Bulmer-Thomas V., Coatsworth J., Cortes-Conde R. The Cambridge Economic History of Latin America: Volume 2, The Long Twentieth Century
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212 Roberto Cort
´
es Conde
banking reform. Because of currency depreciation, taxes were collected in
gold. Customs duties represented half of the revenue of the federal govern-
ment, and exports were the main source of revenue of some states. Toward
the end of the century, a sales tax was added.
In Chile, the expansion of the modern state was aided by the incorpora-
tion of the northern nitrate provinces after the War of the Pacific (1879–83).
By imposing duties on exports, the state seized almost half of the operat-
ing profits of the rich fields. The share of state royalties and taxes on the
extraction of natural resources in fiscal revenue increased from 5 percent
in 1830 to 25 percent in 1880, 47 percent in 1890, 56 percent in 1900, and
53 percent in 1910.Between 1869 and 1879, foreign-trade revenues rose by
1 percent a year and thereafter at a rate of 7 percent. Before the war, the
Chilean government collected trade revenues of about one million pounds.
In 1890,itreceived more than two million pounds, and in 1910,fiveand a
half million pounds. Between 1879 and 1895, state income rose tenfold and,
according to Gabriel Palma, this growth influenced the entire economy
by means of a fiscal multiplier.
2
The state avoided the difficult political
question of burdening other taxpayers by taking its revenues from mining
rents. Although nitrate export revenues were high, Chile raised tariffs on
imports in response to protectionist interests. The alliance between indus-
trialists seeking protection from imports of manufactures and farmers who
feared an invasion of Argentine goods to the mining zones was a decisive
factor in raising some tariffs, although Chile’s tariff levels were moderate
in comparison to the rest of the region.
In Colombia, the conservatives returned to power in 1884, one year
after the outbreak of the civil war. In 1886, the Constitution was reformed
and Colombia turned to a centralized system of government. One of the
main resources of local states, the big cattle slaughter revenue (deg
¨
uello),
returned to the central government. In 1892, domestic taxes were levied on
cigarettes and others were allotted to the central government. The return
to the central government’s monopolistic control caused great dissatisfac-
tion. Between 1890 and 1893, the national government’s income equaled 62
percent of the overall income and those of the departments equaled 28 per-
cent, whereas municipalities hardly reached 10 percent. The customs system
was modified to avoid multiple exemptions and to increase protection. In
2
Gabriel Palma, “Trying to ‘tax and spend’ oneself out of the ‘Dutch Disease’: The Chilean Economy
from the War of the Pacific to the Great Depression,” in Enrique C
´
ardenas, Jos
´
eOcampo, and
Rosemary Thorp, eds., An Economic History of Twentieth-Century Latin America (London, 2000),
234–56.
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Fiscal and Monetary Regimes 213
1897, the states recovered the slaughter revenue without offering additional
services in return, as the national police had been founded in 1891 and
the central government took over high school education.
3
Customs duties
continued to be the main revenue, followed by salt mine leases.
In Argentina, during the 1880s, resources originated from customs
increased thanks to the continuous expansion of foreign trade. The national
government was the main beneficiary of this expansion and left the until-
then quite powerful provinces far behind. Between 1880 and 1890, income
rose by approximately 300 percent. The population increased from 2.5 mil-
lion to 3.4 million and gross domestic product (GDP) grew at an average
annual rate of 12 percent.
4
Import duties were the main source of income
(more than 60 percent of total national revenues). Land sales were not
taxed. In 1891, after the Baring crisis and the fall in import-tax collections,
a law was passed that allotted a major share of domestic taxes to the national
government at the expense of the provinces.
ForPeru, the War of the Pacific was a watershed event because the country
not only had to face a rise in military expenses but also the loss of its nitrate
provinces. The province of Tarapac
´
a was relinquished to Chile, and those
of Arica and Tacna fell under Chile’s control, pending a plebiscite that
took place ten years later.
