Memo To: Domingo Cavallo, Economy Minister, Republic of Argentina
From: Jude Wanniski
Re: Your financial crisis
Now that the Argentine financial crisis has reached the front page of The New York Times business section, perhaps a satisfactory solution will be found. Of course, you must know by now that you have been importing the monetary deflation caused by the errant policies of the U.S. Federal Reserve over the past 4+ years. We have been warning of Argentina’s unique vulnerability to U.S. deflation for several years. Some of my supply-side friends had told me I was too picky in arguing that your currency board would only serve a useful purpose as long as the dollar was wisely managed by Greenspan & Co. Now you have the seemingly impossible task of making interest payments on the $130 billion of foreign debt to Argentine and U.S. banks, and to your creditors in Europe. I see you have tried to juggle the portfolio of the currency board, to offset the dollar’s deflationary influence with the weaker euro. The idea might work in the future, but it cannot solve the problem you inherited when you returned as economy minister earlier this year.
You have only two options now. First, you could ask our government, via the Fed, to monetize some of your domestic peso debt with fresh printing-press dollars. This would ease your path in making the interest payments to our banks. Moreover, as long as the Fed did not sterilize this injection of dollar liquidity by withdrawing an equal amount from our banking system, the dollar would weaken and the deflation would end. The problems the Fed has been causing in our economy would be resolved as well. The only other alternative would be for you to hope the Bush administration would prevail on Greenspan to directly weaken the dollar by targeting the gold price instead of interest rates. If gold were to climb to $325 from its current $268, your peso would automatically adjust through the currency board. In other words, you would import a bit of inflation to offset the deflation of the past four years. The financial markets would instantly see you would be able to grow again and make good on your hard-currency debts. Yes, there is a third option. You could erase the tax increases the IMF shoved down your throat the past three years, which have only exacerbated the deflation problem. Tax cuts would reduce the barriers to risk-taking in the Argentine economy and encourage new investment. The monetary options seem cleaner, though. Here is a memo we ran in this space last September, which you will agree is prescient, I think. Also appended is a more recent letter I wrote to the NYTimes which summed up your problem and its solution.
November 27, 2000
To the NYTimes
Paul Krugman, in his November 22 column, “Shadow of Debt,” rightly cites Argentina's currency board as the source of the country's economic malaise. Tying the peso to the strong American dollar, the board imported the Federal Reserve's dollar deflation and now has sky-high unemployment and interest rates.
Creating a currency board did end Argentina's hyperinflation when the price of gold was stable at roughly $350 an ounce, between 1985 and 1997 -- but as gold has fallen, so has Argentina's economy. In response, the International Monetary Fund gave Argentina a loan but required it to raise taxes, putting the country deeper into the ditch. Now the IMF is back with another loan and more austerity.
Mr. Krugman notes that fans of the currency board say it is the “next best thing” to a gold standard. Indeed, Argentina would be much better off if it dissolved the board, rolled back the tax hikes and pegged the peso to gold. It would soon have the strongest economy in Latin America, instead of being a crippled ward of the IMF.