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History Senior Thesis

Advisor: Professor Martha Howell

Second Reader: Professor Pablo Piccato

The ‘Maradona’ of the Economy

The Rise and Fall of Cavallo’s Integrated Argentine Economy

By Lucas Federico Servideo

I want to thank Professor Howell for her support and patience. Almost midway through my project when I was completely lost she told me to have faith and push on. Hesitantly I did and, as per usual, she was right.
To Professor Piccato, thank you for your continual support as my second reader. To Oliver and Julia thank you for the countless edits, conversations, and laughs. To Professor Chang, a last minute savior, I am truly thankful.
Últimamente me gustaría agradecer a mis amigos, a mi familia, y a Irene. Gracias por aguantar un año de solo escuchar sobre Domingo Cavallo, las privatizaciones, y la deuda externa.


Argentina’s Anti-inflationary Tango: Convertibility 4
Chapter I

La Guarda Vieja: Overview of Argentina’s Political Economy 12

Borrowing 12

Privatization 15

Antecedents 17

Stability 18

Recession 24

Crisis 27
Chapter II

El ‘Lunfardo’ de Cavallo: The Minister’s Words 33

Lessons from Argentina’s Privatization Experience, 1997 33

Period I: Brady Plan Agreements 37

Period II: Borrowing for Convertibility 40
Chapter III

Behavioral Economics as Model For Cavallo’s Argument 45

Chapter IV

La Retórica Se Vuelve Realidad: Debt Used in Privatizations 52

El Ultimo Paso: What Does All This Mean? 59

Guardia Joven: Contemporary Significance 63

Argentina’s Anti-inflationary Tango: Convertibility

At the end of every seven years you must cancel debts. This is how to cancel debt: Every creditor is to cancel what he has lent his neighbor. He is not to collect anything from his neighbor or brother, because the Lord’s release of debts has been proclaimed.” – Deuteronomy 15:1

About 24 years ago, two years before I was born, both of my parents travelled from Buenos Aires to Miami. They had both just finished university and, perhaps a little foolishly, they decided to do some shopping. They paid for the majority of their purchases, as well as their meals, and their stay on credit cards. Probably all of us have made similar bad decisions at some point in our lives – we’ll figure out how to pay this later. Unfortunately, the concept of paying later was a risky one in Argentina in the late 1980s and the early 1990s. The annual inflation rate for the year that they travelled was around 3000%. This meant that when they returned, the value of the austral (the Argentine currency at the time), in which my father earned his salary, had been substantially diminished. The bills, however, had to be paid in dollars. Luckily, my mother convinced her boss to determine her salary on a dollar basis for one more month, allowing them to avoid defaulting on their credit card debt. Their story ends well, but they were the exception, not the rule.

Inflation plagued Argentina throughout the decade of the 1980s. It had been customary for people to sell their property and put their earnings in a bank, but during this period, money would become worthless within two months, leaving them literally homeless. There was no trust in the value of the national currency; those who could do so put their savings in dollars. Perhaps this episode was not as memorable as the inflation suffered by the Weimar republic, acutely captured by the pictures of men carrying wheelbarrows of money or children using cash as toys, but it was just as bad, and possibly even worse.

In early 1991, ten years before Argentina defaulted on its international debt and devalued its currency, an effort was made to address the economic crisis caused by runaway inflation. The subsequent decade, that is the years after 2000, saw the failure of the policies then put in place and marks one of the most tragic periods in the country’s economic history. During the 90s, the country underwent ‘neoliberal’ market reforms centered on open trade and access to capital markets, fiscal responsibility, and a stable currency.1 According to Joseph Stiglitz, a Nobel Prize winner in the field of economics and author of Argentina, short-changed: Why the nation that followed the rules fell to pieces, the policies implemented during the 1990s were doomed to fail. The most influential piece of the policy reforms was the convertibility law, which equated the Argentine peso with the US Dollar.2 Maintaining this exchange parity was of the utmost importance to the country at the time and depended on two measures: the sale of state assets and international borrowing.

