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Argentina Afloat, But the Peso's Sinking
Subject Monetary policy
Topic International Finance
Key Words Devaluation, Exchange Rates, Default, Economic Growth
News Story

Argentina cut the peso, its national currency, free from the dollar in an attempt to rescue an economy that appeared headed towards financial collapse. Eleven years ago, the peso was pegged to the dollar at a one-to-one exchange rate in an action designed to control inflation that was at a 4-digit annual rate. A two-tiered exchange rate system was established: an official rate of 1.4 pesos to the dollar, to be used for foreign trade, and a market-determined rate for the public. The floating peso lost 42 percent of its value, kindling fears of renewed inflation. A free fall of the peso would dampen prospects of economic growth and could affect other Latin American currencies.

Faced with a 4-year recession, unemployment of 20 percent and a poverty rate of 40 percent, a government default on part of its $142 billion debt, Argentines took to the streets to protest their economic plight. Their demonstrations were responsible for the resignation of two Presidents and the installation of Eduardo Duhalde as Argentina's third President in less than a month. President Duhalde was given broad powers to improve economic conditions and freed the peso from its dollar peg. Restrictions on individual Argentines' access to their funds imposed by Duhalde's predecessor remain in place and new controls have been added. Argentines with over $3,000 in savings and/or $10,000 in their checking accounts will not have complete access to their funds for a year or more. Even though the peso has been devalued, the government mandated that banks must accept payment for loans at the old one-to-one rate. Loans represent about 80 percent of all Argentine debt and it is estimated that this restriction could cost banks $6 to $15 billion.

Uncertainty about the government's ability to maintain order and stabilize the banking system contributed to the fall in the value of the peso. Some analysts believe that the peso could fall to 2.7 to the dollar over the next year. Exchange rates of 1.9 or higher could trigger high inflation and have an impact on neighboring currencies, especially Brazil's.

(Updated February 13, 2002)

Questions
1. When the peso's tie to the dollar was eliminated, the peso promptly fell to 1.6 pesos to the dollar. Why did the peso fall in value? What are some of the uncertainties given in the article that would make individuals eschew the peso?
2. The peso to dollar peg was a measure Argentina adopted to control an annual inflation rate of over 1,000 percent per year. How did the dollar peg work? How did it control inflation?
3. The floating peso renewed hopes for a currency union between Argentina and other South American economies. How would a currency union stimulate economic growth? What would determine the value of the peso?
Source Anthony Faiola, "Argentina's Peso Is Freed to Float, And Quickly Sinks," The Washington Post, January 12, 2002.

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