger default, with unprecedented
effects on the entire Argentine population. At most, one could also say that Argentina’s
economic policies were the underlying cause for the crisis that ensued. Parity in Argentina, as
Halevi explains, needed privatization and borrowing. The former had to end at some point, as
states have only so many assets that can be sold, and the latter was dependent on market
sentiment. Argentina needed lenders to be confident about the country’s ability to pay back its
loans. In the end, Argentina accumulated too much debt for its real production to be able to
offset and the country, as a result of lender’s confidence during the 90s, had become too highly
levered. Argentina’s economy was not yielding enough to cover its debts – exports were low, as
improvements in their quality, through investments in infrastructure, had not advanced enough to
cover their high sale price. Therefore, Argentina was continuously selling an expensive yet
‘inferior’ good, leading to its low demand. Upon realizing that the country’s production levels
from activities such as exports could not possibly handle such obligations, financial capital fled
the country and loans were not extended. Leading to a default, this phenomenon ended the prized
convertibility program. The rest of this thesis will be devoted to understanding Cavallo’s
71 These definitions are based on Professor Mehrling’s course Economics of Money and Banking taught at Barnard College. He argues that a country can impose discipline or elasticity on its economy. The former limits the amount of credit in the economy while the latter does the opposite.
31
thoughts on the borrowing-privatization relationship, which was fundamental in maintaining the
convertibility scheme, and then judging whether they were applicable to Argentina’s case.
Chapter II
El ‘Lunfardo’ de Cavallo: The Minister’s Words
Preface
32
During and after his tenure as Finance Minister, Cavallo was an active proponent of his
own ideas. He regularly gave speeches, granted interviews, and lectured international economic
groups on Argentina’s reforms, which provides a range of materials that I can use to examine his
thoughts on privatization and borrowing. This analysis will begin with his paper titled, “Lessons
From Argentina’s Privatization Experience,” published in 1997 for the Journal of International
Affairs.
Lessons from Argentina’s Privatization Experience, 1997
This article, which predominantly deals with the economic gains and the political
implications of privatization, also touches upon the link between privatization and borrowing. In
describing the reasons for the privatizing push, Cavallo provides us with a historic account of the
relationship between debt and the soon-to-be-privatized companies. According to Cavallo,
during the 1980s, the losses of Argentine state-owned businesses were financed by public debt.72
Thus, there was a connection between these particular companies and the issuance of
government bonds. Take, for example, the case of Telefonica (or any other unprofitable state-
owned company). The capital necessary to cover the company’s losses was obtained either
through IMF loans or through sovereign bonds sold to private lenders. This set a precedent in
which companies like this began depending on Argentina’s ability — and willingness — to
indebt itself.
This relationship remained, though in an altered manner, during the privatization policies
of the 90s. Cavallo once again weighed in on this subject. He claimed that the process of
privatization “…itself gives the country the opportunity to attract foreign direct and indirect
72 Domingo Cavallo, Lessons From Argentina’s Privatization Experience (New York: Journal of International Affairs, 1997): 460.
33
investment, as well as domestic private investment that can raise capital productivity.”73 The first
and third parts of this statement are quite standard. Foreign direct investment refers to
international companies spending capital in another country by purchasing assets, a pattern that
Argentina’s privatizations followed. For example, Iberia — a Spanish company — acquired
stakes in state-owned Telefonica, infusing capital into Argentina. The third part, domestic private
investment, refers to a process similar to foreign investment but involving national companies as
the purchasing party. Argentine conglomerate Techint, for example, also bought a stake when
Telefonica was sold. Thus far, this thesis has used the term investors for such companies.
The second part of this statement is more interesting and more relevant to the relationship
between privatization and borrowing that I am focusing on. For Cavallo, privatization attracted
indirect investment, specifically through securities such as stocks or bonds in companies that
were not privatized and in government debt. In this case, the majority of investments came
through the acquisition of Argentine bonds, as they were safer than buying stock. So, Cavallo
claimed that the policy of privatization acted as a signal that encouraged lenders to commit
capital to Argentina beyond the assets being sold, in hopes of high returns. The financiers,
influenced by the outcome and message of privatization, invested in the country. The main
outcome of the policy was that Argentina improved its budgetary position, as the state gained
cash from selling its assets, while the message also influenced the lenders. Argentina, through
privatization, showed signs of commitment to free market economics, which was considered the
de facto optimal policy at the time. Privatization was thus influencing private lenders to purchase
part of the country’s debt.
73 Domingo Cavallo, Lessons From Argentina’s Privatization Experience (New York: Journal of International Affairs, 1997): 459.
34
Thereafter, the relationship between privatization and borrowing still existed in the 90s,
as it had in the 80s. Nevertheless, this relationship had been altered in this 10-year span.
Borrowing was no longer a source used to fund the deficit of state-owned companies since these
companies had been sold to private investors. Instead, privatization was enabling further
borrowing in the international market. Through the mechanisms described above, privatization
was signaling Argentina’s economic improvements, making the country more attractive to
foreign lenders. At the same time, the Argentine government was financing the convertibility
plan with the gains from privatization and the loans from borrowing. Though Halevi explains
this development in his article, “The Argentine Crisis” — which I quoted in the previous section
— he does not mention the link between both. This is one of Cavallo’s key arguments, crucial to
understanding Argentina’s political economy during the 90s.
Analysis of the data supports this point. Although it is difficult to discern/measure the
direct impact of privatization on sovereign bond loans, it is clear that the amount of loans
increased as privatization policies were being enacted. Correlation does not imply causation, but
in this case it supports Cavallo’s argument, considering Argentina’s actual economic experience
in the 90s. Argentina’s external debt rose consistently from 1992 until 2000. The beginning of
this trend coincided with Cavallo’s inauguration as Finance Minister and his acceleration of
privatizations since the early months of his ministry.74 Furthermore, during 1993 and 1994, when
privatizations were under full swing, Argentina’s external debt increased by an unprecedented
amount of roughly 15% each year.
Total External Debt (in US$) for Argentina from 1988 to 2000:75
74 Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 337.75 Instituto Nacional de Estadísticas y Censos, from Sergio Di Pietro, Seis Decadas de Politicas Economicas en la Republica Argentina, 392.
