During the late 1980s, Argentina suffered from hyperinflation. As part of its financial reforms, it pegged its currency to the U.S. dollar, making pesos convertible into dollars. To issue pesos, the central bank had to have an equal amount of dollars, or its equivalent in other hard currencies, on hand. Some economists believed this reform would bring stability to the financial system. Unfortunately, they were proved wrong.
The financial and other institutional reforms worked well in the early 1990s, but then several problems developed. As the dollar appreciated sharply on world markets after 1995, Argentina began to suffer from a large trade deficit because its currency was pegged to the dollar. Essentially, the United States rising currency became Argentina s problem. Wage increases also pushed up the real exchange rate, exacerbating the trade deficit. The Argentinean government including its provincial governments found it difficult to control spending and had to borrow extensively from abroad in dollar denominated loans. Then in 1999, Brazil devalued its currency, putting additional pressure on neighboring Argentina. As investors saw the persistent trade and government deficits that were occurring in Argentina, they became doubtful that the country could repay its debts and feared its currency would be devaluated. Local citizens also became fearful of a devaluation and tried to convert their pesos into dollars, further deepening the problem.
Eventually, Argentina was forced to default on its international debt in 2002 and freeze bank accounts. Middle-class Argentineans who still had funds in their banks suffered a sharp decrease in their wealth. A severe economic downturn ensued. The hopes of the reforms in the early 1990s had become a bitter memory. However, the Argentinean economy proved resilient and began a recovery over the next several years.