Europe can learn from Argentina's woes
Six months ago Domingo Cavallo, the all-powerful Minister of Economy for Argentina from 1991 to 1996, had a warning for Greece. 'Don't even think of abandoning the euro,' he said, 'because that will provoke a financial catastrophe in Greece and various other countries in Europe.'
Best known for his 1991 Convertibility Law, which forced Argentina to abandon the austral, its hyperinflationary currency, and replace it with a strong peso pegged to the US dollar, Cavallo was reappointed Minster of Economy in 2001 during the debt and currency crisis that led ultimately, in early 2002, to the devaluation of the peso and a default on the country's debts.
Cavallo believed in 1991 that since Argentina could not rein in its profligacy, a currency policy that prevented the central bank from allowing out-of-control expenditures would enforce monetary discipline. Similarly, by holding firmly onto the euro, Cavallo argues that Greece would be forced into cutting expenditures.
Since under the current system the Greek central bank cannot print euros, the market's refusal to continue lending money to the Greek government would leave it with no choice but to cut its spending. It would also force labour costs into alignment with those of its stronger European neighbours.
There is a fierce debate about whether or not countries like Greece, Spain, Ireland, Italy, Portugal and Belgium are better or worse off in the long term by maintaining the euro and forcing an adjustment through rising unemployment and sharp fiscal cuts.
But whatever the economists decide, it is important to remember that this is ultimately a political decision. As far back as 1922 economist John Maynard Keynes pointed out that the process of currency and debt adjustment is above all a political process. Whether a country adjusts by restructuring debt, devaluing its currency, raising unemployment or inflating, the choice decides which sectors of the population are going to pay for the cost of the adjustment.
Here the track record of Argentina since 2002 is very suggestive. During Argentina's glory days - after the imposition of the Convertibility Law until the Mexican crisis of late 1994 - Argentina grew solidly by about 6-7 per cent annually. Thereafter it struggled to maintain growth for any long period and went into deep recession in the two years before the crisis, with GDP contracting by up to 8 per cent.
But within months of abandoning the currency and defaulting on its debt, Argentine growth rates shot up to an average of 8 per cent. This is the longest and strongest growth spurt Argentina has enjoyed in decades.
More importantly, unemployment dropped from well over 20 per cent before the crisis to around 7 per cent today, which is the lowest unemployment level Argentina has experienced since the implementation of the Convertibility Law.
So what are the lessons?
On the one hand it is clear that eliminating the monetary straightjacket allowed Argentine growth to surge and Argentine unemployment to fall. On the other hand, critics argue that Argentina has benefited mostly from soaring commodity prices and a dismissal of fiscal discipline that, while creating growth today, will severely constrain growth tomorrow. Although it is hard to say whether Argentina is better or worse off in the aggregate and over the long term, one thing is very clear. The attempt to maintain the currency and repay the debt placed an enormous burden on Argentine workers, who had to pay for the adjustment in the form of unacceptably high unemployment. Not surprisingly, they opted out.This story will repeat itself in Europe. Economists will argue for decades about whether the afflicted countries of Europe should or should not have abandoned monetary discipline and kept the euro. The determining issue today, however, will be the willingness of workers to shoulder the brunt of the cost and the ability of governments to share the burden equally within the population.
History suggests that only a radical solution will prevent several European countries from abandoning the euro and/or defaulting.
It needs complete political and fiscal union in Europe, a willingness on the part of investors and surplus countries to share the adjustment's cost, and for electorates to choose to adjust through fiscal contraction and unemployment. Without such a radical solution, there is little chance that the euro will retain its role in Europe.
Michael Pettis is a professor of finance at the Guanghua School of Management, Peking University, and a senior associate at the Carnegie Endowment