In this thesis I will study the relationship between these two policies through an analysis of Domingo Cavallo’s account, Argentina’s economic minister from 1991 to 1995. By examining his speeches, articles and interviews, and by studying the process of selling state assets in it of itself, I argue that the minister believed that privatization made access to capital markets possible. The story I am telling and my analysis of it obviously have a deeper history that is essentially social and political, but this thesis does not try to place the policies or Cavallo himself in that history except by implication. Instead, I am focusing on the monetary and fiscal history itself: how privatization worked, how it made it possible for Argentina to borrow in international markets; to the extent possible from published data, I am also assessing the extent to which the combination of privatization and borrowing actually worked to restore fiscal health – and when it no longer did.

Traditional treatments of Argentina’s economic policies during the 1990s, in particular those studies dealing with the convertibility law, have considered privatization and borrowing important, but parallel, ways of maintaining exchange parity, not as necessarily interdependent policies. As economist and historian, Joseph Halevi put it, the only way that Argentina could stimulate the capital inflows essential to maintaining its convertibility scheme was by “[…] (3) privatization of public activities such as utilities where a steady flow of rents is always guaranteed; [and/or] (4) borrowing on international financial markets.”3 In brief, as he and many others understood it, the Argentine central bank needed to ensure it had sufficient dollars in reserves to backup the pesos in circulation, a necessity it could fulfill through either borrowing, or privatization, or through a combination of both, as policies working in parallel to one another.4 IMF publications during this decade explained the policies similarly. They were, in the IMF’s view, two separate initiatives, which independently influenced Argentina’s dollar reserves, allowing the country to maintain convertibility. In this logic, privatization would attract foreign investors because it demonstrated Argentina’s commitment to liberal economic policies; once privatized, these industries would be well run, generate profits, and pay taxes. Those few observers who have specifically acknowledged that privatization attracted foreign lenders themselves, not just investors expressing faith in liberal economic principles — principally Steven Darch, former head of J.P. Morgan’s office in Buenos Aires — have only made brief references to the link between privatization and international borrowing and have tended to treat the connection casually, making statements like, if Argentina “wants to be part of the competitive international markets, it has to sell off [state assets]”, and “how can you have a phone system that doesn’t work and expect to attract foreign investment?”5

It is important to stop here and define the terms of the preceding paragraph that will be employed throughout the rest of the thesis; they will be helpful to understand the privatization-borrowing relationship. ‘Investors’ refers to individuals/institutions that bought a stake (debt or equity) in privatized Argentine assets. ‘Lenders’, in contrast, refers to four types of people or institutions: (1) individuals/institutions who purchased debt or equity in Argentine companies that had never been nationalized (2) individuals who purchased government debt; (3) ‘institutional lenders’, that is international organizations such as the IMF, the World Bank, among others, that bought government debt (4) ‘past speculators’, financiers who held defaulted Argentine debt from the 1980s and were allowed to exchange this for equity in the newly privatized companies.

Unlike most observers who commented on the monetary and fiscal policies put in place in the 90s, Domingo Cavallo understood that privatization was very directly linked to Argentina’s ability to attract the dollars necessary to sustain convertibility; it was not just a supplement to borrowing, but an essential part of it. An analysis of his rhetoric demonstrates that the minister believed that privatization actually attracted international lenders by not just building up market confidence. With Argentina being cut off from international markets as a result of defaulting on its debt during the 1980s, in fact privatization allowed it to receive support from the IMF and the United States, because the seized assets (industries), when sold and the funds added to the Argentine treasury, helped the country achieve a budget surplus. Both the IMF and the US were adamant that countries wanting to reenter the international debt markets needed to have a strong fiscal position. Thus, privatization was crucial to garnering their support, which was in turn critical to the country’s campaign to be allowed to become part of capital markets once again, a goal it achieved in 1992.

