Getting Argentina Back to the Future*

In Argentina, workers are rioting for a reason. One in five workers is unemployed and the gross domestic product has fallen by 25% since 1999. The Argentine peso, which for the last decade was worth a dollar, is now worth a quarter. The government has defaulted on its debt and most banks are technically bankrupt. Financial and human flight is rampant. The Argentine provinces are printing their own currency. Prices are rising and hyperinflation lurks. The nation has seen five presidents in six months. And the IMF, not to mention the U.S. government, has largely washed its hands of the country.

How did the Argentine economic miracle of the late 20th century turn into the economic disaster of the early 21st century? While many blame an overvalued currency and a lack of fiscal discipline, the underlying reason was a loss of confidence triggered by economic shocks elsewhere, from Russia to Brazil.

Despite Argentina's decade of impressive economic performance, no one ever fully trusted its economic institutions. The country has a long history of defaulting on investors, changing the rules of the game and printing money to pay its bills. This history hangs like a Sword of Damocles over any policy, no matter how well intentioned and conducted. Foreign investors can too easily decide that Argentina isn't trustworthy and take their money and flee.

Given Argentina's financial crime sheet, how can the country acquire the economic institutions it needs? The answer is simple-import them. Argentina needs to import a whole monetary system, a banking system and a saving system that are subject to the world's best supervision.

First, the country should declare the dollar and the euro the sole forms of legal tender and use its foreign currency reserves to purchase back outstanding pesos and provincial notes. Making both the dollar and euro legal currencies reduces the chance of getting stuck with an overvalued medium of exchange. And by outlawing the peso, neither the central government nor the provinces will be able to print money to "pay" their bills. Hyperinflation will be a thing of the past. So will outlandishly high interest rates.

Is this radical? Not really. Ecuador has dollarized its currency. Most of the European Union has just euroized, and high debt countries, like Italy, can now borrow at the same rates as Germany. Is this different from the Argentine dollar-pegging policy of the last decade? Yes, because it definitely junks the printing presses.

Abandoning the peso means the government can no longer serve as lender of last resort to endangered banks. Enter step two, which eliminates potential bank runs. After the government does what it can to shore up current deposits, Argentine banks should become front offices of major offshore banks in New York, London, Frankfurt and other banking capitals. An Argentine depositing funds in, say, Chase Bank in Buenos Aires, would not be dealing with an Argentine subsidiary of Chase Bank, but directly with Chase Bank in New York. Consequently, her account would be insured by the U.S. government and supervised by New York state and U.S. federal agencies. These foreign banks would not only accept deposits, via wire, but, as confidence in the economy is restored, also make loans to Argentine businesses.

Argentines need not just safe bank accounts, but also secure and inexpensive ways to invest their savings. The privatized Argentine pension system was meant to deliver that for workers. Instead, virtually all of its assets were invested in now worthless government bonds. That money is gone, but future investments should be with an offshore account for each Argentine invested in a single market-weighted global index fund of stocks and bonds. Such a fund would provide maximum diversification and custodial protection at close to zero cost.

Argentina also should restructure its debt, replace provincial with municipal government and de-politicize its judiciary. But fixing the currency, banking and savings systems should be done today. Argentines and the rest of the world would get a clear message that the country is once again a safe place in which to work, save, and invest. Restored confidence would benefit not only Argentina, but also Brazil and other countries in the region that are being infected by the same confidence virus that hit Argentina.

Laurence J. Kotlikoff is chairman of the economics department at Boston University and Juan Pablo Nicolini is president of the Universidad Torcuato Di Tella in Buenos Aires.

* This article was published on June 30, 2002 in the LA Times.