5
Once the war was over, Peru found itself in an
extremely complicated situation. The country had to obtain funds to avoid
bankruptcy. The foreign debt itself was the greatest problem. Railways did
not produce as much as expected to stimulate the economy. The income
originating from guano dropped because of an international fall in prices.
The nitrate lands, which served as a guarantee for foreign loans, were
relinquished to Chile. In 1886,agroup of British interests took charge of
the foreign debt in exchange for the right to exploit guano and mineral
deposits and the South and Central railways. Gradually, Peru started to
recover from the War of the Pacific shock.
6
Access to foreign capital coincided with a widespread and gradual shift
to a monetary regime in which government paper currency became gen-
eralized. The share of bank notes in the money supply increased (except
in Mexico, Bolivia, and Peru, all silver-producing countries). The govern-
ments’ needs for financing and the frustrating experiences with private
3
Lu
´
ıs Fernando L
´
opez Garavito, Historia de la hacienda y el tesoro en Colombia, 1821–1900 (Santaf
´
ede
Bogot
´
a, 1992), 337.
4
Roberto Cort
´
es Conde, La econom
´
ıa Argentina en el largo plazo (Buenos Aires, 1997).
5
Richard Nyrop, Per
´
u: A Country Study (Washington, DC, 1981), 24.
6
Ibid., 25.
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214 Roberto Cort
´
es Conde
banks of issue ended in inflationary episodes followed by more orthodox
restrictive policies, and efforts began for the adoption of the gold stan-
dard. Convertibility–inconvertibility episodes were recurrent, though some
countries maintained legal tender (fiat money) paper currency for a long
time (e.g., Chile).
In Brazil, a monetary and banking reform, the so-called Ouro Preto
reform implemented by Minister Ruy Barbosa, authorized free banks of
issue, which printed a great amount of money of legal tender, unleashing
inflation. The creation of free banks coincided with the suppression of
slavery. The metallic currency system was not flexible enough to pay wages
within a free labor system. The great expansion of banking money caused
the huge inflation known as the encilhamento between 1889 and 1891.To
stop the rise in costs that continued until 1892, hard contraction policies
were implemented in the latter years of the decade, which ended in deep
recession and deflation between 1900 and 1902.Abanking crisis occurred
in September 1901, when banks were forced to have a legal reserve of 100
percent over deposits.
7
Argentina had a mixed monetary system. Metallic coins that circulated in
the interior (the silver boliviano) coexisted with the government of Buenos
Aires’ inconvertible paper currency and banknotes. From 1867,“metallic
notes” and notes from the Bank of the Province of Buenos Aires’ Foreign
Exchange Office also served as currency. Up to 1881, the official monetary
unit was the old Spanish silver peso. In 1881,alaw established a new mone-
tary unit, the gold peso with twenty-five grams of 900/000 silver instead of
twenty-seven grams. However, in 1885, the system returned to inconvertibil-
ity.
8
A law passed in 1887 authorized free banking business with guaranteed
banks, with gold deposited as guarantee. The government intervened by
means of the National Bank, trying to sustain the value of the paper peso.
During the years 1887 and 1888, the premium for gold was stabilized at
about 30 percent. Nevertheless, that dirty flotation implied an important
loss of reserves. This caused an extraordinary capital outflow, much greater
than the amount required to pay the debt service or the balance of trade
deficit.
9
The huge note issues by guaranteed banks led to the 1890 Baring
crisis and, finally, to the liquidation of the banks. Consequently, the central
7
Pel
´
aez and Suzigan, Historia monetaria, 141.
8
Roberto Cort
´
es Conde, Dinero, deuda y crisis, evoluci
´
on monetaria y fiscal argentina:1862–90 (Buenos
Aires, 1989).
9
Roberto Cort
´
es Conde, “Finanzas P
´
ublicas, Moneda y Bancos (1810–1899),” in M.A. De Marco, ed.,
Nueva Historia de la Naci
´
on Argentina,vol. V, (Buenos Aires, 2000).
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Fiscal and Monetary Regimes 215
government took control of all monetary issues. From 1890, money issue
became an exclusive right of the national government.
