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ARGENTINA’S ECONOMIC MELTDOWN:

CAUSES AND REMEDIES

HEARINGS

BEFORE THE

SUBCOMMITTEE ON

INTERNATIONAL MONETARY POLICY AND TRADE

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

FEBRUARY 6; MARCH 5, 2002

Printed for the use of the Committee on Financial Services

Serial No. 107–52

(
(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director

SUBCOMMITTEE ON INTERNATIONAL MONETARY POLICY AND TRADE

DOUG BEREUTER, Nebraska, Chairman

DOUG OSE, California, Vice Chairman

MARGE ROUKEMA, New Jersey

RICHARD H. BAKER, Louisiana

MICHAEL N. CASTLE, Delaware

JIM RYUN, Kansas

DONALD A. MANZULLO, Illinois

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

GARY G. MILLER, California

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

BERNARD SANDERS, Vermont

MAXINE WATERS, California

BARNEY FRANK, Massachusetts

MELVIN L. WATT, North Carolina

JULIA CARSON, Indiana

BARBARA LEE, California

PAUL E. KANJORSKI, Pennsylvania

BRAD SHERMAN, California

JANICE D. SCHAKOWSKY, Illinois

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

KEN BENTSEN, Texas
(III)

C O N T E N T S

Page

Hearings held on:

February 6, 2002 .............................................................................................. 1

March 5, 2002 ................................................................................................... 31

Appendix

February 6, 2002 .............................................................................................. 79

March 5, 2002 ................................................................................................... 105

WITNESS

WEDNESDAY, FEBRUARY 6, 2002

Taylor, Hon. John B., Under Secretary for International Affairs, U.S.

Department of the Treasury ................................................................................ 6

APPENDIX

Prepared statements:

Bereuter, Hon. Doug ........................................................................................ 80

Oxley, Hon. Michael G. .................................................................................... 84

LaFalce, Hon. John J. ...................................................................................... 85

Paul, Hon. Ron .................................................................................................. 86

Taylor, Hon. John B. ........................................................................................ 88

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bereuter, Hon. Doug:

CRS Report for Congress: The Argentine Financial Crisis: A Chronology

of Events ........................................................................................................ 93

CRS Report for Congress: The Financial Crisis in Argentina ...................... 99

WITNESSES

TUESDAY, MARCH 5, 2002

Bergsten, Dr. C. Fred, Director, Institute for International Economics ............. 41

Hanke, Dr. Steve H., Professor of Applied Economics, Johns Hopkins

University; President, Toronto Trust Argentina ............................................... 47

Meltzer, Dr. Allan H., Professor of Political Economy, Carnegie Mellon

University; Visiting Scholar, American Enterprise Institute ........................... 38

Weisbrot, Dr. Mark, Codirector, Center for Economic and Policy Research,

Washington, DC ................................................................................................... 44

APPENDIX

Prepared statements:

Bereuter, Hon. Doug ........................................................................................ 106

Oxley, Hon. Michael G. .................................................................................... 109

Hanke, Dr. Steve H. ......................................................................................... 129

Meltzer, Dr. Allan H. ....................................................................................... 111

Weisbrot, Dr. Mark ........................................................................................... 118

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bereuter, Hon. Doug:

‘‘Aid to Argentina: Strings Attached,’’ Washington Post, March 5, 2002 ..... 158
(IV)

Page

Hanke, Dr. Steve H.:

Currency Boards, Annals of the American Adademy, January, 2002 .......... 139

Meltzer, Dr. Allan H.:

Additional written comments to Hon. Barney Frank .................................... 115

‘‘A Solution for Argentina,’’ Financial Times, January 24, 2002 .................. 117
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ARGENTINA’S ECONOMIC MELTDOWN:

CAUSES AND REMEDIES

WEDNESDAY, FEBRUARY 6, 2002,

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON INTERNATIONAL MONETARY

POLICY AND TRADE, COMMITTEE ON FINANCIAL SERVICES, Washington, DC.

The subcommittee met, pursuant to call, at 10:05 a.m., in room

2220, Rayburn House Office Building, Hon. Doug Bereuter,

[chairman of the subcommittee], presiding.

Present: Chairman Bereuter: Representatives Toomey, Capito,

Ferguson, Frank, C. Maloney of New York, Carson, Sherman and

Sanders.

Chairman BEREUTER. The hearing will come to order. I apologize

for the cramped conditions of the room, but our major hearing room

is under renovation at the moment. We’ll follow the normal Committee rules with respect to the Ranking Member and this Member

and limiting us to 5-minute opening statement and other Members

who might appear 3 minutes. We have many conflicts, including

some mandatory conferences going on right now.

In any case, the Subcommittee on International Monetary Policy

and Trade meets today in open session to examine the financial crisis in Argentina, including the activities of the International Monetary Fund (IMF) within this country. The subcommittee will hear

from the Under Secretary of the Department of the Treasury for

International Affairs, Dr. John Taylor, on the subject of Argentina,

as the Department of the Treasury is responsible for implementing

U.S. policy toward the IMF.

The subcommittee has jurisdiction, of course, over international

monetary policy generally and the United States’ participation in

the IMF, both of which are relevant to today’s hearing. This is the

first hearing under my Chairmanship of this subcommittee which

addresses the activities of the IMF as it relates to a particular

country. Last year, the subcommittee focused on the regional multilateral development institutions and the Export-Import Bank.

At the outset, I would like to convey to the subcommittee Members the sensitive nature of the political and economic situation in

Argentina. For this reason, I would urge the Members to not focus

on the internal workings of the Argentine government, but to instead focus on the Argentine policies which are relevant to any future IMF or U.S. assistance to the country.

Before introducing our distinguished witness, I would like to remark upon the overall fiscal situation in Argentina. At each sub-
2

committee Member’s desk, the following two products are found.

The Congressional Research Service has provided, at my request,

a chronology of events in Argentina and a recent CRS report on the

Argentine financial crisis.

[The information referred to can be found on page 93 in the

appendix.]

The focus of today’s hearing is as follows:

1. Recent Argentine political and economic history.

2. The recent economic plan supported by the Argentine government on February 3, 2002.

3. The recent role of the IMF in Argentina.

4. The recommendations of the Meltzer Commission and its dissenting views as it relates to the IMF preconditionality criteria for

Argentina; and five—and I’ll do this by unanimous consent——

5. Extending my remarks, some of my own views about the IMF.

Because of the limited time, I ask unanimous consent that I may

extend my entire statement into the record.

Without objection, that will be the order.