35
19881989199019911992199319941995199619971998199920000
20000400006000080000
100000120000140000160000180000
Argentina's External Debt
Year
Deb
t (U
S$ M
M)
External debt is not made up solely of sovereign bonds, but given Argentina’s immature
financial market, one can assume that these bonds made up an important component of total
debt; a conservative estimate would be around 50%.76 We do know that Argentina’s bond issues
increased dramatically during this period. From 1993 to 1997 Argentina issued seven sovereign
bonds that would later default. All of these were given a B1 initial rating, and had to pay, on
average, a coupon rate of 10%.77 The total defaulted value of these bonds was around US$6.228
76 Ronaldo Munck, Argentina or The Political Economy of Collapse, 74. 77 The rating judges the risk of default. AAA is a security with no risk of default; an example is a US Treasury Bond. As the ratings go down, (AA, A, BBB, BB, B) risk increases but so does return. Coupon rate is the calculation of this return. A bond issuer is obligated to pay the bondholder a fixed rate over the loan until it matures, and then pay the face value. For example, a 10-year bond with face value 100 and coupon rate 10%, will payout 10 every year until year 10 when it will pay the face value plus coupon, 110.
36
Year Debt (US$ MM)1988 583361989 636721990 622801991 576961992 619531993 709151994 813431995 877071996 977011997 1103041998 1393171999 1524092000 160700
billion.78 In one year alone, 2001, the total value of the defaulted bonds amounted to roughly
US$ 82 billion.79 Hence, we can conclude that there were sufficient sovereign bonds issued while
Argentina’s privatization program was at its heyday to make Cavallo’s argument feasible. In the
following chapter, once Cavallo’s argument is fully understood, I will utilize behavioral
economics as a model to understand his claims.
It is evident that Cavallo believed that privatization stimulated further international
borrowing and Argentina’s data figures support this argument, but it seems that his argument
was not consistently the same in the long run. In fact, an analysis of the body of his publications
over the decade shows that privatization was linked to two distinct periods. The first was during
1992 when Argentina agreed to the Brady Bonds program and reentered the international debt
market. The second was after 1992, when the country actively used its ability to indebt itself in
order to maintain its peso to dollar parity.
Period I: Brady Plan Agreement
Cavallo expresses his thoughts on Argentina’s involvement with the Brady Plan in
several of his publications ranging from 1997 to 2007, using less technical and more personal
language on how Argentina eventually renegotiated its outstanding debt in 1992. Cavallo
claimed that when Argentina underwent its major changes in March 1991, notably convertibility
and privatization, it had little support from the international community. Particularly, he recalls
that David Mulford, Nicholas Brady’s undersecretary, told him that all of Argentina’s reforms
were going to fail one month after they had been initiated.80 This did not happen. Instead,
Argentina’s reforms showed fiscal and inflationary promise. Upon visiting Argentina only 4 or 5
78 Sovereign Default and Recovery Rates, 1983-2007 (Moody’s Global Credit Research, March 2008), 18. 79 Sovereign Default and Recovery Rates, 1983-2007 (Moody’s Global Credit Research, March 2008), 7. 80 Domingo Cavallo, Stanford Speech, 13 Nov 2007, part 1, Chicago Boys and Latin American Market Reforms Collection, Hoover Institute.
37
months later, Mulford was so impressed by the reality of the reforms that he pushed for the
country to undertake the Brady Plan.
In this rendition of Argentina’s history, privatization was being bundled up with the
country’s other reforms, namely convertibility and fiscal austerity. Most importantly, the results
of these policies seem to have influenced Mulford’s decision to allow the country to reenter the
borrowing market. In this case, privatization is seemingly playing a reduced role in Cavallo’s
explanation of the Brady bonds, especially when compared to his 1997 paper. But I will not limit
this analysis to only one speech, as it is an exception in his traditionally privatization-borrowing
focused accounts. Instead, I will explain how Cavallo publicly delivered results about
Argentina’s fiscal reality, the one that impressed Mulford so much in 1991. In a speech given
that very same year, Cavallo broadcast to the Argentine nation the first quarter results of the
convertibility law, and the other changes applied by his ministry. Although admittedly this was a
different audience, one can imagine him presenting the information to Mulford in a similar
manner.
In the speech centered on Argentina’s ability to reach a balanced budget in the first
quarter of 1991, Cavallo explained that it had been done through an accumulation of US$6.8
billion in standard revenue, which consisted mostly of taxes and exports, and US$600 million
from sales of nationalized businesses. He determined that the total cost was of US$7.4 billion,
finally declaring that Argentina had spent as much as it had earned. Cavallo concluded his
message by adding that he expected little change in the fiscal situation in the upcoming months.81
The choice to emphasize privatizations, which made up less than 10% of Argentina’s total
revenue in the first quarter, is interesting and revealing. It becomes clear that this was the key
81 Domingo Cavallo Broadcast to Argentina, Plan de Convertibilidad, Cadena Nacional de Radio y Television, 6th of April, 1991.
38
policy for Cavallo’s plan. Argentina’s reforms included convertibility, tax cuts, and reduction of
tariffs, all of which either lowered the country’s revenue, or increased its spending. Without
privatization it would have been challenging for the country to undergo such drastic policy
changes while maintaining a balanced fiscal budget. In the end, it was this fiscal reality that
encouraged international parties, such as the US Treasury and the IMF, to reassess Argentina’s
creditworthiness. Ultimately, privatization was central to Cavallo’s pitch of Argentina’s
experience. Conceivably, a similar pitch by Cavallo centralized around privatization, allowed
Argentina to renegotiate its debt agreements and be reintegrated with international borrowing
markets.
Although at first it may not have seemed as clear, it becomes apparent that, for Cavallo
and potentially for Argentina, privatization played a fundamental role in the Brady agreements.
That is to say, privatization influenced the country’s ability to borrow during the 90s; it was not,
as existing analyses have it, simply another way of raising capital (see page 13/14 above for that
argument). However, privatization did even more than enable the country to participate in the
scheme designed by Nicolas Brady. In fact, privatization enabled the country to do without the
Brady bonds. As Cavallo himself put it in 1997, “in June 1994, the authorities decided to accept
the IMF recommendation not to make use of the last two scheduled [Brady] purchases since
there had been a substantial increase in Argentina’s voluntary access to international capital
markets.”82 This shows how Argentina had quickly moved away from the debt-relief part of the
plan and had begun borrowing in the open market. The data provided in page 36 supports this
observation. After agreeing to the Brady bonds in 1992, Argentina’s external debt increased by
around 15% for two consecutive years. Debt accumulation slowed down in 1995 with the
Mexican crisis, but then picked up again in 1996 until the 1998 recession. The dramatic increase
82 Domingo Cavallo, Argentina’s Convertibility Plan and the IMF (The American Economic Review, 1997), 18.
39
in external debt demonstrates the country’s active involvement in the international capital
markets. After signing a plan that was supposed to reduce Argentina’s debt payments, almost
paradoxically, the country began to once again borrow heavily from international creditors. The
following section will analyze Cavallo’s thoughts on how privatization influenced this open
market borrowing.
