Argentina's 35 million citizens will not be the only ones to pay a heavy price for that country's latest economic crisis. The fallout may also radically alter economic policies and political relations both within Latin America and with the United States. It is already clear that Argentina will reverse at least some of the favorable economic reforms introduced by President Carlos Menem in the early 1990s. Although Menem's reforms are not responsible for the current chaos, they are a politically convenient scapegoat. Blaming them also provides a rationale for renationalizing Argentine firms, erecting barriers to imports and foreign investment, and increasing government spending.
The current crisis will weaken the prospects for the Mercosur trading arrangement among Argentina and its neighbors (Brazil, Paraguay, and Uruguay) and may kill any chance of a general Free Trade Area of the Americas. Many Argentines are already blaming their troubles on Washington, claiming that U.S. policies got them into this mess and that the United States then abandoned Argentina because, unlike Turkey, it is not of geopolitical significance.
If other emerging-market governments misinterpret Argentina's experience, they too might move away from the promarket policies that hold the best promise of raising future living standards. Gaining a better understanding of the real reasons for the Argentine crisis is therefore essential. Doing so might help Argentina and other emerging countries avoid making the wrong policy choices in the future and reduce the risk of further financial crises.
PEGGED ALL WRONG
An overvalued fixed exchange rate (locked at one peso per dollar since 1991) and an excessive amount of foreign debt were the two proximate causes of the Argentine crisis. Because the exchange rate was fixed at too high a level, Argentina exported too little and imported too much. This trade imbalance made it impossible for the country to earn the foreign exchange it needed to pay the interest on its foreign debt. Instead, Argentina had to borrow to meet those interest payments, causing the debt to grow ever larger.