First, in order to understand the current economic and political

turmoil in Argentina, it’s necessary to review recent Argentine history. In 1991, the Argentine government established a currency

board to set the peso’s value on a one-to-one peg with the U.S. dollar in order to curb hyperinflation. However, because the value of

the dollar appreciated over the past 10 years, it became increasingly difficult for Argentina to export its products. As a result, in

1998, Argentina began to fall into a deep recession. At least that

was part of the reason. By the end of 2001, Argentina had a total

debt of approximately $132 billion.

Furthermore, on November 30, 2001, President de la Rua of Argentina imposed a $1,000 per month limitation on personal bank

withdrawals. As a result of this restriction and other austerity

changes in the Argentine government, violent protests broke out

and President de la Rua was forced out of office on December 20

of last year. Over the next ten days, there were four different presidents of Argentina, including Mr. Eduardo Duhalde, who is currently in power.

When Mr. Duhalde took over as President, he implemented immediate economic reforms. He announced the end of the currency

board with its peg to the dollar and his plan for the devaluation

of the peso. President Duhalde implemented a dual exchange rate

in which the peso was floated for financial transactions and fixed

the ratio at a 1.4 pesos to the dollar for foreign trade and certain

other transactions. He also continued the freeze of bank deposits

in dollars over certain thresholds.

Second, on Sunday, February 3rd, 2002, the Argentine government came forth with a new economic plan, which would completely free float the local peso currency and loosen an unpopular

freeze on bank accounts. This new economic plan was in part a response to the decision of the Argentine Supreme Court which declared the current freeze on bank deposits to be unconstitutional.

To further illustrate the current political and economic instability

in Argentina, their Congress is considering impeaching the judges

who rendered the decision.
3

Furthermore, the Argentine government on February 3 announced it would turn all dollar debts into pesos at a rate of oneto-one. This change would help debtors pay back their loans since

it will reduce the value of their debt substantially because the

floating value of the local peso is at a volatile actual market rate

of around two pesos per dollar. However, both the creditors and the

banks will suffer losses because of the pesofication of debt. Furthermore, this economic plan also turns all dollar deposits into local

pesos at a rate of 1.4 to the dollar. This devaluation of deposits has

angered middle class demonstrators, of course, because of their loss

in savings.

Argentina declared a bank and foreign exchange rate holiday on

Monday and Tuesday of this week to prepare for the new economic

measures. The effectiveness and political ramifications of these reforms remain an open question.

I ask unanimous consent, in order just to cover the background,

that both the Ranking Member and I have 2 additional minutes of

the normal Committee rules. Without objection. Thank you.

Moving on, third, it’s important to note that Argentina has received extensive assistance from the IMF over the past years. For

example, in March 2000, the IMF agreed to a 3-year, $7.2 billion

arrangement with Argentina. Moreover, in January 2001, the IMF

augmented its earlier agreement by pledging another $7 billion for

it as part of a larger $40 billion assistance package which involves

the Inter-American Development Bank, the World Bank, Spain,

and private lenders. However, due to the fiscal instability in Argentina, the IMF withheld its $1.24 billion loan installment on December 5 of last year.

Fourth, the concept of preconditionality for IMF assistance was

endorsed by the majority report of the Meltzer Commission—a controversial recommendation. I take particular interest in the

Meltzer Commission, because I’m the father of that legislative language which ended up in an Omnibus Appropriations Act in 1979.

This Commission, which completed its work in March of 2000,

was charged with studying the future of the IMF, the World Bank,

and the regional multilateral development banks. I would encourage Members and their staff to review both the majority report and

the dissenting views of the Meltzer Commission, as I find them

very instructive regarding this controversial recommendation.

With respect to the preconditionality for IMF assistance, it appears from press reports that both the IMF and Secretary of the

Treasury Paul O’Neill support some form of IMF preconditionality

as it relates to Argentina. Examples of preconditionality include

the free-floating of the local Argentine peso and the reduction of

deficit spending. I do see, of course, merits of a country having a

sound economic structure in place before receiving IMF assistance.

With that background information in mind, I’d like to introduce

Dr. John Taylor, the Under Secretary of the Treasury for International Affairs, who will, I am sure, assist the subcommittee in

examining these important issues. Dr. Taylor has a very distinguished academic and professional record. He received his undergraduate degree from Princeton University and his Ph.D. from

Stanford University. He’s taught economics at Columbia, Yale,

Princeton and Stanford University. He has also directed the Mone-
4

tary Policy Research Program at the Stanford Institute for Economic Policy Research. In addition to these academic positions, Dr.

Taylor was a member of the President’s Council of Economic Advisers during the Administration of President George Herbert Walker

Bush. Moreover, he has also served in the private sector as an analyst for Alan Greenspan’s Wall Street firm, Townsend-Greenspan,

in the late 1970s and early 1980s.

Dr. Taylor, we welcome you to these hearings, your first appearance before a subcommittee. And before we move to you, I’d like

to turn to the Ranking Member of the Minority, the gentleman

from Vermont, Mr. Sanders, for 7 minutes if he’d care to use them.

[The prepared statement of Hon. Doug Bereuter can be found on

page 80 in the appendix.]

Mr. SANDERS. Thank you, Mr. Chairman, and welcome, Dr. Taylor. I think we all know that Argentina today is in a major financial crisis. Unemployment is about 17 percent. The economy is in

its fourth year of recession, and the country is now in the process

of defaulting on its foreign debt.

I am sure that there is a lot of blame to be spread around regarding the Argentine financial crisis. Generally speaking, it is not our

job to try to get involved in the internal financial crises of countries

all over the world. My interest, and what I think is relevant to this

subcommittee is that we are the international financial organizations subcommittee, which deals among other things with the IMF.

So what interests me is what role the IMF may or may not have

played in precipitating or expanding the crisis that exists in Argentina. And obviously there are a lot of differences of opinion about

that.

Let me just quote, if I might, from an article that appeared in

the American Prospect by Robert Kuttner, an economist from Massachusetts. And he says, and I quote: ‘‘Argentina followed the IMF

model faithfully, more faithfully, than almost any other nation. Its

economy was opened wide. Its peso was pegged to the dollar. For

a few years this sparked an investment boom as foreigners bought

most of the country’s patrimony—its banks, phone companies, gas,

water, electricity, railroads, airlines, airports, postal service, even

its subways. As long as this money came in, there were enough dollars to keep plenty of pesos in circulation. But the dollar-to-peso

peg led to an overvalued currency which killed Argentine exports,

and once there was little more to sell off, the dollars ceased coming

in, which pulled money out of local circulation. As Argentina

tanked, the IMF’s austerity program pushed the economy further

into collapse.’’

