How the country was driven into a cycle of recession

Wednesday was the day the Argentine people's patience ran out. After four years of futile austerity policies, forcing the country into a self-reinforcing, ever deepening cycle of recession – all to repay an unrepayable debt, and defend an indefensible exchange rate – the street cried "enough".

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Wednesday was the day the Argentine people's patience ran out. After four years of futile austerity policies, forcing the country into a self-reinforcing, ever deepening cycle of recession – all to repay an unrepayable debt, and defend an indefensible exchange rate – the street cried "enough".

This crisis has been a long time in the making. Its origins lie in state overspending and massive budget deficits in the early 1990s, with a good dash of corruption thrown in. The chosen way out was heavy foreign borrowing and the imposition of domestic fiscal discipline, symbolised by linking the peso to the US dollar.

The therapy worked at first. But since 1998 the country has been locked into recession. Unemployment is close to 20 per cent, while the economy is contracting at the rate of 3 per cent a year, and debt has soared to $132bn (about £90bn).

The imposed parity between the peso and the dollar has in effect turned domestic debt into foreign debt. The growing strength of the dollar has locked Argentina into a grossly overvalued exchange rate.

Pressed by the International Monetary Fund and the US, the government has adopted ever more severe austerity measures, culminating in the "zero deficit" package of the summer, slashing pensions and public sector pay. In a bid to avoid a fatal run on the currency, the government imposed limits on bank withdrawals, partially freezing people's access to their money.

In the sweep of history, Argentina is a tragedy. With its abundance of space, its agricultural and mineral resources, a temperate climate and a highly educated workforce, it should be one of the richest countries in the world. Early last century it was. But between 1913 and 1998 it slipped from being the 10th richest country, measured by GDP per head, to 36th.

Today it stares terminal economic meltdown in the face. Experts agree that a solution to Argentina's woes will have to involve massive assistance from the International Monetary Fund and the US. The successful Mexican rescue package of 1994 offers a hopeful precedent.

In the meantime, events in Argentina recall those in Britain 70 years ago, when the Labour government of Ramsay MacDonald split over the demands of the foreign banks and the Bank of England for budget reductions to defend the pound.

Labour was replaced by a National Government, which obeyed the bankers. The results were riots in the streets when Philip Snowden, the Chancellor, introduced an "orthodox" Budget that cut unemployment benefit and public-sector pay at the height of the Depression. Britain sank deeper into a slump, while the Budget failed to defend the exchange rate. Sterling was forced off the gold standard anyway.

For the pound and gold, read the Argentine peso and the dollar. Whatever happens, economists say, Argentina will have to devalue its currency and to some extent default on its debt. The real choice lies between full dollarisation and allowing the peso to float freely.

The first would hand control of Argentina's economy to the Federal Reserve, though probably with a lower starting exchange rate for the peso. Cutting ties with the dollar entirely would also produce a substantial peso devaluation, making Argentina's exports once more competitive with those of its neighbours.