Watching Argentina
Default in Slow Motion

By DAVID WESSEL

WATCHING ARGENTINA default on its government debt is like watching a car crash in slow motion. It's clear that a collision is inevitable, but it's hard to know who is going to get hurt and how badly.

Most remarkable, markets and rich-country governments view the default of one of the world's largest emerging-market debtors as the financial equivalent of a two-car crash -- undesired, yes, but certainly not a "crisis."

Think about it. We're heading into the worst global recession in 25 years. Flows of credit to emerging markets already have evaporated. The U.S. is at war. The last time a big country defaulted -- Russia in August 1998 -- borrowers as far away as Sao Paulo got hurt, and even the U.S. bond market seized up.

So now, of all times, the International Monetary Fund, which held its nose and dropped $5 billion on Argentina three months ago when the world was a lot calmer, finally decides to say, "No mas!" And, now, of all times, the board of directors of world capitalism -- finance ministers from the Group of Seven industrialized nations -- salutes Argentina for "taking the initiative" as it stiffs foreign and domestic investors who have lent it tens of billions of dollars.

Huh?

ARGENTINA COULD PROVE to be a minor milestone along the path of globalization. By the end of the 1990s, a few things were clear. First, being a star pupil of IMF, World Bank & Co. didn't guarantee economic success or turn a country into a good credit risk. Indonesia proved that.

Second, too many investors overlooked the risks of lending to such countries because they figured the rich countries of the world would come to the rescue, if needed. Mexico demonstrated that in 1995.

Third, the IMF and the G-7, even if they wanted to, didn't have enough money to continue to insure the rich-country capital that was flooding into developing countries. The IMF's late-1990s cash crunch offered ample evidence.

The rub has been finding a way to force investors to bear the losses when emerging-market investments go sour without choking off the foreign capital developing countries need to improve the lives of their people. Talk of "bailing in" the private sector or creating an international bankruptcy court for governments has produced almost nothing. Despite its vow to end ever-larger bailouts, the Bush administration in its early months ended up backing big IMF loans to Turkey and, in August, to Argentina. But not this time.

ARGENTINA MADE IT EASY to say "no." The people who hold the purse strings decided that buying more time for Argentina wouldn't work: It has lost credibility. It cannot pay its debts. It squandered the one-last-chance IMF loan it got in August.

The country has been in recession for more than three years, and the government can no longer afford to service its $132 billion debt. But its politicians have been unable to reach a political agreement to do what's needed to get the economy growing. Provincial governments resist pleas from the federal government to alter an old revenue-sharing deal and settle for a smaller slice of tax revenue. Academic economists criticize the rigid link between the peso and the U.S. dollar for preventing the government from spurring growth by devaluing its currency or cutting interest rates. But the link remains popular as a bulwark against the hyperinflation that once ravaged Argentina.

This moment has been so long in coming that no bondholder can feign surprise. The price of Argentine bonds shows that markets expect default, or a supposedly "voluntary" debt swap that amounts to the same thing. The more this is seen as a uniquely Argentine problem, the less risk that default will discourage lending to neighboring Brazil and other emerging markets. The smaller those risks, the more willing the U.S. and the rest of the G-7 to let Argentina pull the trigger.

After all, officials note, crossing their fingers, the Brazilian currency has been rising recently despite Argentina's woes, an encouraging sign that markets are better at distinguishing among emerging-market borrowers than they were when Russia defaulted three years ago. Perhaps a resolution of Argentina's debt mess, however ugly, will lift the cloud of uncertainty that is discouraging lending to other emerging markets, they suggest hopefully.

In any scenario, the Argentines will suffer more economic pain, but there are still surprisingly few signs of social unrest. Maybe they figure things can't get much worse. "We already have a 21% unemployment rate," Argentine economist Gerardo della Paolera says stoically. "We are already without credit." A big risk now is that Argentines try to escape the car before the collision by pulling money out of their bank accounts -- because they fear either a peso devaluation or a freeze on their dollar accounts -- and hasten the collapse of the banking system.

For the rest of the world, the happy ending is the one where only Argentines get injured. Unfortunately, that's not the only possible ending.

-- David Wessel

Write to David Wessel at capital@wsj.com