Period II: Borrowing for Convertibility
Understanding Cavallo’s thoughts on the influence that privatization had on borrowing in
general is more challenging than comprehending his take on the relationship between
privatization and the Brady bonds. The challenge arises, at least partially, because borrowing was
a policy that Argentine governments carried out over many years, making it less of a highlight in
Cavallo’s publications than the Brady Plan — a once-in-a-lifetime agreement to reenter debt
markets. Nevertheless, an in-depth reading of his materials provides enough information to
discern his opinion on the subject.
Let us begin with an outline of what we already know. In the section titled Lessons from
Argentina’s Privatization Experience, Cavallo explained that privatization drove further
borrowing in the international market, an idea that can be further confirmed through an analysis
of his publications. In his first speeches as Finance Minister, Cavallo pressed on the notion of
Argentina shifting its borrowing attitude and becoming more integrated in international markets.
For example, in a presentation to a group of economists in late 1991, he stated that “Argentina
had opened up again to the world, [and that] at a more practical level, trade and capital flows
were now once more substantially unrestricted”, and thus could flow into the country.83 In the
first years of his ministry, Cavallo envisioned an Argentina with access to capital markets —
83 Domingo Cavallo, Argentina’s Economic Revolution, Presentation for the Group of Thirty, Washington DC, Autumn 1991.
40
recall that in 1991 the Brady Plan was yet to be signed — his focus was therefore on
reintroducing the country to these markets, though being still unsure as to how to proceed.
By 1993, the situation had changed in Argentina’s favor. According to Cavallo,
privatization played a part in garnering the attention of international investors and lenders, an
idea he proposed during an interview with an American think tank in 1993. The attention
resulted in high levels of investment, both direct and indirect, into Argentina. There were
substantial direct investments in telecommunications, electricity, gas, and petroleum. The
indirect investment, usually in the form of bond purchases, allowed the public sector to improve
the roads and highways.84
Cavallo’s thoughts on privatization become clearer in his latter publications. In an
interview granted in 2002, six years after he resigned, when discussing Argentina in midst of the
Mexican crisis, Cavallo explained what he believed were the key changes the country needed to
make in the 90s, and how he had enforced them. For him, Argentina had to open its “economy to
the rest of the world, and to work for a larger share of foreign trade, and bring foreign investment
into the economy, and to recreate a climate of investment in general” in order to improve its
macroeconomic conditions.85 Argentina enforced these changes through the implementation of
reforms, which started, but did not end, with the convertibility program. In this interview,
Cavallo also spoke almost exclusively about the privatization of state assets, hinting that this was
the key reform that Argentina undertook to achieve its goals, which included increased foreign
investment and the recreation of a climate of investment. He claimed that, for “financial markets,
Argentina was seen in those days as the second successful case of the deregulation, privatization,
84 Domingo Cavallo, Interview with William Ratliff, 9 Aug 1993, part 1, Chicago Boys and Latin American Market Reforms Collection, Hoover Institute. 85 Domingo Cavallo, Interview with PBS Commanding Heights, 30 Jan 2002.
41
and stabilization.”86 In his view, the financial markets had responded particularly well to the
policy of privatization, in fact only highlighting this in this interview.
The number of times that he mentions this relationship over the years demonstrates that
Cavallo believed that privatization was once again fueling Argentina’s ability to borrow, as the
capital markets were enamored by the country’s reform. It is a consistent theme in his
publications, independent of their date and their intended audience. But how did he see this
relationship actually working? And why did Argentina have to borrow so much? Cavallo
provides some answers to this question in yet another interview. In explaining how Argentina
recovered from the Mexican (Tequila) crisis of 1994-5, Cavallo puts it as follows:
“So what we did at that time in March, April ’95, just a few weeks before a very important presidential election, was to force privatizations of provincial banks, most of the provincial banks, and get foreign money through the IMF, the World Bank, the IDB [Inter-American Development Bank], and also private banks, foreign and local private banks that added funds to demonstrate that we did have ability to control the situation. And we were successful. Actually, in a few months, Argentina started to get capital back into the economy, and deposits in the banking system started to increase.”87
During such a crisis, borrowing was paramount to the survival of Argentina’s convertibility
program, which in turn was paramount to the country’s economic stability. The low trade
surplus, at times even a trade deficit, worsened during times of crisis. This meant that the country
was incapable of accumulating dollar reserves through traditional means such as exports. To
make matters worse, international lenders became apprehensive and began to pull their
investments from the country.88 The privatization of the banks, in this instance, played a
fundamental role in facilitating Argentina’s access to international capital markets. The policy
worked to instigate a response from international institutions, which provided liquidity (capital) 86 Domigo Cavallo, Interview with PBS Commanding Heights, 30 Jan 2002. 87 Domigo Cavallo, Interview with PBS Commanding Heights, 30 Jan 2002. 88 Domingo Cavallo, Argentina’s Convertibility Plan and the IMF (The American Economic Review, 1997), 18. Quote: “Unfortunately, the panic created by the Mexican devaluation crisis of 20 December 1994 drastically reduced [Argentina’s] access [to international capital markets]”
42
to the country. This liquidity, in the form of loans, allowed dollars to continue flowing into
Argentina and reassured private lenders who began to reinvest in the country. All this translated
into maintenance of convertibility, which was dependent on Argentina’s dollar reserves. This
begins to answer the questions posed above. Argentina needed to borrow, as well as to privatize,
in order to bring dollars into the economy.
Cavallo’s comments above, as well as our knowledge of Argentina’s convertibility and
fiscal programs, give us clues regarding the workings of the privatization-borrowing relationship.
