Internal versus external convertibility and emerging-market crises: lessons from Argentine history

Argentina’s money and banking system was hit hard by the Great Depression. Banks were awash with bad assets when gold convertibility was suspended in December 1929. We argue for an explanation of the crisis that focuses on the inside-outside money relationship in a system of fractional-reserve banking and gold-standard rules with a tension between internal and external convertibility. After financial fragility appeared in the 1914-1927 suspension, resumption in 1928 was probably unsustainable due to the problems of the financial system and a dynamic model illustrates the point well. When the state bank became insolvent, the currency board started bailing out the system using high-powered money. Thus, came about the demise of the currency board and the creation of a central bank in 1935. As one of its first substantive actions, the central bank engineered a bailout of the banking system at a massive social cost. The parallels with recent developing-country crises are remarkable and the implications for the institutional design of monetary and banking systems are considered.