There was another op ed that appeared in the San Francisco Examiner about 2 years ago, which indicated that about 2 years ago,

Argentina signed a technical memorandum of understanding with

the IMF which required Argentina to cut its budget, slice civil services salaries by 15 percent, and cut pensions by 13 percent. If Argentina followed this program, the IMF argued, their production

would increase by 3.7 percent. Instead, production fell by 2.1 percent. It has now dropped off the charts.

In other words—and I won’t go into great detail—while in general it is not our business to worry about the internal affairs of Argentina, Brazil, Colombia or any other country, what should inter-
5

est us is that the role the IMF has played not only obviously in Argentina, but in countries around the world. And some of us for

many years have had a great deal of concern about that.

So I, Mr. Chairman, would yield back the balance of my time.

And Dr. Taylor, I would appreciate in your remarks if you might

want to say a few words about the role of the IMF.

Chairman BEREUTER. Thank you very much, Mr. Sanders. I ask

unanimous consent that the other Members now in attendance

have 5 minutes instead of the usual 3 under Committee rules if

they care to use it. And then for people coming in after this point,

we’ll revert to the normal 3 minutes if they wish to be heard.

The gentleman from Pennsylvania, Mr. Toomey.

Mr. TOOMEY. Thank you, Mr. Chairman. In the interest of hearing from Mr. Taylor sooner rather than later, I will yield back the

balance of my time and wait to have a chance to ask some questions.

Chairman BEREUTER. Thank you, Mr. Toomey.

Mr. Frank, the gentleman from Massachusetts.

Mr. FRANK. Mr. Chairman, this is a very important hearing and

I appreciate your having it and I appreciate Dr. Taylor being here.

Obviously we’ve got a short-term crisis in terms of the violence that

was aimed at us, and dealing with that violence is going to take

a lot of our energies. But there is an ongoing fundamental public

policy issue that we have to address of which this hearing is a part.

And it is the question of how do you promote policies in the world

that increase prosperity without so exacerbating inequality that social tensions reach the point where it interferes with progress?

We’ve got a worldwide consensus that capitalism is without question the best way to generate wealth. There was a few years ago

a consensus that said in addition to a capitalist system, you needed

to make that work by a very minimalist public sector approach.

And that I think has been called into question by events. When

Franklin Roosevelt became President, he made the decision to try

to preserve the capitalist system. There were some hems and haws

in how he ultimately decided to do that. But the notion was that

we would have the capitalist system plus a Government role involving some regulation and some intervention to provide social equity.

Our challenge today is to try and duplicate that kind of approach

on the global scale. Now it’s extremely harder. You’re not dealing

with one sovereignty. But it’s the same kind of intellectual problem. How do you give full rein to the capitalist system, which after

all depends on inequality to work, if you do not have people unequally rewarded according to how hard they work, how smart they

invest, how cunningly they anticipate public needs, and so forth?

Then you don’t get the wealth creation. What I believe and many

others, and I think this was what Franklin Roosevelt argued, there

is a point beyond which the inequality can become dysfunctional.

That it can be more than is necessary to give the proper incentives.

There is also a need for some forms of regulation.

A few years ago it seemed to me we were close to a consensus

among policymakers that essentially all you needed to do was to

remove the restrictions on capital and let capital find its most profitable niche anywhere in the world, and we would be, on the whole,

better off. I think that that has been disproven by a good number
6

of events. Clearly, the thrust of the New Deal was to say, yes, we

want capital to be able to find its best area of return, but not without other factors being taken into account. Again, it’s much harder

to do that internationally.

Argentina for a while was an example of the success of a fairly

unrestrained capitalism. And what we have seen now is that in the

global economy, that is not enough. And this is the point we have

to make—no matter what people think about the appropriate public policy, there is a reaction now within Argentina politically to

people have perceived to be that fairly unrestrained capitalist

model that may be going further than is reasonable. Certainly, it’s

going further than is reasonable in many people’s minds. And you

see these connections. This Administration has made a free trade

agreement for the Americas a high priority. That’s endangered in

part by the political reaction you are seeing in Argentina.

So this, to me, is part of an ongoing effort to try to find a way

to harmonize support for the capitalist system with attention to the

kind of policy issues that Franklin Roosevelt successfully launched

here in the United States. And unless we can come up with a better balance, I think we will continue to have these problems. I

would just point out I was encouraged to see in the world economic

forum in New York City, at least as it was reported to me—I

wasn’t there—the discussion was somewhat different and I would

say more balanced than it had been before. There was more concern about the social aspect. And this is our challenge: How do you

maintain globally a system in which capital is free to do its job of

creating wealth, but not in a way that so exacerbates tensions and

inequality either within countries or between countries where, ultimately, popular resistance will bring it down?

Chairman BEREUTER. Thank you, Mr. Frank.

The gentlelady from West Virginia, Ms. Capito.

Ms. CAPITO. Thank you. I don’t have an opening statement.

Chairman BEREUTER. Thank you very much. For the information

of the subcommittee and others interested, we will be holding the

next round of hearings on the subject on March 5th. We will have

private witnesses and perhaps other Administration testimony as

well.

Dr. Taylor, Mr. Secretary, we welcome you, as I said, to the subcommittee for your first appearance here. Your entire statement

will be made a part of the record. I am not imposing any time limits on your comments, your presentation, because I want you to

deal with it as thoroughly as you feel comfortable. Thank you. You

may proceed as you wish.

STATEMENT OF HON. JOHN TAYLOR, UNDER SECRETARY FOR

INTERNATIONAL AFFAIRS, U.S. DEPARTMENT OF THE

TREASURY

Mr. TAYLOR. Thank you very much, Mr. Chairman, Mr. Sanders

and other Members of the Committee for inviting me to this hearing on a very important topic—the economic situation in Argentina.

Let me first say that what’s quite clear is that the people of Argentina are facing extremely difficult and trying times. And as

President Bush has made very clear, Argentina is a close friend

and a close ally, a country that we’re interested in supporting. We
7

want Argentina to succeed economically, become an engine of economic growth for its people and for the whole hemisphere.

In my written testimony, Mr. Chairman, which I would like to

put in the record, I reviewed recent events in Argentina, a description of the IMF program and what U.S. policy has been not only

regarding Argentina, Latin America, but emerging markets in general.

In my oral remarks here I’d like to focus on the events in Argentina itself. I think it’s very useful to go back, as you did, Mr. Chairman, in your opening remarks, to the early 1990s when the government of Argentina took on a series of very important economic reforms. Perhaps most visible and effective is the one you referred to.

That is, the conversion of monetary policy to what was formerly a

highly inflationary policy leading to inflation of over 3,000 percent

per year, so-called hyperinflation, changing that policy to a convertibility law, which not only pegged the peso one-to-one with the dollar, but limited the amount of money creation that the Central

Bank could generate. That in itself was a major shift in policy.