Between 1890 and 1900,however, no more currency was issued. This
brought about a big monetary contraction taking into account that pop-
ulation and the economy grew significantly. In April 1891, the monetary
contraction deepened because a great banking panic reached its highest
peak when the National and Provincial Banks closed, starting a liquidation
phase that extended to other banks, with the consequent impossibility for
savers to use their deposits as currency. The 1899 monetary reform estab-
lished that the conversion fund founded in 1890 would issue notes in a new
currency unit (the national peso, equivalent to 0.44 cents of the gold peso),
upon delivery of gold equivalent, and would return gold to those who
requested it at the same exchange rate. A Currency Board was organized,
following the Bank of England’s Issue Department, leaving the discount
and deposit functions to commercial banks. It thus distinguished itself from
other European and American models, which granted their banks of issue
(as central banks) rediscount facilities and the possibility of creating money
by means of credit to the government or to the financial sector.
In the last decades of the century, Bolivia faced the consequences of
the devaluation of silver, its main source of income and circulating cur-
rency. In 1895,inorder to provide stability, limited legal tender was granted
to the gold sovereign (Great Britain) and the Peruvian gold pound. In
Peru,atthe start of the War of the Pacific (1879) and during the follow-
ing years, the government sought financing from the banks, which issued
notes accepted for payment of fiscal liabilities. In 1875, these notes had
been declared inconvertible, and the issue of them increased extraordi-
narily, triggering hyperinflation in 1883 and their demonetization in 1889.
There was a huge capital flight because of the war, and only fiscal notes
– and the “boliviano” in the South of the country – remained in circula-
tion.
10
Because of the fall in foreign-trade revenues during Pi
´
erola’s second
presidential term (1895–9), a tax on salt consumption was levied and, when
printed notes lost all their value, silver coins came back to circulation. In
1897, their coinage was discontinued in order to increase their value, and
that same year – in a process that would end up pegging the currency to
the gold standard – the decision was taken to collect customs duties in
gold.
10
Laura Randall, “A Comparative Economic History of Latin America: Argentina, Brazil, Mexico, and
Per
´
u, 1500–1914” (Ann Arbor, University Microfilms International, 1977), 120.
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216 Roberto Cort
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the great expansion, 1900–1914
In the first decade of the twentieth century, foreign trade grew rapidly in
Latin America and, consequently, fiscal revenues increased. The fiscal bal-
ance also improved because revenues were collected in a nondepreciating
currency. In those countries that adopted the gold standard, foreign debts
were consolidated, except in Mexico, where there was a general turmoil dur-
ing the revolution starting in 1910.Outlays went mainly to infrastructure,
also with the exception of Mexico.
In 1903,Mexico established that customs duties should be paid in gold,
which helped balance its budget, because most debt was payable in gold.
In 1905,amonetary reform put the country on the gold standard, but the
outbreak of the Mexican Revolution led to a long period of political and
economic instability.
In Colombia, the One Thousand Days War (1899–1902) caused a severe
drop in tax collections, while war outlays gave rise to huge deficits. Inflation
affected customs revenues because they were collected in paper money. Even
after the civil war ended, defense outlays remained at a high level because of
Panama’s secession.
11
The wartime inflation led to a long-lasting reaction:
the adoption of conservative monetary and fiscal policies aimed at avoiding
similar situations in the future. After that, there came a period of stability
lasting until the 1920s. In 1905, taxes on liquor, furs, tobacco, cigarettes,
and matches were allocated to the national government, but in 1909,a
decentralized system was reestablished and taxes on liquor and tobacco
went back to the provinces.
In Argentina, expenditures went mainly to public works, railways, and
education. An impressive growth of exports allowed increasing imports,
the main source of fiscal revenue. Between 1900 and 1910, the burden of
debt payment shrank from 35 percent to 10 percent of the total income.
Another operation was the launching of a widely placed bond – the 5 percent
Argentine internal credit, by which the government began financing itself
in the domestic capital market.
