Argentina s Convertibility The Repressed Inflation That Wasn t so

Argentina's Convertibility: The Repressed Inflation That Wasn't (so far? ) Carlos Alfredo Rodriguez, UCEMA Conference in Honor of Arnold Harberger, UCLA , February 14 2003

Argentina's Convertibility: The Repressed Inflation That Wasn't (so far? ) Carlos Alfredo Rodriguez, UCEMA From Alito I learned that inflation and devaluation do not happen in a vacuum. In his 1966 paper "The Case of the Three Numeraires"(1966) he provides a useful framework to study the distortionary effects of repressed inflation and allows for a realistic understanding of the dynamic interaction between inflation, devaluation and foreign borrowing. In theory we can study a perfectly anticipated and neutral inflation and concentrate on its fiscal outcome and the measurement of the welfare cost from economizing on cash balances. In practice, constraints on policy makers result in actions that make inflation not neutral towards other real variables: in particular the real exchange rate and real wages. In all of Alito's work, the exchange rate policy plays a critical role in determining the distortions and costs that accompany an inflation process. He has consistently pointed out to the fact that fixed exchange rates coupled with fiscal deficits are an explosive cocktail that sooner or later results in an inflationary 2 explosion and related distortions.

The abandonment of Convertibility that started in mid 2001 was viewed by many as the untying of a long lasting situation of repressed inflation. Hyperinflation was predicted by most local economists, including myself. However it did not happen, at least after one year. The key to this puzzle may lie in the destructive creativity of our policy makers. They have discovered many unconventional ways to violate property rights in order to finance fiscal deficits. The social costs of these measures have been huge and the final result is still to be seen. I now provide a short enumeration of these measures, which I certainly do not recommend to anyone: 3

• Payments of more that $1000 are not valid in cash: only with checks. • Tax on Checks!! (0. 6% both ways!!). • Corralito (little fence): Bank withdraws can only be made with checks or electronic means except $50 a week. • Corralon (big fence): Time and Savings deposits are frozen. • Government defaults on public debt. • Pesification: All dollar denominated deposits, even the frozen ones, are converted to pesos at the rate of 1, 4: 1; the market rate jumps to 4: 1 in a few weeks. Dollar deposits become worthless frozen pesos. • Depositors attack banks on a daily basis with everything at hand, mainly pots and pans. They resort to justice and judges impound any cash that enters the banks vaults. Banks become very insecure places to visit or to put one's money in. 4

• Bank debts are also pesified at 1, 4: 1. Nevertheless debtor organizations lobby for non-payment and all home mortgage executions have been suspended since then. • The bankruptcy law is suspended until IMF pressure forces it back. • Provinces issue quasi-moneys (Bonds looking like bills) as legal tender to pay government expenses. • Prices of public services provided by privatized companies , and public transportation, are frozen. • Export taxes are used to subsidize 2 million unemployed. "Piqueteros" organizations start popping up: they block main roads and bridges to get government to give them subsidies to distribute among their people. • Capital controls are imposed. Persons can buy up to US$1000 per month. The Central Bank sells them a few cents below market: a new profession is created: the "coleros"(queuers). 5

After 12 months the results are: Devaluation: 230% Inflation (CPI): 40% (Home goods probably increased less than 15%) Inflation (WPI): 118% Wages: 8% M 3 total (inc. govt. and quasimoneys)= 23% Private M 3 (w/o govt. and quasimoneys= 7% Cash(pesos)= 80% Poverty Rate: 54% of population (up from 29% two years before) GDP: down 11% Imports collapse and exports fall slightly reaching the biggest Trade Surplus ever ( about 15% of GDP). Since bank money is either frozen , taxed or subject to judiciary impoundment, people keep liquid funds at home (under the mattress). Not surprisingly bank robberies stopped completely and kidnappings for ransom literally exploded. Most of the above horrors happened between Dec. 2001 and Feb. 2002. One year later the statistics show some economic improvement on an annual basis: The government calls this a recovery. I think it just means we could not surpass the unprecedented record of self-inflicted damage reached one year ago. 6

The Real Exchange Rate about tripled in one year. We still have to figure out how much is due to the correction of a disequilibrium accumulated during the 90's and how much is due to changes in the fundamentals. The violations of property rights derived from pesification and default will surely imply a higher equilibrium real exchange rate and capital outflows that will last for a very long time. However, the story is still unfolding. Of the five top presidential candidates, three are proposing for the government to take charge again of the privatized public services. The front runner candidate for Governor of the largest province is asking for choosing NATO as a military conflict hypothesis and nationalizing foreign trade. With so much political turbulence ahead, I think Alito will fully agree that a floating exchange rate is the best policy an economist can recommend at the moment. 7

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Evolution of Financial System in Argentina in millions of pesos 10

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