There was also a move to fiscal policy which led to better control,

if you like, to more fiscal discipline in the privatization program

that Mr. Sanders referred to in his remarks. I also think it’s important to note that there was removal of barriers to trade and international investment.

If you look at the effects of these reforms, I think there’s no question that they were quite impressive and remarkable. Of course,

the hyperinflation ended, to many people’s amazement, very quickly, from over 3,000 percent to nearly zero in short order.

There was also an increase in economic growth from negligible

amounts in the 1980s, near zero, slightly negative, to growth over

4 percent in the early 1990s and into the mid-1990s. Investment

in exports grew remarkably rapidly during this period. That is,

through the 1990s.

I think when you evaluate the impact of economic reforms, it’s

very important to pay attention to the response of these marketoriented reforms, as I’ve just indicated.

As I look at the situation, the policies began to change in the

mid- to late 1990s. And also there were a series of external shocks

that affected the economy. The thing that I focus on is that the government budget deficits began to increase quite noticeably, an indication of a waning of fiscal discipline if you like. That caused the

debt to begin to rise more rapidly. It began to raise concerns about

sustainability of the debt. Risk premium began to rise, and of

course higher risk premium means higher interest rates, which in

turn, tends to reduce economic growth.

This increase in debt itself was compounded by several other

problems. One, a persistent deflation which continued into the late

1990s into 2000 and 2001; a depreciation of currencies that Argentina trades with, in particular countries in Europe and Brazil,

which led to less competitiveness in the Argentine economy.

I think it’s also important to note that expectations, persistent

expectations of depreciation of the peso, even in the face of the convertibility law where the Currency Board created interest rates in

Argentina higher than they would otherwise be. In particular, peso

interest rates higher than dollar interest rates. That, in turn, tend-
8

ed to reduce economic growth, as anyone can see in any other country.

These difficulties of low growth, of growing debt, high interest

rates, continued right through last year and culminated at the end

of last year in the events which really brings us here today.

It became increasingly clear to the government of Argentina and

to private participants in the markets, that efforts to adjust the

budget were just not working. Economic growth was not increasing.

And therefore, it became clear that the debt profile was becoming

unsustainable to a greater degree over time. And that’s why last

fall the president of Argentina at that time, President de la Rua,

decided that he would restructure the government debt to bring the

debt burden down to more manageable levels. Very significant announcement at the time.

However, as that restructuring was underway, because there had

been so few restructurings of sovereign debt over time, there’s always a great deal of unpredictability over how it will proceed and

delays. In any case, as that restructuring was proceeding, uncertainty about its impacts began to develop, in particular uncertain

about its impacts on the banks which had held some of that debt.

This uncertainty began to lead to large deposit withdrawals. People

in Argentina would be withdrawing their deposits from the banks.

And in order to stop these withdrawals, the de la Rua government

decided to impose restrictions on those withdrawals from the

banks.

Soon after these restrictions were imposed, we began to see the

social and political protests which unfortunately turned violent,

and President de la Rua then resigned.

If you think of where we are right now, it’s clear the economic

circumstances in Argentina have deteriorated since the imposition

of these restrictions on deposit withdrawals. Right now there’s a

lack of a functioning payment system, which brings economic activity to a near halt. There’s a shortage of liquidity because people are

restricted in how much they can bring out of the banking system.

What we see now, however, is Argentina is beginning to find

ways to remove these restrictions and to restore liquidity. It announced last Sunday the outlines of an economic plan to gradually

remove the restrictions, to float the peso, which will allow the Central Bank to provide more liquidity. They’ve announced that the

amount of liquidity provided will be limited to a certain amount,

thereby constraining the inflationary forces that could otherwise be

created by the provision of liquidity, and I think through these

measures will effectively be freeing up the payment system so that

economic activity can begin again.

The government of Argentina has just given the outlines of a

broader plan with changes in the revenue sharing agreements with

the provinces, changes in the tax system. And those changes also

must be made if Argentina is to grow again. Economic growth is

the most essential thing for the Argentine economy, for the people

of Argentina. And I think we’re encouraged that the steps have

been taken. In fact, Secretary O’Neill just said earlier this week

that he’s very encouraged, and I certainly endorse this, that Argentina is beginning to take substantive steps to address these economic problems.
9

So I’d like to leave it at that, Mr. Chairman, in my opening remarks and take questions as you and the other Members see fit.

Thank you very much.

[The prepared statement of Hon. John B. Taylor can be found on

page 88 in the appendix.]

Chairman BEREUTER. I thank you very much, Secretary Taylor.

We will now proceed under the 5-minute rule and perhaps we’ll

have an opportunity for a second round of questions too if we don’t

have many more Members attending.

We have such incredible levels of social and economic agitation

today in Argentina that one has to wonder if the prescriptions that

might be recommended by the IMF, whether or not they’re the correct prescriptions, can be swallowed. And it certainly is a very difficult situation for the President and for the Congress and the

other governmental institutions.

I’d like you to comment on three items if you could. One, to what

extent do you think that the external factor of the Brazilian devaluation was a major factor in the problems that Argentina faces,

especially in light of their membership in MERCOSUR with Uruguay?

Second, what do you have to say about the dollar-to-peso peg and

the length of time in which it was put in place, given the accelerated value of the dollar? Hong Kong, of course, has a direct peg,

too. And although people have tried to break it, they’ve not been

successful. But then Hong Kong has fiscal discipline and more than

$90 billion in reserves.

And finally, at least, I would like to start you down a path if you

have time to talk about the recommendations of preconditionality

for IMF assistance to a country as recommended by the Meltzer

Commission, but strongly objected to by the minority opinion.

Mr. TAYLOR. Thank you very much, Mr. Chairman. With respect

to your first question, the effects of the depreciation of the Brazilian currency, and for that matter, the depreciation of the euro

relative to the dollar, I think these were certainly factors in preventing Argentina from growing more rapidly in the last 2 or 3

years. It is not the only factor.

Argentina is, at this point in time, not as open as one may think

in the sense of the fraction of exports, the GDP is relatively low.

It’s not much different than the United States, in fact. It’s not

nearly as important for the overall economy as other small open

economies in Latin America.

So I think it’s important to look at other factors in addition to

the depreciation of the real and the euro here. And to me, those

are the higher interest rates generated by basically expectations of

depreciation of the peso, which generated higher interest rates in

Argentina.

And I think also these changes in policy which I referred to, basically a movement back away from reforms where the deficits were

beginning to increase again and raising questions about debt sustainability, I think that policy shift maybe not so noticeable at the

time, certainly not as noticeable as the remarkable change that occurred in the early 1990s, but a gradual shift away from those

things, the fiscal discipline, the move toward privatization, and so
10

forth. I think that also is an important part of the growth slowdown and negative growth.

