Argentina's implosion has the fingerprints of the International Monetary Fund all over it.

The first and overwhelmingly most important cause of the country's economic troubles was the government's decision to maintain its fixed rate of exchange: one peso for one U.S. dollar. Adopted in 1991, this policy worked for a while. But during the past few years the dollar has been overvalued, which made the peso overvalued as well.

Contrary to popular belief, a "strong" currency is not like a strong body. It is very easy to have too much of a good thing. An overvalued currency makes exports too expensive and imports artificially cheap. Just look at the United States, where a "strong" dollar has brought a record $400 billion trade deficit.

But it gets catastrophically worse for a country that has committed itself to a fixed exchange rate. When investors start to believe that the peso is going to fall, they demand ever higher interest rates. These exorbitant interest rates are crippling to the economy. That is the main reason why Argentina has not been able to recover from four years of recession.

To maintain an overvalued currency, a country needs large reserves of dollars; the government has to guarantee that everyone who wants to exchange a peso for a dollar can get one. The IMF's role here was crucial. It arranged large loans, including $40 billion a year ago, to support the peso. This was the IMF's second fatal error. To appreciate its severity, imagine Washington borrowing $1.4 trillion - 70 percent of the federal budget - just to prop up an overvalued dollar. It didn't take long for Argentina to pile up a foreign debt that was impossible to pay back.

As if all that were not enough, the IMF made its loans conditional on a "zero-deficit" policy in Buenos Aires. But it is neither necessary nor desirable for a government to balance its budget during a recession, when tax revenues typically fall and social spending rises. The zero-deficit target may make little economic sense, but it has great public relations value. By focusing on government spending, the IMF has managed to convince most of the press that Argentina's "profligate" spending habits are the source of its troubles. But Argentina has run only modest budget deficits, much smaller than U.S. deficits during recessions.

The IMF now claims that it was against the fixed exchange rate, and the large loans to support it, all along. Officials say they went along with these policies to please the Argentine government. So now Argentina tells the U.S. government what to do!

This is not a very credible story, but of course verifying who made what decision is a little like tracking Qaida's chain of command. IMF board meetings, consultations with government ministers and other deliberations are secret.

But they do have a track record. In 1998 the IMF supported overvalued currencies in Russia and Brazil, with large loans and sky-high interest rates. In both cases the currencies collapsed anyway, and both countries were better off or the devaluation. Russia's growth in 2000 was its highest in two decades. Argentina will undoubtedly recover, too, after it devalues its currency and defaults on its un payable foreign debt. But the people will need a government that is willing to break with the IMF and pursue policies which put their own national interests first.

Washington has other ideas. "It's important for Argentina to continue to work through the International Monetary Fund on sound policies," said White House spokesman Ari Fleischer on Friday. For the IMF, failure is impossible. The writer is co-director of the Center for Economic and Policy Research. He contributed this comment to The Washington Post.

December 26, 2001.

[Source: The International Herald Tribune]