Let us now turn to a fiscal evaluation of Argentina’s net position during the 1990s, particularly at
times of crisis, such as the one in 1995. Let us also copy Cavallo’s framework from his speech in
1991, covered on page 38 of this thesis. In the midst of the Tequila crisis, Cavallo claims that
Argentina’s first initiative was to privatize provincial banks. The result was the bolstering of the
country’s fiscal position, in an operation like the one described in the 1991 convertibility speech.
The policy provided Argentina with much needed dollars, thus aiding the maintenance of
convertibility. More importantly, fiscal construction increased the chances of the country
receiving funding from the IMF. After all, the institution was adamant on promoting fiscal
responsibility.89 By the second quarter of 1995, IMF involvement had become a reality, as the
organization put together an impressive financial package that stopped a bank run in Argentina.90
Privatizing the banks contributed to Argentina receiving these loans. Beyond the fiscal relief that
the sale of the assets (banks) provided, it demonstrated that Argentina could maintain its
convertibility plan, its stability, and its growth throughout a crisis with additional capital. The
IMF loan, in turn, “was a catalyzer for additional funding from the World Bank and the Inter-
89 This statement is based on Cavallo’s perception of the IMF’s policy advice. It is also based on the assistance that the IMF provided to Argentina in the 2001 crisis, when the organization demanded for the country to improve its fiscal spending by encouraging cuts in government spending. 90 Domingo Cavallo, Argentina’s Convertibility Plan and the IMF (The American Economic Review, 1997), 19.
43
American Development Bank.”91 The support of these institutions improved the market
perception of Argentina’s economy, more specifically in terms of its ability to repay its
sovereign debt. Therefore, the privatization of a set of assets effectively led to Argentina, once
again, being capable of borrowing in international capital markets, as lenders started to invest
once more.
But this was not only the case during economic downturns. Throughout the 1990s
Argentina needed dollars to maintain its convertibility program. According to Cavallo, Argentina
privatized its assets, driving borrowing. The country received support from the IMF at least in
part as a result of privatization’s rewards. This support, according to Cavallo, translated into
good credibility, which resulted in further loans from other international institutions and private
lenders.92 Thus, Argentina utilized privatization as the first project that led to follow-up
initiatives, all of which had the end result of signaling the country’s economic stability. This
stability was dependent on the confidence of international organizations, such as the IMF, the
World Bank, and the IBD, which consistently backed up Argentina during the 1990s. It also
served to reassure foreign lenders, who kept on extending credit to the country, allowing for the
convertibility program to continue.
The next sections will be devoted to developing a model to explain Cavallo’s thoughts, as
well as demonstrating that privatization and borrowing have in fact a historic relationship under
his ministry, one that can be proven through an analysis of one of his policies rather than his
rhetoric.
91 Domingo Cavallo, Argentina’s Convertibility Plan and the IMF (The American Economic Review, 1997), 19. 92 Domingo Cavallo, Argentina’s Convertibility Plan and the IMF (The American Economic Review, 1997), 19.
44
Chapter III
Behavioral Economics as Model For Cavallo’s Argument
Behavioral economics and behavioral finance, both subfields of traditional economics,
deal with identifying the psychological underpinnings of human behavior in relation to economic
analysis and the workings of the market. As the study of the Argentinean case seems to have
been so intricately linked to its economic leader, these subfields can help explain the arguments
set forth by Cavallo. This section will be devoted to using behavioral tools, particularly feedback
loops, to support his ideas. It must be noted, however, that in doing so I do not claim that what
Cavallo’s accounts set forth should be considered a certainty. Rather, I merely present an
alternative analytical framework, suggesting that behavioral economics may help explain/support
the minister’s thoughts on the privatization-borrowing relationship.
One of the main contributions of behavioral economics to the field as a whole was the
criticism of the efficient markets hypothesis (EMH). Robert J Shiller, a Nobel Prize winner in
economics, led the efforts against disproving EMH, which had been used as one of the
fundamental assumption for a majority of the financial models we use today. EMH essentially
claims “that the price Pt of a share (or of a portfolio of shares representing an index) equals the
mathematical expectation, conditional on all information available at the time, of the present
value P*t of actual subsequent dividends accruing to that share (or portfolio of shares). P*t is not
known at time t and has to be forecast. Efficient markets say that price equals the optimal
forecast of it.”93 In layman terms, the formula assumes that financial markets have efficient
93 Robert J Shiller, From Efficient Markets Hypothesis to Behavioral Finance (Journal of Economic Perspectives, 2003), 84.
45
information and, as a consequence, can achieve returns that are above the average market
returns. Shiller however, disagreed with this proposition. Instead, he demonstrated that if we
look back at the stock market and trace the expected present value with perfect information, the
result would be far off from the actual returns that occurred. The simplest way to demonstrate
this variation is graphically as is shown below:
94
In explaining this phenomenon, Shiller turned to “developing models of human
psychology as it relates to the financial markets.”95 The main model that emerged out of this
thought experiment was feedback loops. An example of one is a price-to-price feedback loop,
which can be explained as follows: when speculative prices go up and create successes for some
investors, they attract public attention, promote word-of-mouth enthusiasm or market sentiments,
94 Robert J Shiller, From Efficient Markets Hypothesis to Behavioral Finance (Journal of Economic Perspectives, 2003), 86. 95 Robert J Shiller, From Efficient Markets Hypothesis to Behavioral Finance (Journal of Economic Perspectives, 2003), 90.
46
and heighten expectations for further price increases. In his papers, Shiller backs up this model
through the use of psychological experiments. Additionally, he discusses two derivations of the
feedback loop. The first, that the model includes a “distributed lag with exponentially declining
weights on past price changes through time”.96 This means “that people react gradually to price
changes over months or years, not just to yesterday’s price change.”97 The second, that “a
disturbance in some demand factor other than feedback can in certain cases be amplified, at least
for some time, because it changes price and thus affects future prices through the distributed
lag.”98
Now let us utilize this model, as well as Cavallo’s thoughts to create a feedback loop for
Argentina’s bonds. In order to do so effectively we will need to make some simplifying
assumptions. These are: 1) IMF and other international lenders respond solely to Argentina’s
fiscal position on a quarterly basis when deciding to give out loans, 2) individual lenders actions
are strongly correlated to those of the IMF and other international lenders.
96 Robert J Shiller, From Efficient Markets Hypothesis to Behavioral Finance (Journal of Economic Perspectives, 2003), 95. 97 Robert J Shiller, From Efficient Markets Hypothesis to Behavioral Finance (Journal of Economic Perspectives, 2003), 95. 98 Robert J Shiller, From Efficient Markets Hypothesis to Behavioral Finance (Journal of Economic Perspectives, 2003), 95.