Taxes have to be favorable for economic growth. The tax system

in Argentina is not as favorable as it could be. So I would add all

those other reasons to the depreciation itself.

With respect to the dollar-peso peg itself, I always say when I

talk about this that that provided an enormous degree of stability

to the Argentine economy because it ended the hyperinflation. In

fact, it was a very popular law among Argentine people, because

of the end of the hyperinflation which has very painful memories

in most people’s minds.

There’s no exchange rate system, however, which works perfectly

in all dimensions. And pegs, even very strong pegs, have the disadvantage of not allowing changes in the exchange rate. And sometimes it’s better if those occur. I am of the view that if you have

pegs, they should be as strong as possible. For example, the European Union effectively has pegs for the countries in that union. It’s

very strong and effective. Greece is joining the European Monetary

Union, thereby pegging its currency in a more or less permanent

way with the euro. Those are very strong, very credible, and don’t

have the difficulties of credibility that other kinds of pegs do. So

the interest rates in Greece will converge very quickly to interest

rates in the rest of Europe. That did not happen in Argentina. Interest rates in Argentina, the peso interest rates, were generally

higher than dollar interest rates because of the possibility of depreciation or devaluation.

I think at this point in time, the Argentines have chosen to have

a flexible exchange rate. They recognize that that means there will

have to be other ways to contain inflation. And they have outlined

a program whereby the Central Bank will limit its increase in

money growth. And I think that’s going to be very essential to keep

inflation low, even without the convertibility law. What would be

very pleasing I’m sure for the Argentine people and I know for economic growth if inflation ultimately can be at the very low levels

that it was in the early 1990s after the end of the hyperinflation,

and no different from levels in Chile, Brazil, which are coming

down still, and for that matter, the United States.

The third question you raise about the preconditions. I think that

is a very important issue. This Administration has emphasized

prior actions or preconditions in many times, many programs already. Terminologies differ. I think the basic concept that you’re referring to is that a country before it starts into a program takes

actions which are in place and will not only make the likelihood of

the program continuing greater, but will increase economic growth.

And there was a program in Turkey that was developed during the

course of last year, actually voted on early this week at the IMF.

That program in many respects at Secretary O’Neill’s urging, the

U.S. Government’s urging, contained I think more prior actions

than many other programs. And that has been very accepted positive by the Turkish government, and they have made changes. For

example, changes in the banking law, changes in privatization.

And I think the more we can have changes up front, the more

we can limit the amount of conditions that have to be monitored
11

as you go through time, I think the more effective the programs

would be.

So the general concept of prior actions I think makes a lot of

sense, and we’ll be trying to work with the IMF to have as much

of that as possible.

Chairman BEREUTER. Of course, Argentina was in the midst of

a plan, so that’s a little bit different than the application of

preconditionality.

Mr. TAYLOR. Yes.

Chairman BEREUTER. But I’ll come back to that later. I’d like to

turn to the gentleman from Vermont, the Ranking Member, for his

comments and questions.

Mr. SANDERS. Thank you, Mr. Chairman.

Dr. Taylor, I think it’s no secret to you that many people in the

developing world and some of us in the United States have the feeling that the IMF to a large degree represents the interests of large

and powerful multinational corporations and does not serve the

poorest people of the world well. A lot of people hold that feeling.

I share that feeling.

I want to, if I can, combine three questions to you and see if you

can respond to them. And it deals in fact with the role of the IMF

in Argentina. The Argentine government pegged its currency to the

dollar in 1991. Approximately how much money did the government borrow from the IMF, either directly or through packages arranged with the help of the IMF from that point on? So number

one, first question is, what kind of economic relationships existed

between the IMF and Argentina? And I start off with the assumption, which is no great secret, that the United States is the 2000

pound gorilla within the IMF. We have veto power, and that reflects back on the policies that our Government develops. That’s

question one.

Question two, it now seems to be recognized by the vast majority

of economists that this decision of pegging the peso to the dollar

was a fatal mistake and explains much of the recent meltdown.

Should the IMF accept responsibility for this mistake since it supported the fixed exchange rate for years with tens of billions of dollars of loans? And then again, and obviously this was also before

your time, and what about the role of the U.S. Treasury in urging

the IMF forward on that policy?

Third, the IMF now claims, as I understand it, that it was

against the fixed exchange rate regime all along. There is no written record of either the IMF or Treasury trying to persuade Argentina to abandon the peg. Can you think of any other country to

which the IMF continued to loan and arrange loans for very large

amounts of money to support a policy that the Fund thought was

wrong and which if wrong could lead to economic disaster? In other

words, they’re saying now they made a mistake, but most of us

when we look back on the IMF, the IMF doesn’t lend money to

countries who are not following their dictates. To clarify, we are

not talking about a country missing its targets for the money supply or running a central government budget deficit bigger than

what it committed to. In other words, the issue here is, to what degree should we hold responsible, understanding that the Argentines themselves of course deserve a great deal of the responsi-
12

bility, but this Committee deals not with the internal workings of

Argentina, but with the IMF and Treasury’s role within the IMF.

So those are some of the questions that I would like to address

to you and appreciate your response.

Mr. TAYLOR. OK. Thank you very much. The IMF programs that

are currently actually in play, but they’re in suspension if you like

after December, really got started in March of 2000, the current

program, if you like.

Mr. SANDERS. If I may interrupt you. The original programs go

back a lot earlier.

Mr. TAYLOR. Yes. Many programs, there was loans. The loans

were repaid back, and basically I can go through all the loans that

were made and then paid back, but would you like me to——

Mr. SANDERS. Can we stay on the issue of the pegging of the dollar to the peso, which began in 1991? It’s hard for me to believe

that that was not supported, despite what the IMF may be saying

today, by the IMF at that time. Could you comment on that?

Mr. TAYLOR. Right. There were programs at that time. The programs in the early 1990s, and there were loans made, loans paid

back, loans made, loans paid back. And what I can do is get you

the actual details of where all those stand exactly to the dollar

amount if you’d like. But, there were certainly—there were programs that go back a long period of time with the IMF, IMF programs.

Mr. SANDERS. But, the simple question—and I would appreciate

that if you could get it to me as soon as you could——

Mr. TAYLOR. Yes.

Mr. SANDERS. But, the question is, if I am the IMF and I’m going

to lend you money, and I say I’m not going to lend you money for

fun. I want you to follow my policies. One of the policies I want you

to do is to peg the dollar to the peso. Now in 2002, it doesn’t look

like such a good idea. And then I said, well, actually, that wasn’t

my idea in the first place. What’s the story?

