Why Argentina Is a Mess (and How to Fix It) Jude Wanniski November 5, 2001

Memo To: Ken Dam, Deputy Treasury Secretary
From: Jude Wanniski
Re: Financial Meltdown in Buenos Aires
Cc: Domingo Cavallo

I’m writing to you, Ken, figuring you might have a little more time than your boss, Secretary O’Neill, to understand why Argentina is falling to pieces and why another big bag of money from the International Monetary Fund will disappear into the same black hole as have previous credits. It really is very simple, as we have been explaining to our clients at Polyconomics for the last 18 months while predicting this meltdown. Alas, there is not much of a market for complex problems with simple solutions, especially when economists and bureaucrats get involved. I’ve tried e-mailing Domingo Cavallo, the economics minister who is running in circles trying to avoid national bankruptcy. As I am only a little guy from New Jersey, though, all I get in return are nice little notes from an assistant who thanks me for my concern and assures me they will not devalue the peso – although that is exactly what Argentina has to do, for the good of its people and the Argentine economy and for its creditors at home and around the world.

Capital is now flying out of the country, Ken, because the collective wisdom of the market sees that nobody in high places understand that Argentina is being crushed by the deflation of our American dollar. As far as I know, it is the only country in the world which was so sure it would be doing the right thing by pegging its currency to the dollar – and putting it into its CONSTITUTION that the one-for-one parity could not be touched. It worked fine as long as the dollar price of gold remained roughly stable against gold at $350 per ounce. Tell Secretary O’Neill to imagine a man lashing himself to the mast in the midst of a great storm. It keeps him from being swept overboard, but when the ship sinks, the poor sailor is dragged down with it.

O’Neill will probably ask why the U.S. financial markets are not crashing with the same ferocity as seems to be the case in Buenos Aires. Stocks have sold off, it is true, but U.S. government bonds are climbing in value by leaps and bounds. He may remember, when I saw you both in March, that I explained we were in a slow, grinding deflation that would force a downward adjustment of all prices and wages over time, because the Federal Reserve had paid no attention to the falling price of gold, now at $275 or so. The big difference with Argentina, lashed to our mast, is that our deflation was caused by the 1997 supply-side tax CUTS, which increased the rewards for successful risk-taking in production.

Argentina not only got caught in this aspect of the deflation – because of its constitutional chains to the U.S. dollar – it also never had the benefit of the tax cuts that caused the deflation here!! There was no positive force for expansion. You see? Because Argentina is much more of a commodity-based economy than the U.S., deflation there moves through the price stream more quickly and forcefully. As if that were not enough, the IMF slouched into town and offered the Argentine government a big bag of money to meet debt obligations – on the condition that it RAISE taxes. This occurred not once but in three successive waves. Now you know, Ken, that I have been calling the IMF the “Evil Empire” ever since the Berlin Wall came down. But the stupidity of raising taxes into a financial debacle could only be possible when Ph.D. economists are at the helm -- probably from Harvard, Yale or Stanford. The main reason I’m writing this to you, Ken, is that your Treasury Undersecretary for International Affairs, John Taylor, does not have a clue. A sweet man from Stanford, but clueless. On the other hand, it was child’s play for our global team at Polyconomics to predict disaster.

What should Domingo Cavallo do? First and foremost, he has to get out of the chains pulling down his ship of state, persuade his government to devalue the peso PRECISELY by 20% AGAINST GOLD, not against the dollar. This will immediately lift the deflation off the backs of the domestic economy’s producers AND WILL NOT CAUSE ANY NOMINAL PESO INFLATION!!! Yes, it would cause a 20% decline in the peso’s dollar value, but the dollar is deflating, so the devaluation would merely build a fire break against the dollar deflation process. Peso debtors will be able to pay peso creditors and the domestic economy will be able to right itself. The announcement would bring a tremendous surge in the both the stock market and the bond market. Interest rates would FALL, not rise, as the markets would see the economy would be able to function again and produce the revenues needed to meet debt obligations. The nation’s hard-currency creditors, for the most part in Spain, but also in the U.S., would see the value of the bonds rise and would be eager to get more while the getting is good. The hemorrhaging of cash experienced now would reverse. Hey, instead of doing bad things to the economy, try doing some good things. Like reversing the IMF tax hikes as soon as it becomes clear the devaluation is working. It would not take long. As soon as the market learned you were going to devalue against gold and stabilize there, and NOT DEFAULT on your sovereign debt, it will work in Argentina’s favor instead of against it. Argentina would be back in business in no time at all.

Your Ph.D. advisors will say “Why Not Dollarize?” I’m sure if you give it a moment’s thought, you will realize that if it is the dollar deflation that is wrecking the country that simply changing the color of the currency will do zilch.

Please pass it on, Ken.