47
As the graph above shows and as I have previously explained, Argentina began issuing
bonds again, in late 1992. Previously, I showed that Cavallo believed that privatization was key
in allowing Argentina to reenter the borrowing markets. If we take the assumptions of this
feedback loop model to be true then this argument is in fact reinforced. The IMF and other
institutional lenders were assumed to only consider a country’s fiscal position on a quarterly
basis. Let us take the case of Argentina in 1991 quarter 3, when Cavallo announced the results of
convertibility over the radio. The table below demonstrates the country’s fiscal position with the
terms being used explained in the footnote below:
L B P R E Balanced?
0 0 $600 MM $6.8 bi $7.4bi Yes
99
From this table it is clear that privatization was vital to achieving a balanced budget, and
therefore important in maintaining Argentina’s dollar reserves, which in turn upheld
99 Note: L = loans from institutional lenders, B = bonds sold to individual lenders, P = sale of state assets, R = revenue from taxes, exports, etc, E = expenditure from normal activities, Balanced refers to whether or not the country achieved a balanced budget, with its earnings (L+B+P+R) equal to its spending (E).
48
convertibility. Argentina perpetuated a fiscally balanced budget like the one shown above until
1992, when it was allowed to reenter the borrowing markets. A feedback loop was already
forming, but we must also look at what happened after Argentina began to borrow in order to
understand the loop in its entirety.
From 1992 until the Mexican crisis in 1995, Argentina’s bonds remained at a relatively
stable price, the spread staying below 1,000 points from the US bonds (see graph above). The
mechanism at play here was very much aligned with feedback loops. From our calculations, it
appears that privatizations were yielding Argentina around US$555 million per month. This
means that the country was earning around US$1.5 billion per quarter through the sale of its
assets. Beyond privatizations and convertibility, Argentina was undergoing other important
policy changes, particularly tax cuts and reduction of tariffs. The result of these was a reduction
in government revenue and an increase in government expenditure. Thus, by 1993 Argentina was
in a situation as follows:
L B P R E Balanced?
$1.5 bi 0 $1.5 bi $6.0 bi $7.5bi Yes
100
Essentially, as a result of its balanced budget and maintenance of convertibility (which was
dependent on privatization) the country was receiving loans from the IMF. These in turn, per our
assumptions, played a big role in influencing individual lenders. Therefore, Argentina’s position
was actually as the table below demonstrates:
L B P R E Balanced?
100 Note: these are hypothetical results based on the country’s trends.
49
$1.5 bi $500 MM $1.5 bi $6.0 bi $7.5bi Yes
101
The end result was an increase in lender confidence. Spurred by Argentina’s fiscal attractiveness,
the maintenance of convertibility, the IMF loans, and the investments of other lenders, more
lenders bought Argentina’s bonds. This mechanism was repeated in a feedback loop and
Argentina’s external debt continued to rise as is seen in page 36.
What is truly remarkable about this system is its resilience. When Argentina’s lenders
withdrew during the Mexican Crisis, Cavallo was capable of bringing them back by utilizing the
privatization of banks to jump-start this feedback loop. This can be understood in the following
manner:
L B P R E Balanced?
(1)(2) +$1bi
-$500 MM (lenders withdraw)+$500 (return)
$1.5 bi+$2 bi (sale of banks)
$4.0 (decrease in exports)
$7.5bi Yes
102
In period 1 Argentina’s revenues decrease as a result of the crisis; consequently lenders withdraw
from the market (note that we are assuming there are no IMF loans at the moment). In period 2
Argentina sells its banks, balancing its budget and bringing in a loan package from the IMF and
other international lenders. As a result, some lenders return to Argentina, which drives more
lenders to return as a reaction to word-of-mouth enthusiasm or market sentiment, in a mechanism
identical to Shiller’s price-to-price feedback loop. But Argentina’s loop and Shiller’s argument is
not as simple as this. Indeed, as explained in page 47, there are two important derivations to the 101 Note: these are hypothetical results based on the country’s trends. 102 Note: these are hypothetical results based on the country’s trends.
50
models. The distributed lag comes into play in this example. Although Argentina suffered during
the Mexican crisis, lenders did not just react to yesterday’s price, but also took into account the
past months and years. Therefore, the return of the lenders can also be attributed to Argentina’s
solid economic performance from 1991 onwards. Additionally, if one considers privatization as a
factor of bond demand, as has been done throughout this thesis, it becomes easier to understand
Argentina’s feedback loop. Essentially, with privatization leading to increased bond demand
through the mechanisms described above bond prices increased, this effect is amplified through
the distributed lag, as a change in today’s price affects future pricing. This is reflected in the
bond-spread dropping to below 1,000 basis points, indicating that the Argentine bond had
increased in price. There was a problem however: once Argentina’s privatization program ended,
the country could only maintain a balanced budget and convertibility through loans. For a time,
this worked – lenders continued to lend – but by the late 1900s the game was up. Eventually,
international lenders such as the IMF rejected giving Argentina more loans, institutional lenders
began pulling back bond purchases at a rate of US$ 1 billion per day, and individual lenders
followed. This is what behavioral economics refers to as herd behavior, with the small fish
following the big fish. The result was devaluation and default.
This chapter has utilized behavioral economic models, with strong assumptions, to
demonstrate that there is some validity to Cavallo’s accounts. Essentially, his understanding of
privatization as a driving force in borrowing can be understood through a feedback loop. This
does not make his argument true but it gives us the analytical tools to frame his ideas within an
established field of economics.
51
Chapter IV
La Retórica Se Vuelve Realidad: Debt Used in Privatizations
Many of Argentina’s privatizations of state assets were carried out with debt-to-equity
swaps. This operation is customary in a refinancing deal when a company is unable to pay its
debt holders — in exchange for cancelling its debt the company offers its creditors equity (stock)
in its business. It is also expected that the value of the instruments being swapped, the bonds and
equities, be determined by the market value at the time of the swap. Argentina’s use of debt-to-
equity swaps in its privatizations is interesting because of the divergences from this traditional
model. It is also important as the foundation of the relationship between the policy of
privatization and the country’s ability to borrow in international markets.