Mr. TAYLOR. Well, I’m not sure where the changes of opinion

you’re hearing about are coming from. But let me just say, and try

to answer your question in this way, the views about exchange

rates, about pegs, about floating, about dollarization, about single

currencies, amongst economists, amongst the private sector, evolve

over time. And until the Asian financial crisis, there were many

more pegs around the world than there are now. And I think partly

as a result of that crisis, but partly as a result of other factors,

there’s been a move away from pegs of the kind that we’ve seen

that are unsustainable.

But there’s been a movement away in two directions. One direction is toward flexible exchange rates, as Brazil has recently undertaken, that Chile undertook before that. Mexico is following that

kind of a policy. The movement away from pegged rates toward

flexible rates. And those moves always require that the country

adopt a monetary policy that focuses on keeping inflation low. So

if you’ll notice, each of those countries have some kind of an inflation-oriented price stability program associated with it.

The other move is toward, if you like, harder pegs. That’s like

dollarization is used in Ecuador. Greece joined in the European
13

Monetary Union. Pegs which are viewed as more sustainable, that

don’t have the threat of causing expectations of depreciation.

I think that movement is correct. And I believe either direction

is correct away from this middle ground which has caused so much

difficulty.

I think that the IMF, from what I understand from what I understand of their staff, is in agreement with that basic philosophy.

That the pegs in the middle here have led to difficulties. And one

other recent example of this is Turkey. Turkey’s IMF program

started with a peg and it fell apart in the middle, and now they’re

in a flexible system, and I think many people think that that’s

working better. That doesn’t mean that dollarization or single currencies is a bad idea. On the contrary, in many respects it’s a good

idea. What it means is these pegs in the middle are bad.

So I really can’t answer your questions about shifts in the IMF’s

view or saying that their view was different three weeks ago or

four weeks ago from what it is now. I do know—I’ll maybe finish

my answer with this—that what the U.S. Government feels is that

an exchange rate decision by a country is one that is very important to emphasize the country’s ownership of that. Exchange rate

systems involve history of the country, involve politics, really the

inner workings of a country more so perhaps than many other policies, but certainly a policy where ownership is important.

So what we have said in our policy about exchange rates is that’s

a decision for the country. And in terms of which works, I think

my view here about the ends of the spectrum are the ones that

tend to work and the ones in the middle——

Mr. SANDERS. Can I ask one great big last question?

Chairman BEREUTER. I ask unanimous consent that the gentleman have an additional minute. Is there objection? Hearing

none, the gentleman may proceed.

Mr. SANDERS. Thank you, Mr. Chairman.

In your view, what role did the IMF austerity program on Argentina have to bring about the current crisis?

Mr. TAYLOR. I think that the IMF has over this period of time

tried to give recommendations to Argentina to get their economy

growing again. I think there’s many things an economy can do to

increase growth. But to me, it’s basically lower taxes, a more efficient tax system, if you like, tax reform.

Mr. SANDERS. You’re not asking the question, sir. The austerity

program imposed by the IMF in causing the current crisis. Austerity program meaning cutting budgets and so forth.

Mr. TAYLOR. I would not characterize the IMF’s program that

they worked out with Argentina as an austerity program.

Mr. SANDERS. There are some who would respectfully disagree

with you on that point.

Mr. TAYLOR. Of course. I know that, sir. But it seems to me that

what the IMF wanted to do was work with Argentina to find a way

to get their economy stable. In fact, it was the Argentine government this year that decided to move toward the zero deficit law,

which I think in the terms that you’re talking about would be classified as quite austere.

Mr. SANDERS. I should think so.
14

Mr. TAYLOR. And they did that because they wanted to continue

with the program and not begin to restructure their debt. That was

the decision that they made in the summer. That turned out not

to be sustainable, and they’re off of that program. Now the new

government announced I believe yesterday a program where there

would be a deficit for the year 2002.

Mr. SANDERS. Thank you very much.

Chairman BEREUTER. Thank you, Mr. Sanders.

I want to call Members’ attention to the CRS report before us,

January 14th. On page 5, you’ll see that the record of the IMF

lending to Argentina traces back to 1986 and the repayment. Your

staff may look at that to see if you agree with that. You may not

have to send information. This is from the IMF website.

The gentleman from Pennsylvania, Mr. Toomey, is recognized.

Mr. TOOMEY. Thank you, Mr. Chairman. It seems to me what’s

vitally important for an economy is that there be a medium of exchange in which all players can have confidence. Borrowers, lenders, consumers, everybody can have confidence that the value will

remain roughly constant and that there not be excessive inflation

or deflation, and therefore a credible peg—and I think that’s an important distinction that you made—can serve that goal very, very

well. And there are examples, many, in which it does.

And in fact it strikes me that contrary to the notion that the peg

was the cause of the economic problems, it seems to me this is a

very clear example of where free market, classic or liberal economics were working extremely well. From the history, as I understand

it, and correct me please if I’m wrong, but having established in

the early 1990s a solid currency in which investors and borrowers

and others could have confidence, imposing fiscal discipline on the

part of the government, lowering trade barriers and privatizing

government entities, generated tremendous economic growth and

prosperity and income growth and job growth and trade and so on.

And in fact, it was when the government lost that discipline on

the spending side and started incurring an unsustainable level of

debt that the problems began to occur. Do you believe that the excessive level of government spending and therefore debt contributed more to the economic decline in Argentina than the fact that

they chose to peg their currency to the dollar?

Mr. TAYLOR. Yes I do, Mr. Toomey. I think, just as you say, the

changes made in the early 1990s had a great deal of success, and

as long as they were continuing, things were working just fine. So

I would point to the problem you just mentioned, is moving back

from those reforms as a major factor.

It’s not to say there weren’t external shocks and changes in exchange rates or interest rates in the U.S. economy and other economies around the world. But I think you’re pointing to the fundamental fact.

Mr. TOOMEY. My follow-up question is, by early 2000, do you recall approximately what was Argentina’s debt as a percentage of its

GDP?

Mr. TAYLOR. Approximately—you’ll have to accept some round

numbers—approximately 45 percent.

Mr. TOOMEY. And looking to grow significantly at the time?

Mr. TAYLOR. Yes.
15

Mr. TOOMEY. As opposed to the United States where we’re somewhere in the low thirties as a percentage of GDP and as a percentage of GDP, not likely to grow terribly significantly?

Mr. TAYLOR. It has been falling remarkably.

Mr. TOOMEY. The United States has been falling remarkably?

Mr. TAYLOR. Yes.