Up to 1902, there were deficits in Brazil, but during the next five years
the situation changed. In fact, during those years, there was a slight surplus
attributable to orthodox measures. The service of the debt increased in
milreis because of devaluation and reached 25 percent of total expenses. A
similar percentage of the budget went to military expenditures. Transfers
11
Panama was part of Colombia until it became independent in 1903.
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Fiscal and Monetary Regimes 217
and subsidies remained low, amounting to less than 4 percent of total
government outlays. Increasing capital expenditures should be mentioned
because they reached almost 20 percent between 1910 and 1913, after falling
to 4 percent between 1897 and 1902. The three administrations prior to
World War I implemented large public-works programs (railways, canals,
or ports).
12
Several countries – such as Argentina, Brazil, Mexico, Peru, and
Uruguay – adopted the gold standard (under a Currency Board with
100% gold reserves, or government banks of issue and mixed systems with
different levels of reserves). Colombia and Chile remained under a regime
of forced circulation. There was general use of paper money.
In Colombia, money issue, which grew more than 100 percent per year
during the One Thousand Days War, was the only source of financing,
producing huge inflation. During the following period, Colombia kept a
forced circulation system, mainly of treasury notes and notes issued by
banks. Metal coins also circulated, though with a smaller share in the
circulation. Paper money was slowly written off, and it was possible to
return to convertibility in 1923.With the 1905 reform, it was possible to
reduce the debt attributable to fiduciary currency circulation by devaluing
it according to the market exchange rate (100 paper money pesos = 1 gold
peso) and making conversion easier. Also in 1905, the Central Bank of
Colombia began operating. In 1907, fiscal revenues earmarked to paper
money amortization were not enough, and the nonissuing commitment
was violated.
13
In Argentina, after some early hesitations, the Currency Board had a
remarkable success. The gold inflow guaranteed currency supply expansion,
which increased more than 11 percent annually between 1903 and 1913.
The Currency Board regime stressed the seasonal and procyclical nature
of money expansion and contraction. During harvest season, there was
gold inflow and credit expanded additionally because banks wanted to
place their surpluses. During the winter season, banks were concerned
with the amount of their reserves and contracted credit. The National
Bank took some measures to reduce its impact, such as lending without
taking account of its reserve fluctuations. After a long expansion period,
the first problems appeared in 1912 because of the crisis in the Balkans,
12
Raymond W. Goldsmith, Brazil 1850–1984: Desenvolvimento financiero sob un s
´
eculo de inflac¸
˜
ao (S
˜
ao
Paulo, 1986), 123–4.
13
Jorge Enrique Ib
´
a
˜
nez N
´
ajar, “Antecedentes legales de la creaci
´
on del Banco de la Rep
´
ublica,” in Banco
de la Rep
´
ublica: Antecedentes, evoluci
´
on y estructura (Bogot
´
a, 1990), 58–65.
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218 Roberto Cort
´
es Conde
with an important reserve outflow. The start of World War I in 1914 and
the immediate suspension of convertibility in belligerent countries caused
a high gold outflow, which led the Argentine administration to suspend
convertibility.
In Bolivia, although silver coins circulated, there were already banks
issuing notes convertible into silver. In 1904,British gold coins and peru-
anos (Peruvian gold pounds) were granted legal tender status, and in 1908
they were granted unlimited legal tender status (gold standard). Banks had
to convert bank notes into gold, and 50 percent of customs duties were
collected in gold. The government stopped silver circulation, which was
then used just for some fractional currency and exported as a commodity.
In 1904, the “peso boliviano” was pegged to the gold standard, at a rate
of 12.5 bolivianos per British pound.
14
The National Bank of Bolivia was
founded as a semi-official agency, with the exclusive right to issue money
after 1911.
In 1901,Peru adopted the gold standard, establishing the convertibility
of notes and silver coins into gold at a rate of one Peruvian pound to
ten soles. The gold standard regime coincided with a number of monetary
disturbances caused by external factors, the most important of which was
the 1907 U.S. crisis. In 1914, because of the war, convertibility was suspended
and gold exports forbidden; money issue and expenditures increased and
inflation began.
