Turkey, Argentina and the IMF

[Louis Proyect <lnp3@xxxxxxxxxxxxx>]

NY Times, December 8, 2000

Floyd Norris: With Argentina's Peso Overvalued, It Can't Compete

By FLOYD NORRIS

It's bailout time.

The International Monetary Fund, having just broken speed records for
arranging a huge cash infusion for Turkey, will turn next week to
Argentina, where it is expected to anchor a $25 billion rescue package.

The moves seem to have calmed markets in both countries, and it is to be
hoped that they will work in the long run, too. But these countries' need
to be bailed out reflects their failure to learn a clear lesson of the 1998
Asian crisis: Fixed foreign exchange rates have a way of blowing up when
the going gets tough.

That lesson was ignored because fixed rates have such clear attractions
when things are going well. Businesses can enter into contracts with
foreign companies with confidence about exchange rates. The fixed rate is
supposed to discipline governments, which learn they cannot simply print
money to get around problems and therefore must make the tough decisions
needed for economic stability.

All that is true enough. But what happens if those tough decisions are not
made, or if external events overwhelm otherwise sound policies? When a
crisis arrives, people start selling the currency to the government, which
obligingly buys it and drains foreign exchange reserves. Mehmet Simsek, a
Merrill Lynch economist, notes that the $7.5 billion the I.M.F. is putting
into Turkey is about equal to the amount Turkey's central bank spent
defending the lira to keep it from depreciating more than the planned 1
percent a month.

In Argentina, the government uses a currency board to assure that one peso
equals one dollar. That policy helped end hyperinflation a decade ago and
remains popular.

But it is also largely to blame for the country's inability to cope with a
run of bad news. Neighboring Brazil devalued its currency, commodity prices
fell, the dollar became the strongest currency in the world, and
international investors became risk averse. "It was the biggest set of
negative shocks Argentina has had since the 1930's," commented Francis
Freisinger, a Merrill Lynch economist.

With a currency board, Argentina could not devalue its currency to stay
competitive with Brazil. It cut wages of its workers, but not by enough.
Unemployment soared, those with jobs had less money to spend, and the money
supply contracted as investors took money out of the country. Argentina
found itself in a classic Catch-22: Investors would not put money into an
economy that was not growing, but there was no hope of growth without that
investment.

The I.M.F. bailout buys time, and Alan Greenspan's hints that the Federal
Reserve will reduce American interest rates provide hope. Since Argentina
does not have its own monetary policy, it is stuck with Washington's. That
hurt when the Fed raised rates while Argentina was in a recession. The best
situation for Argentina next year would be a big decline in the dollar,
which would devalue the peso and make Argentine exports more competitive.

Perhaps that will happen. If not, in a year or so the I.M.F. may have to
decide whether to step in again. To keep that new aid from simply flowing
out to foreign bondholders, Argentina might have to restructure its debts
in a way that penalizes bondholders. If speculation ever rises that the
dollar peg might be in jeopardy, the rush of local companies to buy dollars
could force devaluation.

Two years after its devaluation, Brazil is booming. Argentina's currency
board solved one problem, but it left the country unable to cope with a new
round of adversity.


Louis Proyect
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