The actual process of privatization under Cavallo’s ministry reflects this understanding. Many of the assets that had been previously seized by the state as part of the nationalization efforts of the early 1990s were sold in exchange for outstanding debt that was trading at a deep discount (around 15 cents on the dollar), in what is referred to as debt-to-equity swaps.6 Thus, individuals and corporations that had invested in Argentina’s bonds during the 1980s (past speculators) and had then seen their portfolio radically decline in value as the country failed to meet its debt obligations, were able to exchange their devalued bonds at face value (full value) for equity in the assets being privatized. In accord with the logic Cavallo expressed, which will be explored more fully in this thesis, this plan was designed to restore the value of the previously discounted bonds and in the process recuperate market confidence in Argentina, which would allow future borrowing. This also had an effect on the still outstanding Argentine debt, for it now seemed more attractive to lenders, given that the government was making a concentrated effort to pay back its loans. Hence, from the beginning of the privatization policy in the early 1990s, the debt-to-equity swaps created a direct relationship between privatization and borrowing.7 Interestingly enough, some investors/lenders, not economists, picked up on this phenomenon, and I will use them in the body of the thesis to support my argument that this connection was a self-conscious part of Cavallo’s plan. There I will consider Cavallo’s speeches and writings, paying careful attention to the way he acknowledges the privatization-borrowing pairing. Additionally, I will seek to expose their relevance to Argentina’s actual economic experience during the decade. The organization of my chapters follows this chronology.

Chapter one begins with a section devoted solely to explaining both of these initiatives at length, both in general terms and with respect to Argentina’s case. It continues by providing a historical sketch of Argentina’s economic experience from 1983 when the country reclaimed its democracy, up to the default and devaluation that took place in 2001. It describes Argentina’s long history with inflation, the early successes of the convertibility program, and its eventual failure. In a sense it condenses and simplifies a relatively complex economic history in order to foreground the ensuing analysis of Cavallo’s speeches and publications. Furthermore, in providing this long economic overview, chapter one shows how others have described privatization and borrowing.

The second chapter focuses exclusively on Cavallo’s publications. It is divided chronologically, beginning with those narratives that deal with Argentina prior to it being allowed to borrow in 1992, and finishing with Cavallo’s thoughts after the country was actively borrowing in capital markets. In the midst of this analysis, this chapter not only demonstrates the minister’s conviction that privatization enabled borrowing – it did not just accompany borrowing – but also his understanding of how the relationship worked. Beyond analyzing Cavallo’s thoughts on the matter, the chapter also highlights data that proves the feasibility of his argument. Demonstrating the plausibility of the link between privatization and borrowing.

The third chapter utilizes behavioral economics to give an analytical framework to understand Cavallo’s argument. Through the use of psychological tools, specifically feedback loops, it explains how the minister’s account could be understood. In doing so it does not make a claim about the plausibility of the argument, merely demonstrates that if it were taken as true it could fit within this discipline of economics.

The final chapter takes an in-depth look at how many of the sales of nationalized assets were actually carried out. It turns out that several of the state assets, as was briefly mentioned earlier, were bought with debt forgiveness. That is to say, debtors forgave Argentina’s outstanding debt in exchange for equity in these newly formed private companies, which were previously state assets. This chapter looks into the significance of this operation, starting with the historical relationship between debt and privatization, and moving on to the effect that such operations had on individual and institutional lenders. Again, we see Cavallo’s policies in action. In short, we can now see very clearly that the country was able to attract foreign investors not only to companies being privatized, but also that these operations increased confidence in the country so that other companies and the nation itself appeared to be credit-worthy. This influenced lenders who, in turn, primarily bought governmental debt, playing an important role in maintaining the country’s convertibility scheme.