BETWEEN THE WARS: 1914–1945
the 1914–1930 period
World War I and the subsequent protectionist policies adopted by the devel-
oped countries caused a sharp reduction in international trade, leading to
fiscal crises in regimes based on taxes on foreign trade. The crisis showed the
need to reform the fiscal system to avoid its high level of dependence on for-
eign trade, emphasized by the effect of foreign currency inflows (outflows)
on monetary expansion (contraction). In countries with a federal political
regime, reforms had to redefine the relationship between federal and state
(or provincial) governments because central governments depended mainly
on customs revenues (even in countries such as Brazil, where export taxes
also went to the states).
14
Eduardo L
´
opez Rivas, Esquema de la Historia Econ
´
omica de Bolivia (Oruro, 1955), 20.
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Fiscal and Monetary Regimes 219
At first, the need to implement reforms rose as a response to the inter-
national emergency, although things were expected to go back to normal
once it was over. Although this did not happen, governments were still
convinced that they could return to the old system. Still, some countries
started collecting income and sales taxes. It was only after 1930,however,
that major fiscal reforms were implemented, when the expectation of going
back to “normalcy” finally disappeared.
Mexico’s fiscal system was undermined by the revolution that went on
until 1917. The centralized tax administration disappeared. Each revolu-
tionary chief collected taxes within the territories under his control and
issued paper money as the main source of revenue. During the World War I
years, the price of oil and industrial minerals substantially increased but
not so much as to cover the costs of the general disorder and the foreign
companies’ reluctance to pay royalties. When the civil war was over and
Venustiano Carranza became President, the tax administration was put in
order and taxes were imposed on oil companies (the 1917 Constitution
declared the subsoil to be the nation’s property).
During the postwar period, the international demand for food and raw
materials declined, affecting most Latin American countries. The result-
ing fall in revenues called for a reduction of expenditures, which was
never successful, and fiscal deficits were recurrent. Expenditure compo-
sition changed: first, economic outlays went up because of public works
and, in the 1920s, social expenditures also increased.
Since the turn of the century, Chile had made huge investments in
infrastructure, health, and education (reaching one of the highest levels
in Latin America) by using resources derived from the government’s share
in mining rents. In Brazil’s coffee-producing states, especially S
˜
ao Paulo,
expenditures included financing, purchase, and storage of coffee stocks to
stabilize world prices. In Argentina, expenditure fell during the first postwar
years.
15
In the 1920s, during the expansion phase, outlays went up again
and there was a substantial increase in real wages and in the number of
public servants, public works being the main expenditure item.
16
In Bolivia, most of the expenditure went to the army, public educa-
tion, and the police. There were also substantial investment expenses not
included in the budget, such as those for public works. In Peru, under
15
Pablo Gerchunoff and Lucas Llach, El ciclo de la ilusi
´
on y el desencanto: un siglo de pol
´
ıticas econ
´
omicas
en Argentina (Buenos Aires, 1998), 71.
16
Ibid., 98.
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220 Roberto Cort
´
es Conde
Legu
´
ıa’s (1919–30) second presidency, large public works programs were
undertaken and many schools created.
17
In Mexico, during the revolution
and the civil war, most of the expenditure went to the military. After the
1920s, it was expenditure on infrastructure that grew. In Colombia, there
were considerable investments in railways and roads during a period called
“growth through debt,” coincident with substantial capital inflows and
foreign financing mainly from the United States.
The fall in revenues during World War I led to recurring deficits, domes-
tically financed either by local banks, by money issue (as in Chile until 1925,
when the Central Bank was created), or by increasing floating debt (as in
Argentina and Brazil). Colombia faced tax-revenue declines and resorted
to tapping Currency Board funds. In Mexico, during the revolution, the
government resorted first to foreign bank credits (afterwards repudiated);
later, the contending factions paid for their war expenses by issuing money.
