In the past week Argentina has been ravaged by riots triggered by an economic crisis. With President Fernando de la Rua's resignation and changes in the Cabinet, Argentina has become the center of international attention amid worries that its economic problems may trigger a domino effect across South America.
Argentina has experienced days of glory. In the 1930s, the country was neck and neck with France in terms of per capita income, thanks to its beef exports. However, beginning from the 1940s, it retreated from the international stage, driven by isolationism, domestic unrest and military authoritarianism. By the end of the 1980s, inflation was running at 200 percent per year.
After becoming president in 1989, Carlos Menem tried to stimulate business growth by easing trade restrictions and privatizing government-owned enterprises. In 1991, the country pegged its currency, the peso, to the US dollar and regained market confidence. Its financial markets also gradually stabilized. Foreign capital poured in and Argentina's economy strengthened. The country enjoyed a robust 7.7 percent economic growth rate in the early 1990s.
However, the Argentine peso has undergone only small fluctuations and has been unable to adjust to economic reality. With a dollar-pegged peso, Argentina essentially gave up control over its monetary policy. While useful in tackling runaway inflation, a pegged, unresponsive currency can do more harm than good to economic-recovery efforts.
Argentina escaped the fallout from the Mexican peso's steep devaluation in 1995. And when the Brazilian real fell in 1999, Argentina's peso failed to follow suit. As a result, Argentina's export prices became higher than those of its neighbors. Falling prices for agricultural products and the global economic slowdown have also aggravated Argentina's economic woes. Falling exports have blunted the country's ability to earn hard currency and repay debt.
Argentina has two options for salvaging its economy: one is to stop pegging its peso to the US dollar and allow the peso to devaluate -- thereby reflecting economic reality. This would restore its competitiveness. However, because its external debt is calculated in US dollars, the peso's devaluation would further impair its ability to repay that debt and could lead to bank closures and capital divestments. The second option is to completely replace the peso with the US dollar, a step some neighboring countries have taken with their currencies. This would restore the confidence of foreign investors. The disadvantage is a higher risk of negative economic growth.
Some economists have suggested a two-pronged approach that would allow the peso to devaluate, followed by the dollarization of the peso at a relatively lower exchange rate. This would prevent the negative effects of plain devaluation and dollarization.
However, with empty government coffers, Argentina will be unable to make good on its promises of debt repayment. Global financial institutions such as the IMF should intervene to help Argentina maintain its credit, prevent an expansion of the crisis and stabilize South America's regional economy.
Following the Japanese yen's recent devaluation, Taiwan's central bank first allowed the New Taiwan dollar to devaluate and then acted decisively to defend a stable exchange rate. Argentina should serve as a warning to Taiwan's government of how a mistaken policy can erode a country's economic foundation over a long period of time. Taiwan should work to maintain its economic vitality by adopting steady and flexible policies in currency exchange and cross-strait trade.
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