A historical perspective on the crisis

BUENOS AIRES HERALD - 30.07.2002 - FINANCE & ECONOMY

The current financial crisis, that many say is the worst in Argentina's history has given rise to a multitude of thoeories as to its causes and origins.

However, a book released yesterday, Straining at the Anchor: The Argentine currency board and the search for macroeconomic stability, 1880-1935, by Gerardo della Paolera and Alan Taylor, maps out the turbulence in Argentina's past economic history and imparts some serious policy lessons.

A concise way to sum up Argentina’s experience would be to present it as a problem of bad design in the overall financial architecture. Certain elements looked reasonable and stable on their own, but put together the entire edifice could not hold up to the eventual strains.

This observation has some fairy clear implications for how we view recent calls for reform of the world’s financial architecture. The argentine experience shows that -to stretch the metaphor- a little repainting here and there, some new wallpaper, or a rearrangement of the furniture might not suffice to make a structure sound.

Rather, what might be needed at the level of a specific country is a tear down, or at least full attention to the whole structure right down to the foundations. Partial reforms of money and banking regimes could be ineffective, and might even be damaging.

In the Argentine case it is clear where the architectural renovations paid off, and where neglect in the design stage come back to haunt everybody. A safe, quasi-narrow bank such as the Banco de la Nación, and a Conversion Office set up as a currency board to maintain a good reputation, were created to solve the 1890s crisis.

It was hoped that, unlike the other predecessors, they would never descend to soft-budget constraint activities. But external economic forces and internal political manipulations during the interwar period generated a set of challenges and temptations that disturbed the institutional design and pulled it ever so gradually off the rails until there was no possibility of return.

External discipline could not solve all the problems. The Conversion Office was internationally visible, easily monitored and verified; it was a clear and sound adoption of the rules of the game, a well-behaved and consistent institution in this small open economy. Much less visible (internationally and domestically) was the financial system and its workings. In the first phase of its existence (1891-1913) the new Argentine money and banking regime functioned smoothly, faced few shocks, and was little tampered with by policymakers. In its second face (1913-34), a series of economic shocks polluted first the private banking system and then, despite a seemingly solid design to prevent bailouts and moral hazard, took down the Banco de la Nación and the Conversion Office as the illness spread and Argentina reverted to what critics of the day called "Gaucho banking".

The end result was the creation of an institution -the central bank- that could, with the help of opaque and dubious maneuvers by IMIB, cover up the mess and finally throw in the towel on the idea of external convertibility.

Loosening the nominal anchor was to have adverse long-run implications for inflation performance. And having no compelling restraint on the bailouts used to protect internal convertibility, the central bank embraced a Lender-of-Last-Resort function with regard to the private banks that was to invite moral hazard and continuing real resource drains for decades to come.

With banks subject to neither supervision, nor banking laws, nor regulations, and with the mysterious ad hoc evolution of the Banco de la Nación, the system got itself on a path toward inconsistent policies. Instead of a classical Lender-of-Last–Resort system, a free insurance or bailout scheme was the end result. This need not have compromised the Conversion Office and Argentina’s commitment to stable macroeconomic policies. But when the 1929 crisis hit, it was so big that the banking system’s weakness threatened a disastrous collapse of intermediation absent a rescue, and further real costs.

The price was to abolish the Conversion Office and revalue gold, once and for all losing the notion of parity that had endured since the 1899 resumption.

With the loss of a commitment to a stable external value of the currency and, in the longer run, to a stable price level, the genie –money printing- was yet again out of the bottle.

We might consider how Sarmiento, Roca or Pellegrini would have viewed these events. These former Presidents saw Argentina as having an internal tension between progressive sectors of society seeking to create modern institutions with clear rules of the game, and conservative forces seeking to maintain a status quo where outcomes usually depended on arbitrary forces and the manipulation of power and influence. Sarmiento’s magnum opus, Facundo [Civilizacion i barbarie], was devoted to exactly this issue.

The Conversion Office in some sense epitomized the economic attempt at civilizacion, by playing to clean rules and meeting externally verifiable standards and monitoring. The more clandestine relationship between private finance and the state, and the capacity of the private and provincial banks to obtain successive bailouts from the Banco de la Nación via political means, were more reminiscent of barbarie.

In the end, in the sphere of macroeconomic policy at least, the results seem clear. The Belle Époque was marked by prosperity in incomes, not in institutions. By accident or, we might say, by lack of design, barbarie triumphed.

The book is published by the University of Chicago Press and the authors promise that a Spanish/language edition will be available shortly.

Por PJ
de la redacción de BUENOS AIRES HERALD