Mr. TOOMEY. Argentina’s been going up. My question really is,

do you believe it was really prudent for the IMF to contribute to

increasing this debt load, which it did, from March of 2000 adding,

as I understand it, over $7 billion in debt? January of 2001, another $6 billion. August of 2001 another $8 billion. Increasing the

debt which arguably was significantly contributing to the very

problem while there was not systematic reforms that would bring

back the discipline yet that had gotten the economic prosperity in

the first place? In other words, was the IMF now contributing to

the problem?

Mr. TAYLOR. Well, that’s a very good question. The most recent

augmentation of the IMF program occurred last August. And that

was for a particular purpose which was actually to stem or to halt,

curtail a run on the banks. Basically deposits were being withdrawn last summer at a pretty rapid rate. And so those funds were

put in there for that purpose.

The IMF makes loans. That’s the way their funds are distributed. So their support is always in the form of loans. So since that

was for that particular purpose, I think it would not qualify as

something that would cause the dangers you refer to. The second part of that was a $3 billion loan which would be

available if Argentina began to restructure its debt. So in other

words, that loan was for the purpose of actually reducing overall

loans. IMF loans are of course a much lower interest rate than Argentina has to pay in the market. And so that loan actually was

used as a way, if they wanted to do it, to begin to restructure the

debt and therefore reduce the debt.

However, I would say in general, your question raises some important issues. And that is, is it really correct when a country is

in a high debt situation to provide loans? And the general thought

about that is if you’re convinced, if the IMF is convinced and the

shareholders are convinced that those loans will, if you like, bridge

to better times where you can see a decline in the level of debt

compared to GDP, then we make sense. But, if it’s just loaning to

an increasingly high level of debt compared to GDP, then it doesn’t

make sense and it shouldn’t be done. And I think that’s where we

have to insist on more. That we don’t provide loans in those circumstances, because effectively those loans are bailing out the

bondholders who at that point in time having received very high

rates of return, shouldn’t be bailed out.

Mr. TOOMEY. Thank you.

Chairman BEREUTER. Thank you very much. An important conclusion I think.

The gentleman from Massachusetts, Mr. Frank, is recognized for

5 minutes.

Mr. FRANK. Mr. Taylor, one of the problems I think we have is

however they got into the fix, they’re in it and here it seems to me

there is this dilemma. The things that they need to do in Argentina
16

to reduce the problem almost certainly will have unpleasant shortterm effects on a large number of people in Argentina. And that’s

part of the dilemma. How do you get a democracy to do that? I

mean, this is one of the things I think we have to deal with. It’s

a democracy, and we have a commitment in the U.S. which has

been bipartisan. In fact, one of the encouraging things about Latin

America is if you go back 30 years and compare it to today, democracy has clearly thrived, and it has clearly improved its standing.

But how do we deal with that? I mean, this it seems to me is

a major issue for policymakers. How do you get a democratic electorate to accept politically short-term pain? We have seen a succession of very obstreperous, and in some cases, as you point out, violent responses to things. Given what we would suggest Argentina

do, do you see a problem in getting a democratic government to

persuade its electorate to go for it?

Mr. TAYLOR. I think at this point in time the payment system

needs to be freed up.

Mr. FRANK. What system? I’m sorry.

Mr. TAYLOR. The payment system in Argentina needs to be freed

up. There needs to be at least a gradual removal of the freeze on

deposits, and both of those things are going to be things that the

Argentine people would like right now.

Mr. FRANK. Well, except you’re saying gradual removal. They

don’t want a gradual removal. They want a quick removal. A gradual removal means a continuation for a while. It seems to me a

gradual removal was not all that popular.

Mr. TAYLOR. At least it’s an improvement from where it is. You

mentioned in your question about frequently economic changes or

reforms require pain in the short run in order to get the gain in

the long run. And I think in this case there’s a real opportunity to

relieve the pain in the short run.

Mr. FRANK. You’re coming in in the middle of the movie, and

they were there for the whole movie. That is, yeah, once you’ve got

the freeze, it is better not to gradually relax the freeze than to keep

it going, but should they have had a freeze in the first place?

Mr. TAYLOR. Well, I think in the first place it would have been

better and everyone agrees that they never got to the position

where they needed the freeze.

Mr. FRANK. I agree. The best way to go on a diet is never to get

fat in the first place. I understand that.

[Laughter.]

Mr. FRANK. But I don’t think you make a lot of money selling

that as a diet plan, except maybe on the internet where you can

sell anything. But the question is, given where they are today—I

think you’re just ducking the question, frankly. I don’t understand

the point of that. Yes, it is better to have a gradual, from a political

standpoint, it’s better to have a gradual relaxation of the freeze

than to have it forever. But the problem is, if you thought a freeze

was necessary at all, yeah, it would have been better not to have

needed a freeze. But do you think they needed a freeze? And if they

did, how do you sustain that in the face of political unhappiness

even if you’re going to gradually relax it?

Mr. TAYLOR. Well, as I said in my opening remarks, they imposed the freeze because of this withdrawal of deposits. And in a
17

reserve banking system in the currency regime they were in at that

time, they couldn’t have this continual withdrawal of funds. That’s

the reason they put it in.

Mr. FRANK. I understand that.

Mr. TAYLOR. You could say that, given that situation, they had

to put the freeze in and—— Mr. FRANK. Well, you could say, you want to say. I mean, you

could say a lot of things. What do you want to say?

Mr. TAYLOR. Well, I want to answer your question.

Mr. FRANK. OK. Then answer my question. My question is, do

you think given where they were they had to put on the freeze, and

if they did, how do you deal with the political resistance to something like a freeze which is unpopular?

Mr. TAYLOR. Dealing with the political resistance it seems to me

is you want to emphasize to people the benefits of getting to a better system. And if there is in any case some pain in the short run,

you want to emphasize to people that that is short run and there

are going to be such good gains for you in the future that you

should pay attention to those.

The other thing is you can find ways to relieve the pain in the

short run. In many societies, the United States included, we have

ways to help people who lose their job, who have no income, and

that’s—— Mr. FRANK. But those require government spending don’t they?

In the short term to help people who have lost their jobs?

Mr. TAYLOR. Well, certainly.

Mr. FRANK. And they would add to the deficit. But that’s the dilemma that if believing that part of the problem was an increase

in government spending, then alleviating the pain in the short

term.

Let me turn to one other quickly. By the way, when you talk

about the long-range gains, I know you’re not a Keynesian. But

Keynes’ political advice I think was superb, regardless of what you

think of his economic advice. But public reaction, as you know,

when they are told about the long run, they say in the long run

we’ll all be dead. The public understands that and their tolerance

for long-range gain over short-term pain it’s I think hard to deal

with.

Chairman BEREUTER. I ask unanimous consent the gentleman

have another minute so he can get his last question in, without objection.

