Argentinean government borrowed from IMF and international bankers some US $120 billion through the years. It was unable to make USD payments on interests and principle and therefore defaulted on its loans. An ordinary Argentine never imagined what then took place.
The conditions were miserable. Even though peso's were getting to be worthless, people couldn't even get hold of them. Without a currency, the entire economy shut down, including essentials like hospitals. Doctors and nurses had to rely on international aid for imported medicines from Chile. People were starving on the street without food or money, some ventured into rural farms, stole and slaughtered cattle for food.
The entire Argentinean congress resigned in mass. Many escaped by helicopters. The country went through 3 presidents in 2 month.
The Argentines of 2002 went back to stone ages of exchanging eggs for light bulbs. Without a currency, provincial government bodies started issuing municipal notes to pay servants and employees. Keep in mind those notes are only promises from the provincial bodies to deliver goods and services in exchange for those notes back. Naïve as they were, people and merchants began accepting those notes issued by various provincial bodies.
Once the government stabilized (i.e. the self-serving power-struggles ended), the new left-wing president defaulted on international loans, focused on domestic problems and began to re-open the banks so businesses can carry on. Investor confidence returns in 2 short years and the exchange rate now settled on 3 pesos to 1 dollar.
Fearing international bankers freezing Argentinean financial assets, the Argentinean government elected to keep its foreign reserve in gold.
We saw how local municipal notes came about in the above example. Now I want to take a step back further. Before 1913, paper money was as good as gold since one could redeem paper notes for gold at a fixed rate at a local bank. Seeking income, some people took those notes and loaned them to others - essentially loaning out their gold for interest payments.
As commerce evolved, people began trading those loans. The value of the loan depended on the duration of the loan, the interest payments on the loan, and the credit worthiness of the borrower. So far so good, so what's the problem?
Fast forward, what we have now is really quite different. The typical "loan" we have today is the promise to pay dollars. The dollar itself is a promise by the US government to deliver goods and services, not unlike the notes created out of thin-air by Argentinean provincial bodies.
Table: financial assets in 1913 and their equivalents today
Yes I am sounding repetitive - the dollars are just loans to the government. The value of any loan promising to pay dollars depends not only on the creditworthiness of the borrower but the creditworthiness of the US government. I am not even going to get into options on bonds.
This is what I mean by paper economy detaching itself from the real economy. The cost is to producers and savers who are lost in the mixed signals and subsequently making bad investment judgment.
John Lee
john@losb.net
www.maucapital.com
28 February 2005
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