The primary difference between the traditional model and Argentina’s case is the fact
that, in the latter, we are dealing with a country instead of a single company. Argentina had
defaulted on its international debt in 1982 and it was this debt what was exchanged for equity in
the state companies being privatized during the 1990s. Companies such as ENTel (the state
owned phone line provider), Aerolineas Argentinas (the airline business), and YPF (the national
oil company) among others were sold for a combination of cash and debt forgiveness. For
example, ENTel was sold to a group of international companies, which included JP Morgan and
52
Citibank (both banks held defaulted Argentinean debt), and then divided into two companies,
Telecom and Telefonica. The total value of the sale was around US$7.27 billion, with US$5
billion coming from debt forgiveness.103 Below is a copy of a table detailing sample sales
transactions of the program published by the World Bank. Note that several of them were paid
off with debt. Additionally, those that have the subscript b next to their debt amount refers to
sovereign debt that was trading at 15 cents on the dollar. This means that the value of the debt in
the market was inferior to the value that the Argentine government accepted. The details of this
operation will be covered in the proceeding pages.
104
In doing these operations, the Argentinean state was utilizing the sale of its assets in order
to reduce the level of indebtedness. This marked the beginning of the relationship between
103 Argentina’s Privatization Program (The World Bank, 1993), 13. 104 Argentina’s Privatization Program (The World Bank, 1993), 13.
53
privatization and borrowing. By lowering the amount it owed to international creditors Argentina
was positioning itself in a more favorable place to be able to borrow in the future. Instead of
paying back its debts in a traditional manner, Argentina found a way to circumvent its payments
in the form of cash. This circumvention arose out of the dire situation the country found itself in
during the early 1990s. The 1980s was a period of economic difficulties for most Latin American
countries including Argentina; after all, this period was referred to as the lost decade. The
country did not, at that time, have a budget surplus that could be used to pay off its existing
debts. Argentina improved its economy in the 1990s under Cavallo’s convertibility plan, but the
maintenance of the program came at a cost. Although inflation was curtailed, budgetary
surpluses were almost impossible to achieve, as Argentina’s goods had become more expensive
with the dollar to peso parity. Once again, Argentina was in no position to pay its debts with
cash, thus it turned to the alternative mechanism of debt reduction. Privatization allowed
Argentina to once again be in a position in which it could be considered a reliable bond issuer,
effectively helping the country to borrow in the open market.
Another important aspect of the debt-to-equity swaps utilized in Argentina’s sale of state
assets was the valuation of the debt held by the country’s creditors. Instead of following the
traditional model, which values the debt at the current market price, Argentina assessed the debt
at its nominal (full) value. At the time these operations were taking place, the market value of
Argentine bonds was around 15% of full value, a measure of the lack of confidence in the
country’s creditworthiness. Argentina had defaulted on its debt in 1982 and suffered under the
economic downturn of the 1980s. The valuation meant that creditors could acquire Argentine
companies at a discount, if one considers the bond market pricing accurate. Take, for example,
the case of ENTel once more. The company was sold for a total value of US$7.27 billion, but
54
only US$2.27 billion was paid in cash, the rest (US$5 billion) was paid for with debt relief.105 If
Argentina’s creditors had taken the same bonds that were used to purchase ENTel and sold them
in the open market, they would have only received US$ 750 million, which is 15% of the
nominal value (US$5 billion). This was an attractive option for many investors, and hence, was
effective in aiding Argentina to reduce its total debt, as it influenced creditors to partake in the
country’s privatization efforts. This, in turn, allowed Argentina to borrow in the international
market once more.
This was not the only effect of Argentina’s privatization program. As Eduardo Basualdo,
a well-respected Argentine economist and historian, puts it:
“The fact that external debt bonds have been capitalized for a total sum of roughly US$14 billion was of particular importance to international creditors. In the first place, because it allowed the Argentinean government to reduce its indebtedness. In the second place, because the bonds of Argentina’s external debt utilized in the privatization program were taken at their nominal value (when, at this moment, their market price was below 15% of its full value), thus this enforced a considerable revaluation of the bonds. […] In other words, as a product of their participation in purchasing the main assets of the Argentinean state, the international creditors were capable of exchanging large volumes of devalued bonds for assets with high profitability.”106
Basualdo focuses on the effect on the price of bonds, which has not yet been covered in my
analysis. Accordingly, by swapping debt with equity at the nominal value, the Argentine
sovereign bonds were revalorized in the international markets. This occurred because the
privatization program was, as Basualdo puts it, exchanging devalued bonds for assets with high
profitability. The market responded to this operation and Argentine bond values began to rise, as
there was an expectation that these could be used to acquire the highly profitable state assets
being sold by the government. Privatizations were therefore not only reducing the country’s level
of indebtedness, but also affecting the market’s valuation of Argentina’s outstanding debt. Both 105 Argentina’s Privatization Program (The World Bank, 1993), 13. 106 Eduardo Basualdo, "Privatizaciones, Rentas De Privilegio, Subordinación Estatal Y Acumulación Del Capital En La Argentina Contemporánea ." Monografias, 2 – free translation.
55
of these were aiding Argentina in forming an image as a trustworthy debtor to international
investors. On the one hand, the country was making substantial steps (around US$14 billion) to
reduce its total level of debt; on the other, the outstanding debt was becoming more valuable,
hinting at prospects of economic recovery. Privatizations were essentially reversing the negative
perception of Argentina that originated from the economic failures of the 1980s through this dual
mechanism of debt reduction and bond revalorization. In a way this argument almost plays into
the feedback loop outlined in the previous chapter. Through these equity swaps privatizations
were influencing lender confidence.
Perhaps the most telling evidence on the effects of privatization is the commentary by
Richard Handley, the President of CEI Citicorp Holdings SA — an open private-capital company
that emerged out of the privatization of Argentinean state assets. To comprehend the importance
of his commentary one must first have a grasp CEI Citicorp Holdings’ history. The company was
backed by Citibank and held several Argentine assets in the sectors of telecommunications and
energy. It originated as a result of Citibank utilizing its devalued Argentine bonds to purchase
ENTel, and grew through similar acquisitions, reaching US$2.4 billion in market assets in the
region. The company was the product of the debt-to-equity swaps. More importantly, it was a
successful case of an international corporation thriving under Argentina’s privatization program.
