Argentina’s Convertibility Peso — The Anti-Inflation Cure That Became a Trap

The Argentine convertibility peso is the rare Zero Hour case that died not of too much inflation but of too little flexibility. It was born as the antidote to the hyperinflation chronicled in PP-002 — the austral that disintegrated in 1989, when prices rose roughly 200% in the single month of July and around 5,000% across the year — and for a decade it worked spectacularly. Then, in January 2002, after a sovereign default and a deposit freeze that pried the country’s savings out of its own hands, the government repealed the law that had defined the currency and let the peso float. It fell from one-to-one with the US dollar to nearly four-to-one within months. The verdict is Devalued: not a hyperinflation, not a redenomination, but the collapse of a hard peg and the roughly 70–75% depreciation that followed.

The cure had been brutally simple. The Convertibility Law, which took effect on 1 April 1991 under President Carlos Menem and Economy Minister Domingo Cavallo, fixed the currency at one peso to one US dollar and required the central bank to back the monetary base substantially with dollar reserves; in 1992 the peso convertible (ARS) formally replaced the austral at 10,000 australes to one peso. The arrangement functioned as a near-currency-board: the central bank could not simply print to cover deficits, because every peso in circulation had to be answerable to a dollar in the vault. The inflation tax that had defined Argentine life for forty years was abolished by statute. Annual inflation, which had averaged some 600% from 1983 to 1991, fell to about 4.6% a year from 1992 to 1998; for a time, capital poured in and the economy boomed.

The trap was the rigidity itself. A peg that cannot move forces all adjustment onto everything else — wages, prices, employment, output. When the dollar strengthened in the late 1990s, when Brazil devalued its real in 1999, and when commodity prices sagged, Argentine exports priced in expensive dollars became uncompetitive, and a recession that began in the third quarter of 1998 ground on with no exchange-rate escape valve. The government, barred from monetizing its deficits, borrowed instead — and the debt mounted until markets stopped lending. By late 2001 the peg’s two preconditions, external financing and fiscal discipline, had both failed.

The end came in weeks. On 1 December 2001 Cavallo imposed the corralito — the “little fence” — capping bank withdrawals at 250 pesos a week to stop a run; meant to save the banks, it detonated the politics. Riots and a revolving door of presidents followed; in late December 2001 Argentina suspended payments on its sovereign debt, the largest default in history to that point (figures range from roughly US$93 billion to as much as US$132 billion depending on what is counted). In early January 2002 President Eduardo Duhalde’s government repealed the Convertibility Law and floated the peso. It overshot to nearly four per dollar by mid-2002 — devalued, not abolished, but the decade-long promise of one peso, one dollar was over.