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
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
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
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
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