By Jack Kemp
December 27, 2001 for Townhall.com
When democratic governments create economic calamity, free markets get the blame. In today’s world that means the International Monetary Fund, with U.S. backing, bails out lenders on the condition that creditor governments agree to poison their citizens with fiscal austerity, causing the people to rebel and turn to socialism. If you want to know where the next riots will break out, follow the IMF “candy man” around the world.
It’s happening in Argentina today. The economy is melting down, there have been deadly riots in the streets, President George W. Bush insists that Argentina stay with the IMF program of fiscal austerity, the government has fallen and Peronist governor Adolfo Rodriguez Saa has been sworn in as president.
Economic collapse in Argentina began with a failure of U.S. monetary policy that created worldwide dollar deflation and led to a global recession. Because Argentina’s peso is linked one-to-one to the dollar through its currency board, the government was forced to sit idly by since 1997 while its currency appreciated 30 percent in tandem with the dollar against gold, other commodities and other currencies around the world.
The result was a dearth of peso liquidity that resulted in falling prices and economic contraction. Today wholesale prices are falling at an annual rate of 7 percent, and consumer prices are declining at a 1.5 percent annual rate. The money supply continues to shrink at double-digit rates.
Ironically, the IMF, usually obsessed with the shibboleth of “overvalued” currencies, failed to recognize the effects of dollar deflation and instead mistook effect for cause and blamed Argentina’s economic woes on budget deficits and unmanageable debt. While it is true that the former government of Fernando de la Rua mismanaged the nation’s fiscal affairs and allowed spending to get out of hand, these mistakes were by no means the prime cause of Argentina’s meltdown.
Argentina’s debt has become “unmanageable” because its economy hasn’t grown in three years. De la Rua’s biggest mistake was to succumb to the fatal attraction of bailout loans once the economic slide began and join in dangerous liaison with the IMF to increase taxes, impose salary reductions on public employees and slap on financial controls that threatened to seize up the financial system.
Think of Argentina’s one-to-one exchange rate between the dollar and the peso as an aircraft carrier (the United States) and a motorboat (Argentina) afloat on the high seas. If the motorboat economy floats freely, an economic squall can swamp and sink it, but if it tethers itself to the aircraft carrier, the resulting stability allows it to weather most storms.
A currency anchor, however, won’t prevent the political crew of the motorboat economy from making policy mistakes like raising tax rates and increasing regulations, which can create an economic crisis. When that happens, the IMF typically comes around with cash in hand insisting on more tax hikes to reduce deficits and demanding that the small economic craft cut itself loose from its currency anchor in the hope that a free-floating currency has a better chance of righting itself.
Bad advice. Small currencies invariably sink in high economic seas as speculators make runs on the currency, capital flees the country and wealth is destroyed.
What happens, though, if the motorboat is shipshape but the aircraft carrier for some reason, say deflationary monetary policy, begins to take on water and ride lower in the sea? An aircraft-carrier economy may not be much affected by the additional monetary ballast of a heavier currency, perhaps experiencing little more than a slight slowdown in speed. But small changes to how high the motorboat’s anchor ship floats can have catastrophic consequences for the smaller vessel. If the anchor ship sinks low enough and the point at which the two vessels are tethered cannot be adjusted higher up on the hull of the anchor ship, it can drag the motorboat under water.
Argentina’s economy will not recover as long as it lies prostrate between the hammer of dollar deflation and the anvil of IMF austerity. With 80 percent of Argentina’s debt in dollars and workers’ and businesses’ income in pesos, allowing the peso to float freely would impoverish the country and increase the debt burden.
A new government cannot be established on the foundation of debt repudiation. The new government’s default on Argentina’s $155 billion debt must be followed up by debt rescheduling and a plan to reliquify the economy, cut tax rates and reduce regulations. One approach would be to allow the central bank to print sufficient pesos to buy up enough debt to reverse the currency’s unwarranted appreciation. Alternatively, the United States could alleviate the deflationary squeeze by having the Fed purchase sufficient new peso bonds to inject adequate dollar liquidity into the economy to relieve the deflation without breaching the currency board.
Time is short. Unless America lends a hand, the socialists and the IMF will only wreak more havoc in Argentina.