And The Money Kept Rolling In (And Out)

Wall Street, the IMF, and the Bankrupting of Argentina

Book by Paul Blustein

Article and Review by GlobalMacroForex

In late 2001, Argentina’s economy and political leadership collapsed.  There was a freeze on bank withdrawals, the debt was restructured, the political leadership changed hands many times, people violently rioted on the streets, and the peso significantly dropped in value.  In this book summary, we’ll cover a general timeline of events, divided into the following headings:

·      Argentina’s History

·      1:1 Peso/USD Peg

·      Debt Buildup

·      First Cracks in Bubble

·      Bubble Pops

·      Corralito Bank Freeze

·      Total Collapse

·      Author’s Recommendations

Let’s dig right in…

Argentina’s History

Argentina has a turbulent history marked by military coups and high inflation.

Stage 1: Juan Peron

Juan Peron seized control in 1943 after World War 2 and fiercely cracked down on the descent.  He imprisoned his rivals, censored the media, and drastically increased the power of the government.  His rule was under a military dictatorship.  His reign continued until 1955 when he was forced to resign and fled to Spain.

Stage 2: Military Coups Galore

Once Juan Peron fled, multiple leaders struggled to maintain control with the military.  A long list of coups happened, and this was an extremely turbulent and violent time.

Stage 3: Juan Peron’s wife & Dirty War

In 1973, Juan Peron comes back just before his death.  He passes power onto his wife Isabel.  She rules for a short period of time before a coup takes power and gives it to the Military Junta.  The Military Junta carries out a “Dirty War” against socialism that killed thousands of people.  Some sources, such as Wikileaks and the New York Times, accused the United States of approving, funding, and giving other resources for this coup.  Although the level of support given varies by the news source.

Stage 4: Real Elections

Finally, in 1984 there are real non-military democratic elections.  The interim president quickly passes it to the 1989 winner Carlos Menem.  This marks the beginning of democracy in Argentina.

1:1 Peso/USD peg

Not long after the start of democracy, Domingo Cavallo is appointed head Economy Minster to handle the horrible inflation that had been plaguing Argentina for all these years.  (The previous inflation was due to the military governments printing massive amounts of money to finance the military itself).  On April 1, 1991, Domingo Cavallo pegged the Argentine peso to the US dollar at 1 peso = $1 USD.

This exchange rate peg is done through a currency board.  Under this system, Argentina has to keep foreign exchange reserves in US dollars to exchange them for pesos when someone tries to make good on the promise. 

While the Argentina Central Bank does lose power and control over the monetary supply, this situation is not as bad as complete dollarization like Ecuador.  Ecuador literally uses US dollars because nobody trusts the local currency what-so-ever.   With a currency board peg like Argentina had, at least the USD reserves can earn interest.  However, keeping this peg system requires a balanced fiscal budget because printing money to pay for the debtor drive down government interest rates isn’t an option.

The pegged exchange rate immediately achieved its goal of inflation reduction.  From 1991-1994 inflation totally subsided and the economy started to flourish, as this chart from shows:

However, Wall St started to lend large amounts of money to Argentina’s government, since it earned a much higher interest rate, but was paid in a currency pegged to the USD.  Portfolio managers started to neglect the exchange rate risk because of the peg and assumed they would be able to exchange out of the peso at a 1:1 rate.

Debt Buildup

All of these willing debt buyers on Wall St (because of the 1:1 peg), pushed Argentina’s interest rates down and allowed even more borrowing.  Not only was the national government borrowing, but the local municipalities also loaded up on debt.  None of the politicians wanted to lose an election, so they approved every spending project and refused to cut the local and national budgets.  To make matters worse, the local governments were lying and fabricating budgets to make the debt seem less than it was.

The debt grew to 41% of GDP as the IMF warned Argentina if it continues down this path, they will suspend its program with Argentina.  In 1995 the Mexican currency had a crisis followed by the 1997 Asian currency crisis.  All these other crises made the IMF less willing to push Argentina out of its program for fear of the market reaction. 

First Cracks of Bubble

In January of 1999, Brazil devalued their currency due to their own currency crisis and Argentina’s exports to Brazil fell drastically.  Overall because of all these currency crises in a row (Mexico, Thailand, Indonesia, Hong Kong, Brazil, Russia), capital flows to all emerging markets dried up.  This deflationary effect of a strong USD and less EM growth led to a decline in worldwide agricultural commodity prices, especially wheat and Argentina’s other exports.

This was the first major crack in Argentina’s bubble as the national government’s bond prices fell and interest rates rose.  This chart from The Economist magazine presents the situation:

The “country risk” increased, which is defined as the spread between US Treasury yields and Argentina’s yields.  In October of 1999, Fernando la Rua was elected president with Jose Luis Machinea as economy minister.  They immediately tried to address the problem of the debt buildup.

