SYNOPSIS:

There's an interesting  story in today's Washington Post about Wall Street's role in Argentina's debacle. There's a lot there I didn't know. But I think the story downplays the role of the convertibility law, which pegged the peso to the dollar, in two ways.

Some background: I was an Argentina pessimist long before it became fashionable. In fact, in 1995 I told a retreat of the Argentine Financial Executives Institute that I didn't expect the convertibility law to survive the decade. I was wrong, of course: it collapsed, bringing huge devastation, in 2001. (Incidentally, I gave that talk in Ushuaia, on Tierra del Fuego; so I have probably given the most southerly economics lecture in history.)

The reason I predicted eventual failure was that the peg deprived Argentina of crucial flexibility. And so it turned out: the rigidity of the Argentine system in the face of declining capital inflows, the Brazilian devaluation of 1999, and the rise of the dollar between 1999 and 2001 was a large part of what went wrong.

But that wasn't the whole role of convertibility: it was also crucial to the bullishness of Wall Street. The article hints at that, but I think fails to grasp the full extent of the story.

Throughout the 90s, almost up to the bitter end, Wall Street was utterly convinced that Argentina's currency board - which in effect reproduced the gold standard - was simply a wonderful idea. When you raised questions about the economy's performance, the answer was always that this marvelous monetary system ensured the country's success. And Domingo Cavallo, the architect of the system, was treated as a hero.

Now the funny thing was that there was no evidence to back up this enthusiasm. There was and is a case for currency boards; there is also a case against. You can choose sides in that debate, but nothing in actual currency experience justified the huge enthusiasm of Wall Street economists.

So why the wild enthusiasm? Because a currency board fitted a conservative ideology: by eliminating any discretionary monetary policy, it moved us back toward a pre-Keynesian world. That's why Forbes and the WSJ editorial page sang Argentina's praises; and Wall Street economists swallowed the whole thing.

But, you say, aren't financial analysts supposed to be hard-headed types who look at the facts, never mind the ideology? Well, we can talk about why it doesn't work that way. But the bottom line is that these guys - with some honorable exceptions - are suckers for anyone who fits their ideological preconceptions. And they are very, very reluctant to admit it when a government that talks the free-market talk, and says that to grow rich is glorious, is in fact running the country into the ground.

Does any of this bear on the unwillingness of Wall Street to face up to our own fiscal catastrophe, and its repeated declaration of business cycle victory even as jobs continue to melt away? What do you think?

Originally published on the Official Paul Krugman Site, 8.3.03