Saturday, April 30, 2005

The US has similarities to Argentina?

A Bloomberg news piece entitled "U.S. Shows Some Parallels With Argentina of '90s:" by John M. Berry

April 28 (Bloomberg) -- The U.S. is not Argentina. Certainly not.

Real wages in this country aren't 20 percent lower than they were seven years ago, goods imported from Europe don't cost more than four times as they did then and 40 percent of the population isn't living in poverty.

Still, there are some disturbing parallels between the U.S. of today and the Argentina of the 1990s when the country was living well beyond its means, borrowing abroad to finance large budget and current account deficits, while government leaders ignored the urgent need for more prudent fiscal policies.

And in the final pages of a new book that tells in exquisite and chilling detail the Argentine story of borrowing, boom and bust, Washington Post financial reporter Paul Blustein notes some of those parallels in terms of large foreign borrowing and the possibility of a shock associated with a reduction in such flows

``It could happen here,'' Blustein writes in ``And the Money Kept Rolling In (And Out)'' (published by Public Affairs).

``Americans who give Argentina's story fair consideration and conclude otherwise are deluding themselves. The risks are much lower for the United States than they were for Argentina, but they are unacceptably high.

``The words of Miguel Kiguel, Argentina's former finance undersecretary, are apropos: `Once you know the markets are there, and there is financing, you behave as if financing will be there forever.'

Same `Cavalier' Attitude

``The United States has shown every sign of having adopted that same cavalier, incautious attitude in the first few years of the twenty-first century,'' Blustein says.

Argentina had its spree and since the end of 2001 has paid a horrendous price for its folly. It had borrowed in dollars and hadn't nearly enough to repay its exploding debt when foreign investors shut off the flow of new money.

There has been no similar day of reckoning yet for the U.S., and the eventual price to be paid is unknown. It shouldn't be on a scale vaguely comparable with that of Argentina's, though it may be uncomfortably large.

The U.S. economy is far larger than Argentina's of the '90s, and thus better able to sustain even a large shock. More importantly, this country's foreign debt is also denominated in dollars, which the Federal Reserve can create at will -- though last week Fed Governor Donald L. Kohn warned there is a distinct limit to that will.

Sharing the Blame

The book by Blustein, a former colleague of mine at the Post, is a fascinating, well written international tale, as the subtitle indicates: ``Wall Street, the IMF, and the Bankrupting of Argentina.'' Some key U.S. government officials also played a role and hardly covered themselves with glory.

Everyone gets a share of the blame. Argentine politicians who would not curb deficit spending so long as foreign financing was available, International Monetary Fund officials who foolishly helped the country defend an ultimately unsustainable currency peg of one peso to $1, and investment bankers who made tens of millions of dollars in underwriting and trading fees on Argentine government bonds while issuing misleading research reports on the country's prospects.

Blustein, a meticulous reporter, quotes liberally from previously unpublished internal IMF staff memos that called for taking a tougher line with the Argentine government as its debts mounted. When only a miracle could have allowed Argentina to maintain its currency peg and avoid defaulting on its debt, top IMF officials temporized, partly to avoid having the IMF blamed for triggering a default.

Current Account Deficit

The delay in recognizing reality made the eventual cost of changing policies far greater. For one thing, the government forced banks to buy large quantities of government debt, which in the end all but destroyed the Argentine banking system. In the process, the savings of many ordinary citizens were wiped out.

In his speech on April 22 at Bard College in Annandale-on- Hudson, New York, Kohn said the burgeoning U.S. current account deficit, which is predicted to be close to 6 percent of GDP this year, is unsustainable. Eventually there will have to be an adjustment, he said.

``In all likelihood, adjustments toward reduced imbalances in the United States and globally will be handled well by markets, without, by themselves, disrupting the good, overall performance of the U.S. economy -- provided, of course, that the Federal Reserve reacts appropriately to foster price and economic stability,'' Kohn said.

Restoring Fiscal Discipline

On the other hand, likelihood is not certainty.

``Complacency would be ill-advised,'' he cautioned. ``Although the odds seem favorable for an orderly adjustment, the current imbalances are large and -- importantly for gauging risks -- unusual from a historical perspective.''

While it isn't clear the shift from federal budget surpluses in the late '90s to today's large and continuing deficits has played a large role in making the current account deficits worse, a better fiscal balance going forward could help when they begin to shrink, as the eventually must.

``A permanent correction to the spending imbalances must involve the restoration of fiscal discipline and long-run solutions to the financing problems of Social Security, Medicare and Medicaid,'' Kohn said. ``Achieving these objectives are important in any event, but they take on added weight to the extent that we cannot count on an ever-increasing flow of global savings coming into the United States.

The Need for Listening Up

``Without a resolution of these fiscal problems, the balancing of aggregate production and spending would be much more difficult and would result in intensified pressures on interest rates,'' Kohn said.

And he concluded by saying that no one should assume that monetary policy could necessarily offset those pressures on interest rates if cutting rates would jeopardize price stability. Indeed, if inflation threatened, the Fed should not ``hesitate to raise rates because higher rates mean higher debt-servicing burdens for the current account, the fiscal authority or households,'' Kohn said.

Yes, the Fed could provide a plentiful supply of dollars when the foreign capital inflow slows down, only it won't if the cost is a surge in inflation. The fiscal authority -- that is, President George W. Bush and Congress -- ought to listen up.

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