In January of 2000, the IMF approved a plan to reduce Argentina’s budget deficit.  However, the cuts to many government payrolls decreased GDP enough to actually still increase the debt-to-GDP ratio.  This caused the market to raises Argentina’s interest rates even higher and Vice-president Carlos Alvarez resigned further signaling a deterioration of the situation.

Bubble Pops

In December of 2000, the IMF lent $14 billion to Argentina, but these additional foreign exchange reserves did little to help the outflow of capital from the country.  On March 2, 2001, Jose Luis Machinea resigned as economy minister, then 3 weeks later his replacement successor Ricardo Lopez Murphy also resigned.

“Then in a surprising twist, the man who originally pegged the peso to the US dollar 10 years ago in 1991, returned to his same economy minister role.  Domingo Cavallo was back in charge on March 20, 2001, and even as Argentina’s foreign exchange reserves dwindled, he remained committed to keeping his original 1:1 peg in place.

Cavallo’s new plan was a megaswap, which switched old bonds for new bonds that stretched out the interest and principal payments.  In addition, Cavallo wanted to crush the debt down, so instituted a “zero deficit” policy which cut 13 percent of government salaries and pensions.  Combining these measures on August 21, 2001, IMF bailout rescue package to the tune of $8 billion.

Corralito Bank Freeze

As the market disregarded these reforms, interest rates continued to rise, and Argentina took even more creative measures to restructure debt.  On November 6, 2001 (in response to the restructuring) S&P lowers Argentina’s rating to “selective default”).  This was a huge turning point and led to both foreign Wall St investors and local citizens realizing that the 1:1 pegboard would likely be abandoned.  Everyone rushed to pull their money out Argentine banks and the foreign exchange reserves the IMF had lent to Argentina were quickly gone.

Domingo Cavallo was determined to maintain the value of the peso, so rather than allow a bank run, he instituted a freeze on withdrawals.  On December 1st, 2001, this bank freeze was known as “corralito” which means a child’s playpen.  Cavallo was counting on one package of loans from the IMF.  Unfortunately, those loans never materialized.

Total Collapse

On December 5, 2001, the IMF pulled the rug.  They said they were “unable at this time” to consider making another loan package and left Domingo Cavallo high and dry.  Things quickly collapsed and soon rioters were on the street, angry about their frozen bank accounts.  This chart of GDP from shows the severity of the situation:

On December 19-20, 2001, Mass violent protest led to the resignations of Domingo Cavallo and the President de la Rua.  Ramon Puerta took over on an interim basis.  On December 23, 2001, Adolfo Rodriguez Saa was elected president and opted to default on the private foreign debt.  This created a large amount of turbulence and Adolfo Saa resigned amid more protests.  After the previous interim president (Puerta) refused to accept it again, Eduardo Camano became the new interim president (he was previously president of the lower house).  This period had a lot of chaos.

Finally, on January 1, 2002, Congress elects Eduardo Duhalde as president and he terminated peso convertibility.  The Argentine peso plummeted in the markets and left the economy in shambles.  Poverty soared and economic output fell 11 percent.

Author’s Reflections

The author has a lot of suggestions on how to alleviate these types of crises going forward.  I’m only going to review a few of them.  One of his criticisms of Wall St is the “electronic herd” of portfolio managers who move money in and out of a country with the pack.  He views one way out of this group-think mentality is to reduce bond portfolio manager’s reliance on outperforming an index, specifically the EMBI-Plus index.  By being forced to outperform an index, it encourages portfolio managers to invest in bubble situations because the index is rising and they need to be including those bonds in their portfolio even if they doubt their long-term value. 

The second suggestion from Paul Blustein is to create bonds that are more like equity.  These “growth linked” bonds pay an interest rate that rises or falls based on GDP.  While Argentina tried to sell these, Wall St didn’t buy.

A third suggestion is to reduce the reliance on international courts for emerging market debt.  If international investors think they have to reclaim defaulted assets in the debtor country’s own courts, they will be less likely to lend if the borrower has unstable debt levels.  However, Mr. Blustein doesn’t mention there might be an increase in the interest rate in these types of scenarios to compensate the borrower.


This book gives an excellent overview of the events leading up the collapse of the Argentine peso.  We can see that the 1:1 peg did an excellent job at stopping inflation, at the cost of forcing the government to balance its budget through fiscal means.  When Argentina was unable to do that, not only on a national level but on a local level with local politicians lying about their budgets, it overall led to an unsustainable situation.  The 1:1 peg made Wall St investors think they would be getting a higher rate of return for a near US dollar equivalent.  The IMF bailout programs made them stick out the high-risk debt longer than they would otherwise.

Paul Blustein provides not only a timeline of the events but suggestions to reduce these types of situations going forward.  Among his suggestions are a reliance more on equity and less on debt, ‘growth bonds’ whose interest is tied to GDP, less reliance on indexes for bond portfolio managers, less reliance on international courts, and he also suggests left-wing actions such as taxes or capital controls.  Regardless of how one feels about the politics of his suggestions, overall I would recommend this book for someone interested in learning how emerging market currency boards can break down.