Thus far, historians have paid little attention to Cavallo’s understanding of the necessary link between privatization and borrowing, leaving out the commentary/opinion of the minister who implemented these reforms. By showing how they were related and how Cavallo explained their relationship, this thesis seeks not only to illuminate an aspect of the country’s economic history during this tumultuous period, but also to help show why these policies were doomed to fail.

Chapter 1

La Guarda Vieja: Overview of Argentina’s Political Economy


At the end of 2001, Argentina suffered an unprecedented economic collapse accompanied by social and political unrest. The collapse was preceded by negative GDP growth from 1998 onwards and was followed by a debt default of US$ 155 billion, the largest in history. In this section I will outline the economic and political history that led to this event with the goal of providing the background to my analysis of Cavallo’s thoughts on privatization and borrowing.

This overview covers the years 1983 to 2001 in order to capture a full picture of Argentina’s economy during the years prior to the crisis and is divided in four distinct, chronological, subsections: Antecedents (1983-1991) – the aftermath of the military dictatorship, and Argentina’s struggles with hyperinflation; Stability (1991-1998) – implementation of neoliberal polices and their success; Recession (1999-2001) – the moment negative GDP growth began showing the inadequacies of the system; and Crisis (2001) –the economic collapse that ensued.8 9 Firstly, however, I will provide two detailed sections on borrowing and privatization given their importance to this thesis.


International borrowing is an important macroeconomic tool used by most modern economies to finance long-term projects or government deficits. Emerging economies have customarily used this initiative to facilitate investments in infrastructure and other expensive ventures and have done so because it gives them access to easy capital that they cannot produce endogenously. These countries generally do not have a budget surplus and usually run trade deficits, as they are still developing their export industry.

Latin American countries have historically followed this route. Notably, Buenos Aires provides an example. The city obtained financing to build its port, Puerto Madero, in 1881 with Barings Bank, an English merchant institution. Although this was a successful example, Latin America has not always been so lucky with borrowing. Another more recent and relevant instance is the one that led to the Latin American debt crisis of the 1980s. During the 1960s and the 1970s many of the region’s countries, notably Brazil, Mexico, and Argentina, borrowed unprecedented amounts of money in international capital markets to develop their industrialization programs, resulting in an increase of Latin American external debt from $75 billion to $315 billion between 1975 and 1983. This amount equaled 50% of the zone’s GDP. When the world went into a recessionary phase during the 1970s and 1980s, many of these countries suffered a liquidity crunch – the moment when nations need additional borrowing to cover their interest payments. Customarily, many of their debts would be extended, but under unstable macroeconomic conditions debt holders were unsure of the countries’ ability to repay its loans, so they cancelled the refinancing. Like its neighbors, Argentina was having serious difficulties covering its interest payments and in 1982 it had to approach the IMF for financial assistance. Eventually, it was cut off from the capital markets.

During the 1980s Argentina attempted, and failed, to reenter the borrowing market; the country’s unsuccessful bids to renegotiate its loans with commercial banks marked the decade. A major breakthrough came in 1992 with the Brady Plan. Proposed by Nicholas Brady, the US Treasury Secretary at the time, the plan consisted of a market solution for “emerging market” debt. Instead of commercial banks providing “new lending to give countries time to grow out of their debt-servicing difficulties,” the Brady plan provided “permanent relief through market-based debt and debt-service reduction for countries adopting strong economic reform programs.”10 The key innovation behind it was the introduction of Brady bonds, which were dollar-denominated bonds issued by emerging economies. These bonds were made up of converted bank loans that had defaulted in the 1980s, which allowed commercial banks to exchange their claims/debts on developing countries into instruments that could be traded — the Brady bonds. This translated into banks removing the bad loans from their balance sheets. More importantly, it meant that Argentina and other emerging economies were once again capable of tapping international capital markets for financing. The conditions to be eligible for this program varied on a country-to-country basis, but they were generally centered on adopting strong policies to guarantee debt reductions.11

