August 03, 2003

20-20 Hindsight

Paul Blustein of the Washington Post has a nice article ( Argentina Didn't Fall on Its Own) on Argentina, the inflow of foreign capital, and its recent collapse.

I do, however, think that he overplays the "poor investors" and the "poor Argentinian government" line:

Wall Street firms touted Argentina as one of the world's hottest economies as they raked in fat fees for marketing the country's stocks and bonds. Thus were sown the seeds of one of the most spectacular economic collapses in modern history, a debacle in which Wall Street played a major role.

The fantasyland that Argentina represented for foreign financiers came to a catastrophic end early last year, when the government defaulted on most of its $141 billion debt and devalued the nation's currency. A wrenching recession left well over a fifth of the labor force jobless and threw millions into poverty.

An extensive review of the conduct of financial market players in Argentina reveals Wall Street's complicity in those events. Investment bankers, analysts and bond traders served their own interests when they pumped up euphoria about the country's prospects, with disastrous results...

Argentina's politicians were told at extraordinary length by their own economic advisers, by the U.S. Treasury, and by the IMF of the risks they were running by combining a hard fixed exchange rate with large unbalanced budget deficits. And the things that I saw from Wall Street seemed to me to be pretty accurate: combining optimism (and there are grounds for optimism for a country that grew at 7% during 1997, the first year of the East Asian financial crisis) and warnings that balancing the budget is "vital" to keep the economy growing, productive, and competitive.

For example, here's Carlos Janada writing for Morgan Stanley in June 1998. He doesn't fit Blustein's characterization. IMHO, Mr. Janada's major fault (which I shared) in his analyses of Argentina was that he could not conceive that Argentina's politicians would be as short-sighted and incompetent as they turned out to be:

Global Economic Forum: Carlos Janada: We remain positive about the prospects for the Argentine economy and believe that President Carlos Menem is still committed to the economic program of market reforms.... We were in Buenos Aires last week and sensed that business sentiment was relatively positive despite the international environment... the fiscal deficit. It's here that Argentina has to be careful. The country met the 1Q98 fiscal target, and it looks like it may also meet the 2Q98 target. However, Argentina has been unable to keep its trade deficit below $5 billion.... Statistics show that the economy is still growing at a respectable pace: The government recently announced that GDP rose 7% in 1Q98 from 1Q97.... Even in a deflationary environment, growth is still taking place... international reserves have been growing this... what we like most in the Argentine story is the remarkable change in productivity that has helped the country to remain competitive despite a fixed exchange rate....

These changes in productivity and competitiveness lie at the heart of the "Argentine Miracle" in the 1990s. It's also where the major risks are.... The real threats to the Argentine story... come from... inside. Enter the labor and fiscal reforms... vital to keep productivity and competitiveness on track...

On the other hand, by the time Blustein moves into 2000 and 2001, I think he is on much firmer ground. And I've never understood what the IMF, the U.S. Treasury, Argentine Finance Minister Domingo Cavallo, and David Mulford of Credit Suisse First Boston thought they were doing in 2001. (Of course, IMF Chief Economist Michael Mussa was similarly uncomprehending. As he wrote in his 2002 book, Argentina and the Fund: From Triumph to Tragedy (Washington: Institute for International Economics: 088132339X), about analyses supporting policies like the swap, "If... if... if... as we used to say in my neighborhood, if my grandmother had wheels she'd be a bus!")

Posted by DeLong at August 3, 2003 08:45 AM | TrackBack


"Wall Street Week" was televised from Argentina and Brazil early in 1999. The program gushed about the Argentine currency dollar peg and moaned about the refusal of Brazil to adopt such a peg. Spanish banks and investors in particular were active in Argentina through the peg years. There was great great Spanish pressure on the Argentine government not to drop the peg.

Morgan Stanley was no wise as influential in Argentina during the peg years as Citigroup and Fleet and other American investors for whom the peg seemed a source of risk free profits. To heck with the Argentine m iddle class, Spain and America were banking on Argentina.

Why not drop the peg? What would that mean to dear Citigroup? Of course, Argentina's leaders bear blame but so do the Spanish and Americans.

Paul Krugman described the problem while the currency could easily have been devalued.

Posted by: anne on August 3, 2003 09:07 AM

By Paul Krugman

There's an interesting story in today's Washington Post about Wall Street's role in Argentina's debacle. There's a lot there I didn't know. But I think the story downplays the role of the convertibility law, which pegged the peso to the dollar, in two ways.

Some background: I was an Argentina pessimist long before it became fashionable. In fact, in 1995 I told a retreat of the Argentine Financial Executives Institute that I didn't expect the convertibility law to survive the decade. I was wrong, of course: it collapsed, bringing huge devastation, in 2001. (Incidentally, I gave that talk in Ushuaia, on Tierra del Fuego; so I have probably given the most southerly economics lecture in history.)

