The Upside of Argentina's Default
Assume that a friend makes available to you a generous line of credit to your firm at very agreeable terms: low interest rates, loose repayment requirements, and (nod-nod, wink-wink) the implicit agreement that if you can't make your payments in the future there will be more dough forthcoming. Assume that all of your neighbors have similar agreements with the same friend and seem to be doing fine. All you have to do is sign on the bottom line.
Of course, there are some strings attached. You have to arrange your finances in ways that are acceptable to your friend, who claims the right to oversee your finances and can tell you exactly how to arrange them if he doesn't like your current business plan. Your friend also claims the right of constant oversight of your activities and in fact opens several offices near your place of business, employing a cadre of people whose only job it is to watch how you spend your money.
What's more, your friend has monopoly power on the ability to print the money you need at will, allowing him to become the de facto only lender available, because his bad money tends to drive out any alternatives that might otherwise be available to you. When you find yourself deeper in debt than you ever imagined possible, you have no alternative but to comply with his solutions, or risk becoming a pariah.
Some friend, right? Only the most desperate and shortsighted of individuals would be drawn to him. But since desperate and shortsighted describes most governments today, it explains why the World Bank and the International Monetary Fund have so many customers. Several countries have become dependent on the money spigot these taxpayer-supported organizations make available to unpopular and corrupt governments, and it is rare for any country to stand athwart the system it manipulates. That is why the case of Argentina is so compelling.
When its economy reeled from the aftereffects of the Peronist episode in the 1950s, a period of time during which a nation once admired for being the world's breadbasket became one of the world's basket cases, Argentine authorities welcomed the intervention of world credit agencies. Instead of suffering the consequences of its policies, its rulers opted for a deal that allowed them to remain in power for several decades and to avoid paying the political price for the effects of its brand of socialism. For Argentina, the perverse effects of Peronism persist to this day.
Economists call such policies examples of moral hazard: a skewing of incentives resulting from not holding people or institutions responsible for the consequences of their actions. Moral hazard is the primary product peddled by the World Bank and the IMF. They encourage governments to engage in those policies that bring positive short-run effects that allow them to remain in power. When negative long-run effects eventually kick in, effects that are consistent with economic theory, more loan money becomes available to mask them while ushering in new rounds of short-run stimulus.
And so it goes, over and over again, with new loans being approved by the credit agencies on a periodic basis. It requires some interesting intellectual reasoning by economists to justify this system—which perhaps explains why World Bank economists are not required to pay taxes, effectively making them an anointed class of government employees. It also causes World Bank and IMF-dependent countries to constantly alternate from economic miracles (resulting from the initial injection of new money into their economies) to economic crises (the inevitable result of malinvestments made possible by it). This explains, for example, why the Mexican government is good for a major currency devaluation every decade.
That this scheme works this way is obvious to everyone but the governments who operate it and the sycophantic economists that are employed by it. So it is significant that after a year of protracted and severe suffering by the Argentine people, with pockets of the country being reduced to barter and with starvation being reported in some of its provinces, Argentine officials have recently announced that the country is defaulting on a $1 billion World Bank loan. Such a policy is practically unprecedented—only Zimbabwe and Iraq have defaulted on such loans in the past.
Though this policy is not the first choice solution of the country's politicians, it represents both the pressure they are under to reclaim Argentina's economic sovereignty and popular disgust with never-ending boom and bust cycles. Both the World Bank and the IMF assumed one year ago that its payments could continue if only Argentina would agree to new loan terms, but government authorities began rejecting terms willingly accepted by their counterparts in Brasilia, Líma, and Bogotá. "We're not saying the blame for what's wrong should be pinned on the fund (IMF)," Alfredo Atanasof, Argentine President Edwardo Duhalde's cabinet chief, told the BBC. "We assume the responsibility as a country ... but what we are saying is the bureaucracy at the Fund has promoted the policies that put us in this situation."
It was only a year ago that the IMF halted loans to Argentina, forcing the government into the largest foreign debt default in history. The country halted payments on about $95 billion of its $141 billion in foreign debt. Shortly thereafter, the cash-strapped government in Buenos Aires confiscated private dollar holdings in its banks, replacing them with Argentine pesos, a move reminiscent of Franklin Delano Roosevelt's confiscation of gold holdings in the 1930s. Bank runs and holidays, coupled with massive protests against the government, became commonplace as the economy collapsed into itself.
Since then, the government has been slow to accept the Keynesian stimuli offered by IMF officials. Much of the new money (which would add to the country's debt) would arrive earmarked to pay for new projects such as AIDS programs, high schools, and farm aid at a time when it owes billions of dollars to private sector creditors. New layers of government would be created when public disgust with state interventionism is at an all-time high.
Needless to say, the stakes of Argentina's decision are huge. After all, what if other countries dependent upon IMF and World Bank loans also announced, "We are not going to pay," as Atanasof did last week? Most likely, it would represent a necessary first step toward freeing their economies from the deleterious effects of such dependency. Like the private firm that files for bankruptcy, countries might even notice that there is an upside to default.
Of course, a country that defaults on a World Bank loan cannot be compared to a firm that defaults on a commercial loan originating in the private sector. The theory of banking requires some form of collateral be in existence to assuage the risk that is a part of any loan contract. While the collateral does not eliminate loan defaults, it instills a sense of urgency on the part of the borrower to repay the loan that may not otherwise exist. Collateral reduces moral hazard effects.
Such contingencies do not exist when countries borrow money. First, IMF and World Bank loans are comprised of coerced capital appropriated from taxpayers, not from voluntary deposits made available by investors participating in financial markets. The directors of the IMF do not face the same penalties as the directors of a private sector bank when loans perform poorly. They are less likely to lose their jobs, and they are immune from profit and loss constraints. What's more, operating in an era of fiat currencies, such organizations have the ability ensure repayment in ways that private banks would never be allowed in a free market. While Visa and MasterCard cannot loan customers enough money to make minimum payments, the IMF and World Bank routinely do.
Second, countries do not have collateral in the sense that conventional borrowers do. Only the threat of coercion—in the form of reduced access to credit in the future—compels countries to repay loans. Since government bureaucrats that allocate such funding do not stand to benefit from utilizing it in ways that maximize its social benefit, they are more likely to use it in ways that bring short-term political gain. Cronyism reigns.
In such a situation, private banks in the U.S. would rarely loan private capital to foreign governments on their own accord, unless pushed to do so by public authorities. They very well might loan to private firms operating in countries such as Argentina. But this is the type of funding that IMF and World Bank loans crowd out of the global financial system.
And that is the crux of the problem. While capital will flow anywhere in the world where it is secure from violations of property rights, governments routinely violate property rights through taxation and inflation—two of the primary effects of IMF and World Bank regulations. Since IMF and World Bank loans inherently increase the levels of taxation and inflation, they institutionalize an environment in which private capital is less secure and in which wealth becomes depleted. Argentina, and a myriad of other countries dependent on IMF and World Bank funding, will always be at a disadvantage in attracting sorely needed investment capital as long as property rights are not protected.
By defaulting on one loan, Argentina may be acknowledging that no country ever became wealthy depending on public financing organizations from another hemisphere. One can hope. Such ideas can lead to economic sovereignty and wealth creation. Such ideas, if spread, can cause industrial revolutions.