Argentina signed a deal with its bank creditors on December 6th, 1992. The deal consisted on the exchange of bank loans for different options of Brady bonds. The IMF calculated that the whole operation was equivalent to buying back the existing debt at 38% of its original value.12 Argentina’s acceptance into the Brady bonds program was dependent on free market reforms. As one IMF official put it, “we believe that the sweeping market-oriented economic reforms that are being implemented are exactly the sort of policies we had in mind when the international financial community endorsed Secretary Brady’s proposals for debt and debt-service reduction.”13 Argentina also received loans from the IMF, and other international monetary institutions, as a result of the country’s adoption of free market reforms. Note that in saying so, it becomes clear that for the institutional lenders privatization was only one policy within a set of other equally important policies that demonstrated the country’s reforms, which ultimately paved the way to the country’s reemergence in the capital markets. Cavallo’s accounts challenge this position; I will demonstrate this from page 33 onwards.

By the mid 1990s, Argentina was once again fully integrated into international capital markets. Lenders were as confident as the international organizations in the country’s prospects, which allowed Argentina to once again obtain loans at an unprecedented rate during this decade. From 1991 onwards the country’s external debt grew at a rate of 12% per year. By 1999 the balance totaled roughly 50% of the country’s GDP.14 Argentina, unlike in previous decades, was predominantly utilizing the capital from these operations to finance its convertibility scheme.15 By 2001 the debt and interest obligations were too much for the country to meet timely payments, leading to a default on its international debts.

Argentina’s recent borrowing history moved from one extreme to the other. Either the country amassed unfeasible debts, engaging in intense borrowing, or it was cut off from the international market after defaulting on its debts. In any case, it can be said that borrowing was central to Argentina’s political economy. What is truly remarkable about the country’s experience during the 90s is how effectively it was able to return to borrowing, a phenomenon that I will address later.


Latin America underwent a period of intensive privatization during the 1980s and 1990s, following the Western neoliberal economic ideology. State companies, which had been acquired during the previous two decades’ wave of nationalizations, were sold to private investors faster than anywhere else in the world. Overall, more firms and larger ones, raising more proceeds, were privatized in Latin America than in the rest of the globe.16

Argentina was the crown jewel of privatizations in the region. The sales began in 1989 — before the Menem administration — and by 1996 every state asset that could be put on the market had been sold. The country was selling at a rate of US$555 million per month.17 The initiative was aggressive enough to catch the attention of the international press. A 1992 New York Times article, “The Big Push Towards Privatization in Argentina,” was just one of many.

Argentina’s 1990s privatization history is much simpler to explain than its borrowing trends, though both policies played an equally fundamental role in the country’s political economy during this decade. To maintain convertibility Argentina needed an inflow of dollars — recall that every peso in circulation had to be backed up by a dollar held in the central bank. The country, historically, had only a small trade surplus. Convertibility, however, made export surpluses almost impossible, as Argentine goods were more expensive than goods from countries with lower value currencies — a result of the fixed exchange rate. Thus, dollars or other strong currencies were not entering the country in significant amounts through commerce; rather, it was the reverse as Argentinians bought from foreign suppliers. The convertibility policy was in a sense based on contradictory logic. On the one hand, it needed dollars to be maintained, but on the other it limited the inflow of dollars into Argentina by making export surpluses unlikely. The solution to this problem was instead on privatization and borrowing: the country utilized the capital from its privatization program, as well as continuous debt issuances, to have a steady supply of dollars. In turn, this growing reserve allowed the government to maintain the peso-to-dollar parity. If the government had been able to keep dollars flowing in, Argentina may have never devalued its currency, as it did in 2002.

This section has explained Argentina’s economic history, particularly borrowing and privatization at length because it is a crucial step in order to comprehend the country’s convertibility model. The peso-to-dollar parity put the country in a situation in which it needed to either borrow or privatize, and traditional historiography has generally treated both of these initiatives as separate if related. The remainder of this chapter will utilize the understanding of both policies to explain Argentina’s long economic history.

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