In the 1920s, those countries that had serviced their debts or made new
arrangements with their creditors reentered the international capital mar-
ket. Up to 1923,Brazil had substantial deficits, but between then and the
beginning of the 1930s, budgets were more balanced, and the country’s
financial needs were covered by foreign credits. In Chile, during the 1920s,
domestic reforms stemming from the Kemmerer mission and easier terms
of payment in the international capital market made foreign loans avail-
able.
18
That determined an increase in expenditure, which went on until
the beginning of the 1930s and increased the foreign debt. A fall in fiscal
revenues because of the 1930 economic crisis led the country to default.
Lacking access to foreign credit and depending only on direct taxes on
internal revenue, Mexico cut down expenditure and tried to balance its
accounts.
When World War I broke out, convertibility was suspended. In the post-
war period, several countries made efforts to go back to the gold standard,
this time with new central banks. In the Andean countries, central banks
were mostly founded during the 1920s. Peru, which had changed from silver
to the gold standard at the beginning of the twentieth century, admitted
an unlimited mintage of gold coins, whereas silver and copper coins could
only be minted upon authorization by special laws. In Bolivia, though sil-
ver coins were commonly used, three banks were issuing notes convertible
17
Nyrop, Per
´
u, 28.
18
Paul W. Drake, “La Creaci
´
on de los Bancos Centrales en los Pa
´
ıses Andinos,” in Pedro Tedde and
Carlos Marichal, eds., La Formaci
´
on de los Bancos Centrales en Espa
˜
nayAm
´
erica Latina (siglos XIX y
XX),(Madrid, 1989), 107–9.
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Fiscal and Monetary Regimes 221
into silver coins, among other commercial activities. In the countries with
currency boards, money issue was limited by the inflows to reserves. In
others, money was issued against commercial credit or government debt.
Only a part of the reserves were in gold.
After several frustrated efforts to adopt the gold standard, Chile contin-
ued until 1925 under a paper-money forced circulation. In other countries,
such as Colombia, the forced circulation (mainly treasury notes and notes
from banks of issue) went on until 1923, when the country went back to
convertibility.
In Mexico, in July 1913, convertibility was suspended, and between June
1913 and August 1914, the peso depreciated by 40 percent. From August 1914
to June 1916, paper money predominated. The amount of different notes
in circulation was huge (a 1916 decree refers to twenty-one different types
of paper money, all of them of legal tender, to which illegal issues – many
of them not strictly counterfeit – were added). Paper money quickly depre-
ciated. By the middle of 1915, acknowledging the problems that counterfeit
money entailed, and in spite of the fact that accepting constitucionalista
notes was considered a debt of honor, it was decided to exchange them for
anew currency, giving the other notes no value at all. The new currency,
though difficult to counterfeit, also suffered a large depreciation because of
over-issuing.
As in Europe, World War I entailed the suspension of convertibility in
most Latin American countries with high gold outflows, such as Argentina,
Brazil, and Peru. The latter declared a four-day legal holiday in August 1914,
followed by the passage of a law that forbade free gold exports; commercial
banks were authorized to issue banknotes called “circular cashier’s checks,”
backed by the assets of the banks of issue and guaranteed by metallic gold.
During the inconvertibility period, currencies floated. In some cases
(e.g., Argentina), the money issue was still backed by gold reserves. At first,
the peso suffered a slight depreciation; then, between 1915 and 1918,it
appreciated 2 percent with regard to the dollar and 3 percent to the pound
sterling. From 1920 on, the peso floated, showing a small depreciation dur-
ing the first half of the 1920s and going back to prewar values with reference
to the gold peso, the dollar, and sterling in the second half of the decade.
19
In other cases, the money issue answered to the government’s credit needs.
In the 1920s, with the different Kemmerer missions to Andean coun-
tries, the first Latin American central banks were founded. The first was
19
Rafael Olarra Jim
´
enez, Evoluci
´
on Monetaria Argentina (Buenos Aires, 1968), 183.