The reason I predicted eventual failure was that the peg deprived Argentina of crucial flexibility. And so it turned out: the rigidity of the Argentine system in the face of declining capital inflows, the Brazilian devaluation of 1999, and the rise of the dollar between 1999 and 2001 was a large part of what went wrong.

But that wasn't the whole role of convertibility: it was also crucial to the bullishness of Wall Street. The article hints at that, but I think fails to grasp the full extent of the story.

Throughout the 90s, almost up to the bitter end, Wall Street was utterly convinced that Argentina's currency board - which in effect reproduced the gold standard - was simply a wonderful idea. When you raised questions about the economy's performance, the answer was always that this marvelous monetary system ensured the country's success. And Domingo Cavallo, the architect of the system, was treated as a hero.

Now the funny thing was that there was no evidence to back up this enthusiasm. There was and is a case for currency boards; there is also a case against. You can choose sides in that debate, but nothing in actual currency experience justified the huge enthusiasm of Wall Street economists.

So why the wild enthusiasm? Because a currency board fitted a conservative ideology: by eliminating any discretionary monetary policy, it moved us back toward a pre-Keynesian world. That's why Forbes and the WSJ editorial page sang Argentina's praises; and Wall Street economists swallowed the whole thing.

But, you say, aren't financial analysts supposed to be hard-headed types who look at the facts, never mind the ideology? Well, we can talk about why it doesn't work that way. But the bottom line is that these guys - with some honorable exceptions - are suckers for anyone who fits their ideological preconceptions. And they are very, very reluctant to admit it when a government that talks the free-market talk, and says that to grow rich is glorious, is in fact running the country into the ground.

Does any of this bear on the unwillingness of Wall Street to face up to our own fiscal catastrophe, and its repeated declaration of business cycle victory even as jobs continue to melt away? What do you think?

Posted by: anne on August 3, 2003 09:36 AM

Since there were typical mean comments posted about Paul Krugman and a Social Security "howler," here is what we should be howling about -

Paul Krugman

I hear from the grapevine that people are fulminating about comparisons between Social Security and the Bush tax cuts. The tax cuts must be minor, they insist, compared with the "real problem".

Sheesh. Is it really so hard to do a bit of homework?

The basic point - that the Bush tax cuts are much bigger than the actuarial shortfall of Social Security over the next 75 years - isn't even controversial, at least among those who've done the numbers. Here is a good summary. Here are more up to date numbers.

General point: anyone who talks fiscal policy without regularly reading the work of the Center on Budget and Policy Priorities and the Tax Policy Center is either lazy or doesn't want to know. Yes, they're both (mildly) liberal in outlook. But they're also both scrupulously honest. And there's no counterpart on the other side. I wonder why?

Posted by: jd on August 3, 2003 09:48 AM

I don't know if I can do this but I am going to try.
Encouraged by Economists, the IMF and most especially Wall Street Bankers everybody from CA, to Germany, the USA and Argentina started selling what were state assets. Heralded as freeing markets these assets allowed Governments to raise funds, brokers to pocket profits and did in general the public very little good. Like the telecommunications act of 1996 which was suppose to free competition and lead to innovation what we were sold was a scam. SBC ate up Pactel and Ameritech and then destroyed their competition. The Clinton administration, like the European nations sold off billion dollar spectrum allotments, Clecs did IPOs to buy overpriced telecom equipment and people just gave away computers with the hope of someday recouping the losses by delivering your groceries on line. People who were able to profit from this madness did well. The people involved in this madness made billions (Simon Weill for instance) and the people who thought their 401k plans were safe got screwed.

So now we are in Argentina in 1998 and the government starts to run a deficit. What does the IMF do? They loan them money. They just keep doing this year after year until Argentina can no longer even hope to recover from this debt. Brilliant! It is like telling a drunk he shouldn't drink and supplying him with wine.

Just compare the world banks efforts here.

To Norway.

In my neighborhood it was your grandmother wears combat boots.

Posted by: Bruce Ferguson on August 3, 2003 03:27 PM

Stiglitz has pointed out that international banks' dominance in Argentina limited small and medium businesses' access to credit. He also blames the IMF's "insistence [...] on contractionary fiscal policy."

Posted by: Will on August 5, 2003 08:36 PM

Bruce, Will, I love seeing your comments in tandem. As the lender of last resort the IMF deals with nothing but drunken profligates. On one side they are criticized for subsidizing these profligates and the other for not allowing the profligates to spend more.

Posted by: Stan on August 8, 2003 12:46 PM


I must admit my ignorance of the Argentine situation. If Argentina were spending far beyond its means -- which, given its Peronist past, wouldn't surprise me -- then imposition of spending restrictions would be correct. However, all too often the IMF neglects its duty as supplier of liquidity for anticyclical deficit financing in favor of postponing the inevitable crash of overvalued currencies, ensuring crushing interest rates that make the situation worse. Keynes is still right.

Posted by: Will on August 9, 2003 03:25 PM
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