Supply and demand curves in Argentina during the 2001 fixed exchange rate crisis

¶ … supply and demand curve, why Argentina had to give up fixed exchange rate in 2001

Demand and supply are normally directly proportional which means as demand of a product increases, its supply normally increases too. In the case of Argentina which had fixed exchange rate till 2001 but had to give that up, demand and supply principles came into play in different ways. For one, we must understand how demand of anything would affect exchange rate. When Argentina's economy was prospering and its products were in high demand, it was primarily because of those products were cheaper for other markets. However as soon as the demand reached a certain point, fear of overvaluation of currency also emerged which means that when it was felt that Argentina products were becoming expensive in the foreign markets not because the prices had been changed but mainly because of overvaluation of its currency, the peso. With changes in exchange rate against dollar, Argentinian products became less popular and its exports decreased. This means that with lower demand, supply had to be curtailed too. This led to a budget deficit which means that the country now did not have enough revenue coming in to fund all its ventures repay its debt and take care of its other financial liabilities.

This also meant that now foreign exchange was no longer coming in as rapidly or in the same amount as before. When foreign exchange reserves began depleting, this only meant one thing: peso was about to lose its value. When pegged against dollar, as in most fixed exchange rate economies, foreign exchange depletion can cause devaluation of local currency. For this reason in 2001, the government decided to give up fixed exchange rate and opt for dual exchange rate instead.

It must also be understood that there is another scenario to demand and supply connection. When demand for a product is high but supply is low, it can cause a sudden price hike for the product. Similarly when supply is high and demand is low, a sudden decrease in price results. Now let us place this situation on what happened to peso in 2001. With fear of devaluation, peso began losing its place in the world markets and was no longer as desirable as before. This meant that while supply was high, demand was low which led to fear of further devaluation. Similarly for U.S. dollar, the supply was low and demand was high and hence the dollar went up in value and a large amount of foreign exchange was taken out of Argentina within matter of months.