The Grand Illusions

Politicians are often accused of promising what cannot be delivered. In Argentina, economists sold politicians on two dreams that could not be fulfilled. Their failure plunged the country into its deepest political and financial crisis in decades. President Fernando de la Rúa was brought down by riots that left 29 dead. Citizens, facing unpaid salaries, frozen bank accounts and unemployment of 20%, are suffering the consequences of two grand economic illusions.

The first concerned the supposed restorative powers of a currency board. Call it the magic wand illusion. When in 1991 Argentina tied the peso to the dollar and prevented its central bank from printing pesos freely, the world applauded - with good reason. The new policy ended decades of high inflation and currency debauchery. But the currency board was not just a monetary system; it was also a reform strategy. That overreach began Argentina's undoing.

The country had not reformed previously - the theory went - because it did not need to. If unions bid up wages too high, a devaluation could fix the problem; if provincial governments spent a little too much, a quick round of peso printing would save the day. Inflation was the grease that had kept the wheels of Argentine politics going.

Shut off the peso spigot - economists counseled - and politics would fix itself. Without an inflationary cushion labor markets would have to be modernized, and peso wages would fall to the point were the country could compete internationally. Fiscal policy would also be straightened out because the central bank was no longer the lender of last resort. Local banks and corporations would never again overborrow, knowing that no safety net would catch them when they fell. Even politicians liked this theory, since they could blame the monetary straightjacket for some of their unfulfilled promises.