avatar
Don’t Cry for the IMF, Argentina


Weisbrot

How

many times can the most powerful financial institution in the world — the

International Monetary Fund — make the same mistake? The answer seems to be: as

many times as it wants to. As Argentina teeters on the brink of defaulting on

its $150 billion foreign debt, and finance minister Domingo Cavallo jets all

over the world trying to convince the financial markets that the inevitable is

not going to happen, there is an eerie familiarity to the whole sequence of

events.

Think

back to November 1998: Brazil’s currency was highly overvalued and most

economists expected the peg — its fixed exchange rate against the dollar — to

collapse. Enter the IMF, arranging a "rescue" package of $42 billion in loans,

and its usual application of leeches to bleed the patient: sky-high interest

rates and budget cuts, guaranteed to slow the economy and put the burden of

"adjustment" on the poor.

Within two months the Brazilian real had collapsed anyway, leaving the country

with nothing to show for the IMF plan but a pile of foreign debt and a

stagnating economy.

Argentina may be headed for a similar fate. The Argentines pegged their currency

to the dollar a decade ago, and the move is widely credited with helping to end

an era of high inflation.

But

there are disadvantages to a fixed exchange rate, and Argentina has come to see

the worst of them in the last few years. As the US dollar rose in value the

Argentine peso had to rise in step with it. When the Fed raised interest rates

in the United States, Argentine interest rates had to go up too, even with their

economy already in a slump. When Brazil’s currency collapsed, it made

Argentina’s exports to that country inaccessibly expensive.

It

all adds up to a finance minister’s worst nightmare: an overvalued currency and

a fixed exchange rate that many investors believe cannot hold. The country must

borrow at ever higher interest rates, because of the increasing risks of both

currency collapse and default on the foreign debt. And as the country borrows

more, these risks increase. Argentina now has debt service that is approaching

its total export earnings.

The

IMF’s role in Argentina, as in similar situations, is not helpful. First, they

act as "enabler" for the loan-addicted government, providing enormous loans to

prop up the currency. Some of the better-connected and wealthier investors are

thus able to get their money out before the inevitable collapse, or even worse,

to make a fortune by speculating against the domestic currency.

The

IMF argues that to let the currency fall would risk a return to hyperinflation.

But no such thing happened after the Brazilian real collapsed. And for the

Russian ruble in 1998, where the Fund also wasted billions and bled the economy

in order to prop up an overvalued currency, the result of the currency’s

collapse was even more favorable. Not only was the ensuing inflation easily

manageable, the economy has since registered its highest real growth in two

decades.

All

this is consistent with standard economic theory. We would not expect terrible

inflation from a currency devaluation in a country where imports are a

relatively small fraction of the economy (about 11 percent in Argentina, 7

percent in Brazil). A devaluation of the domestic currency is often the best

solution in these situations: it makes the country’s exports cheaper and its

imports more expensive, thus improving the trade balance and stimulating growth.

The

Fund also plays another destabilizing role in these crises, by setting targets

that the country’s government must meet in order to "reassure financial

markets." But these targets may be politically difficult to meet — as well as

unnecessary or even harmful to the economy.

And

when the country fails to do what it is told, the crisis worsens. In Argentina’s

case the government budget deficit target for 2001 has been increased from less

than 1 percent, to now 2.3 percent of GDP. These are very tight constraints for

an economy in the midst of a long recession: for comparison, the US ran a budget

deficit of 4.6 percent of GDP during our last recession (1991), and 6.1% coming

out the previous, deeper recession (1983).

One

year ago the Meltzer Commission, a bi- partisan Congressional panel appointed to

review the IMF’s practices, recommended a number of steps to downsize this

institution, and reduce the likelihood of these repeated and often disastrous

economic failures. Maybe it is time to put some of these reforms in place.

Mark Weisbrot is co-director of the Center for Economic and Policy Research

(www.cepr.net) in Washington, DC.

 

Leave a comment