It showed that spending in Argentina could be profitable to outside investors. Discussing the
success of his company, Handley stated, “the economy was jump-started with new capital
inflow, modern technology, strong investment, trained management and the payment of taxes
and dividends which granted access to more active capital markets, heralded a return to country
credibility and sparked a positive reaction from capital markets worldwide.”107 All of the factors
that jump-started the economy can be attributed to the privatization program. Thus, Handely was
107 Richard Handley, From Bankers to Shareholders – The New Banking-Industry Relationship.
56
emphasizing the importance of Argentina’s privatization program to Argentina’s economy. This
is of particular importance because it shows the opinion of an active investor. If one assumes that
other investors shared this opinion, it is possible to state that privatization was fundamental in
reaffirming investors’ confidence in Argentina.
Handley goes on to state that CEI was the first company to place a 10-year US$175
million debt bond in pesos on international markets, which demonstrates the growing trust in
Argentina as an investment opportunity.108 Argentina had gone from an insolvent nation, unable
to pay its debts in the 1980s, to a country with thriving backers capable of raising money in
capital markets to continue investing in the country. Moreover, if CEI was capable of issuing
bonds, so was Argentina. Thus, it seems that privatization, at least for Handley, was the driving
force in allowing Argentina to once more be able to borrow in capital markets. In a way this is
logical. For a moment forget about the Brady Plan and the IMF assistance and focus on private
investors, like Handley. The privatization program consisted of debt-to-equity swaps at nominal
value; this meant that those who held Argentinean bonds were in an advantageous position to
purchase state assets at a relative discount. These investors were rewarded for Argentina’s past
insolvency with cheap government assets. Those who did not hold Argentine bonds became
aware of the government’s commitment to honor its debts — the country’s total outstanding debt
was decreasing and its outstanding bonds were being revalorized. Through its privatization
program Argentina was fostering confidence among its lenders, both past and prospective. This
confidence ushered the path for Argentina to be allowed to borrow again, as it changed the
perception of nation, from insolvency to investment-worthy.
Thus, it is fair to say that Cavallo’s thoughts on the necessary connection between
privatization and borrowing have a historic precedent. The debt-to-equity swaps carried out by
108 Richard Handley, From Bankers to Shareholders – The New Banking-Industry Relationship.
57
the Argentine government intrinsically tied debt to privatization by using debt forgiveness as a
means of payment. Beyond this, debt forgiveness also reduced Argentina’s level of indebtedness
and increased the value of its outstanding bonds, which made the country a more attractive
investment destination. In the end, it is this attractiveness that truly paved the way for Argentina
to borrow in the capital markets, as it did throughout the 1990s.
58
Conclusion
El Ultimo Paso: What Does This All Mean?
Faced with poor economic conditions during the 1980s and early 1990s following a
period of unimaginable hyperinflation and a default on its debts, both at national and
international levels, Argentina embarked on a project to reform its economic policies and
become, once again, integrated within the world economy. The major reform, implemented
under the ministry of Domingo Cavallo, was the convertibility law that made the Argentine peso
equivalent to the US Dollar. The plan bore fruit and inflation was quickly controlled.
Furthermore, through the confidence that the new currency instilled, the country had high levels
of domestic and foreign investment that pushed Argentina into an almost unprecedented period
of economic prosperity. GDP rose steadily for five years, while, during the same period, the
misery level continuously declined. Beyond that, the privatization of many state assets led to an
improvement in services, while the strong currency meant that many Argentines’ could now
afford foreign goods. Overall, in part due to convertibility of its currency, Argentina relived a
moment of economic prosperity equivalent to its economic belle époque, a period in the 1800s
during which it had been one of the wealthiest countries in the world. Nevertheless, excluding
these early successes, scholars, such as Joseph Stiglitz and IMF officials, particularly IMF’s First
Deputy Managing Director from 2001 to 2006, Anne Krueger, have come to the consensus that
convertibility was not only doomed to fail, but also one of the causes of the larger crisis that
ensued in Argentina in 2001.109
109 Anne Krueger, "Crisis Prevention and Resolution: Lessons from Argentina, Address by First Deputy Managing Director, IMF.
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Indeed, maintaining convertibility was not easy. Traditional historiography has
pinpointed two key policies as the main buttresses of convertibility: alternative net capital
inflows, Argentina selling its state assets, or borrowing in international markets.110 As explained
previously, the whole issue was about having sufficient dollars, and because exports were
expensive as a result of the parity, Argentina turned to these auxiliary measures in order to keep
them flowing in. Throughout his tenure, Cavallo sought to develop a relationship between
privatization and borrowing, convinced (as I am) that the latter would not be possible without the
former. He expressed his views, as we have seen, in many speeches, articles, and interviews,
while the data we have about how these two processes were implemented further displays their
connection, and is finally reinforced through economic theory based on psychology. The key
takeaway from this exercise is that in the eyes of Argentina’s most influential Finance Minister
to date, privatization played an important role in influencing borrowing. In short, I make the
claim that the economic system put in place by Cavallo was much more integrated than has been
generally recognized.
Beyond adding a new realm to the already extensive historiography of Argentina pre and
post crisis, this thesis has also dissected two realities of the economic functionalities of the
country throughout the previous decade. The first is that in his accounts Cavallo chooses to focus
almost exclusively on privatization and borrowing as the pillars for the maintenance of
convertibility. If one gives this some thought it seems odd. Presumably, the minister was aware
that the state had only so many assets to sell and that borrowing indefinitely was unfeasible,
nevertheless he was adamant on the maintenance of the currency board. This meant that there
was a third, almost forgotten, pillar – increased productivity. This would increase the inherent
value of the Argentinean goods, thus offsetting their increased price from the strong currency,
110 Joseph Halevi, The Argentine Crisis (Monthly Review), 3.
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leading to an increase in their demand, and eventually establishing a trade surplus, which would
maintain parity. So why does Cavallo, at least in the accounts available to me, fail to make
adequate mention to this? Perhaps he was only aiming for a temporary convertibility scheme?
Maybe he had some Machiavellian plan that he never successfully completed? Or, most likely,
he mistakenly believed that Argentina had made significant advances in technology and
infrastructure. These are just postulations, as there is no answer to this question, nevertheless it is
one that should be answered if one wants to get to the bottom of Argentina’s political economy
during the 1990s – hopefully something I can undertake in a latter project.
The second reality that this project unveils is the remarkable level of integration that
Argentina achieved in between its convertibility plan, the sale of its state assets, and its
borrowing in the international markets. This phenomenon speaks to a larger pattern that is typical
of developing and developed nations alike – the creation of complicated systems of signals and
perceptions that ultimately play an unquestionable role in each country’s economy. Finance is
not only a matter of quantitative analysis but also a matter of market perception. A stock or a
bond (equities) may be fundamentally sound, that is to say its earnings or coupon may be above
market estimates, yet the equity may tank in the market as a result of perception. If investors
expect the equity to go down in price and act on this expectation it will most likely happen, as
each speculator is reacting to the other’s action. As a result of this and the fact that more and
more countries are actively using capital markets, economies are becoming increasingly
dependent on their ability to transmit a message of stability/prosperity to investors worldwide.
The case of Argentina provides an extreme example of the development of an intricate
system of market perception, which eventually played an important role in influencing the
country’s real economy. Unlike other countries the sale of bonds was not undertaken to raise
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money for a government projects, but rather to keep its currency at an equal price to the US
dollar. The maintenance of a strong and stable currency was fundamental in forming an image of
Argentina as a safe investment destination, but was simultaneously and paradoxically itself also
dependent on this image. The outcome was the creation of an extensively complicated system,
mixing politics, economics, and diplomacy in order to preserve this fixed exchange rate. This
demonstrates that if market sentiment plays an important role in a country’s economy, that
country will most likely develop the necessary tools to shape it to its advantage.
The problem with this is that it creates an unsustainable system. In Argentina’s case, the
privatizations provided fiscal boosts that improved the country’s economic standing, but these
operations were not sustainable in perpetuity. In fact, most privatizations only ameliorated
Argentina’s economy in the short-term. Thus, through the privatization program, the country was
finding a way to sway market sentiment in its favor, artificially making itself more attractive as
an investment while in reality it was not a safe investment at all. It had an overvalued currency,
which required dollars to be preserved; yet the exchange rate was actually making dollars
difficult to come by, as it curtailed exports by making them more expensive. It was this type of
redundancies that weakened the Argentine economy. As Warren Buffet, the billionaire mogul
investor, puts it, “price is what you pay, value is what you get.”111 For Argentina, the price of its
debt did not reflect its value. Debt was overpriced and overbought, leading to an unsustainable
accumulation of it, which culminated in the 2001 economic crisis.
111 Warren Buffet, Berkshire Hathaway Investors Letter (2008), 5.
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Epilogue
Guardia Joven: Contemporary Significance
This thesis cannot end without mentioning two recent occurrences in Argentina’s
political economy. Although my study finishes in 2001 this does not mean that Argentina
recovered completely from its crisis. From the moment of devaluation onwards the country has
struggled with bouts of inflation. Thankfully, they have not been as severe as those in the 1980s
but they have still hit the population hard. Interestingly enough, the government has once again
taken an active role in determining Argentina’s exchange rate with respect to the US dollar.
Nevertheless, unlike Cavallo, the current cabinet has not been able to convince the Argentine
population to trust them as determiners of the peso’s value. Unlike the 90s, when the minister
imposed convertibility law he made an unbinding commitment to keep the peso equal to the
dollar at whatever cost necessary, today’s government has not made such a pledge. Instead, the
population has turned to dollars as an alternative currency. In an effort to stop this, the
government has passed legislation (currency controls) to ban excessive purchase of dollars, but
this has failed. Instead, a black market for dollars has emerged and most Argentine’s are taking
advantage of the different exchange rates to perform arbitrage operations. Over the past few
months the black market rate for US$ 1 has been at 10 pesos, while the official market rate for
US$1 has been at 5 pesos. Radio stations defiantly broadcast information about exchange houses
that specialize in giving their customers the black market exchange rate and thousands of people
go on a daily basis. The situation is extremely bizarre but many Argentines’ are actually thriving
under this new economic scheme. For example, they are capable of travelling abroad to the US
by paying for their expenses with their national cards, which value the peso at the official rate;
however at the end of the month when the bill comes due they exchange dollars that they had
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saved up at the black market rate and essentially cut the price of their trip in half. Earlier this
year the government has tried to narrow the gap between the two rates, and failed, in January the
unofficial peso dropped to an all time low.112 The predicament is a dangerous one for Argentina.
The lack of savings in pesos is affecting the government’s ability to tax. Furthermore, the
amount of illegal hoarding/trading in the economy has skyrocketed and there is absolutely no
faith in peso. Many businesses have shut down or dramatically increased their prices.113 Cavallo
can be criticized for driving Argentina to an unsustainable debt crisis, but at least he was capable
of keeping inflation in check for almost ten years. Moreover, he managed to convince Argentines
to trust in their national currency, a truly remarkable feat.
The other recent occurrence in country’s economic history relates to the costs of
Cavallo’s policies. I have repeatedly touched upon the fact that Argentina ended up defaulting on
its international bonds in 2001, but I did not cover what happened after this default. The majority
of the debts were settled at either 27 or 29 cents to the dollar. This meant that the Argentine
government paid its debtors only around 30% of the full value of their investments. Over 90
percent of bondholders accepted this deal, but some, including Italian pensioners and some
vulture hedge funds, did not.114 These parties have utilized the New York State Court to
successfully win a lawsuit against Argentina. The court ruled in favor of the debtors claiming
that, Argentina had an obligation to pay them off before paying its new bondholders. 115 In
response, Kirschner’s government has stated that if they are forced to pay their old debt they will
stop paying coupons on their new debt altogether. Furthermore, they have taken the case to the
112 Charlie Devereux, "Argentine Black Market Peso Sinks to Record on Flight to Dollars." Bloomberg.com. January 7, 2014.113 Pablo Gonzales & Daniel Cancel, "Argentina Devaluation Triggers 30% Whirlpool Price Markup." Bloomberg.com. January 27, 2014114 Vulture hedge funds invest in debt with a high risk of default. They generally buy the debt at a discounted price and profit from suing the debt issuing company. 115 After 2001 Argentina reenter the capital markets, issuing a new set of sovereign bonds.
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US Supreme Court. If Argentina follows through with its threat to default this will be the second
time in less than 13 years that the country has done so, it would also find itself out of the global
financial system once more.116 Over ten years may have passed since Cavallo’s convertibility
experiment failed in spectacular fashion. Nevertheless, the effects of the default on its debt still
plague the Argentine economy.
116 Steven M Davidoff, "Argentina Takes Its Debt Case to the U.S. Supreme Court." DealBook NY Times. February 25, 2014.
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