Mr. FRANK. I have just one regional issue. The banking sector,

obviously, is heavily engaged. And it seems to me there’s another

dilemma. Yes, people who lend money know they’re at risk. On the

other hand, if the result is nobody wants to lend any money in the

future, we also have a problem. Have you looked at what the impact might be on a couple of major American banking institutions?

And obviously I don’t want to see moral hazard, but I don’t want

to see the reactions of any kind of support there’s a total withdrawal. How do we deal with that dilemma?

Mr. TAYLOR. Well, I think one of the biggest problems that have

existed in these emerging markets in the last 3 or 4 years has been

a decline in the flows going through them. If you look at a chart

of emerging market——
18

Mr. FRANK. Decline in what? I’m sorry. You said a decline in

what? I didn’t hear the words.

Mr. TAYLOR. Decline in capital going through the emerging markets, into the emerging markets, capital flows, if you like. It’s declined dramatically in the last 3 or 4 years. And what we’ve been

trying to do is trying to reverse that, because those flows are really

what’s going to help developing economies, emerging market economies grow more rapidly.

So one of the ways you want to do that is to have a more sensible

IMF policy, a more predictable policy with respect to debt sustainability.

So that’s a fundamental—— Mr. FRANK. Is there a tension there between that and trying to

totally eliminate moral hazard?

Mr. TAYLOR. I didn’t hear the first part of your question.

Mr. FRANK. Is there a tension between that goal and totally

eliminating any moral hazard?

Mr. TAYLOR. I actually think it’s a win-win situation. If we reduce moral hazard, create better certainty, more certainty in the

markets, more predictability, I think there will be more flows into

these markets. The difficulty in these markets is too much uncertainty.

What’s happened in the last year, which I think we need to recognize, is that the markets have showed much less of contagion

from one country hitting another country, than existed several

years ago. And there are many reasons for that. But it’s a very important development, and I think a favorable development, which

will keep people in these markets and in fact bring more people

into them. I’m not sure if I answered the full part of your question.

Chairman BEREUTER. The gentleman’s time has expired. We will

be able to come back if the gentleman sticks with us.

The gentlelady from West Virginia, Ms. Capito, is recognized for

5 minutes.

Ms. CAPITO. My original first question was much along the lines

of my colleague in that can you restore confidence with all the civil

unrest and turnover in the presidents, and so forth. Can you stem

the tide of civil unrest? But I’m curious to know as well the

leadover effect on other countries in South America, and certainly

their economies are intertwined and where you see the reforms

that are trying to be taking place in Argentina or the political situation there playing out in the rest of the continent.

Mr. TAYLOR. Well, first, the fact that there has been less economic or financial contagion I think is important to note. And the

emerging markets generally have—the spreads have gone down. It

went up on 9/11, of course, but they’ve come down dramatically

since then, surprisingly.

The political carryover, if you like, sometimes people call it political contagion, to answer your question on that, it seems to me that

it needn’t occur if we are very clear about what actually has happened and has happened in Argentina. One thing I’ve tried to do

in my testimony is indicate that it’s not economic reform, it’s not

market principles. It’s not fiscal discipline. It’s not low inflation

that caused the problems in the Argentina, it was moving away

from those principles.
19

So if anyone wants to draw lessons from that, that seems to me

that should be the lesson. And that suggests that there shouldn’t

be a movement away from good economic policy that seemed to

work in other countries. And I think what we need to do is communicate that based on the facts and based on the analysis.

To me, discussions about possible political contagion here are

similar to all the discussions about globalization that have occurred

over the last few years. People for various reasons arguing that reduction in trade barriers, market principles are really not beneficial to the world economy, and many people trying to argue that

that’s not the case. That free trade is a way to reduce poverty and

improve people’s welfare. And I think because of events like this,

we may have to have a response that pertains in particular to Argentina, and in particular to other countries in Latin America. But

the arguments are very much the same. And that is to show as

much as we can the facts, the reality that market principles, free

trade, growth-oriented policies are good for people.

Chairman BEREUTER. Next we’ll go to the gentlelady from New

York, Mrs. Maloney, Ms. Carson and Mr. Ferguson. The gentlelady

from New York is recognized.

Mrs. MALONEY. What’s going to happen next? We thought the IMF was going to give them a loan at $1.3 billion in December, and

they have backed off from that. So what’s next? We need the market reforms then they’ll give them the loan? What’s going to happen next? They obviously need help.

Mr. TAYLOR. That’s true. The IMF in December, as part of its

regular review of what was happening in Argentina, as in every

program, judged that the fiscal targets in the program were not

met and that on that basis did not give the next tranche, the next

loan, the next installment, if you like. And so what’s next is for Argentina to make the decisions, as they’re beginning to do, to get

their economy moving again so they can get into a program again.

So the next part is really playing out as it should in Buenos

Aires and Argentina to take some decisions to improve growth in

the Argentine economy.

Mrs. MALONEY. And what if they don’t do that? What happens?

Mr. TAYLOR. Well, I very much hope that they do do that, and

I don’t want to think of any alternative. That’s the alternative is

to continue to have low growth and continue to have policies which

are painful to people. There’s a great opportunity to improve

things, and I very much hope they—— Mrs. MALONEY. Why is there less contagion now? It used to be

that something like this would happen and there was like just an

international concern that it would destabilize more countries and

really hurt individual investors and mutual funds and retirement

plans.

Mr. TAYLOR. That’s a very interesting question.

Mrs. MALONEY. Because I can remember Indonesia having similar problems, everyone—some of the Asian countries. But this one

they’re treating it very differently. So I’m wondering why you’re

thinking there’s no contagion.

Mr. TAYLOR. Well, I think several things have happened. One is,

there’s much more analysis of what’s going on in these markets

than there was 3 years ago at the time you’re referring to. So that
20

investors themselves differentiate between countries’ policies, good

policies, bad policies. And they also differentiate between policies

and external events that hit countries. And that’s not just with respect to Argentina vis-a-vis other countries, it’s with respect to all

the markets.

I think that the U.S. and this Administration has tried to build

on that change by commenting on it very early in our Administration, we commented on how contagion is changing. It’s not automatic. It’s more based on fundamentals. And in fact we were criticized quite a bit for that. But our purpose there was to communicate with the markets that we understood what was happening

there and that our policies were going to reflect that. And I think

that has helped to reduce the contagion as well by making our policies hopefully more predictable.

Mrs. MALONEY. What is the role of the international financial institutions in this? I know at one point they threatened to leave the

country when they were going to structure the conversion to pesos

really to a disadvantage to their accounts. What role will they play

in this in helping to—— Mr. TAYLOR. Well, the international institutions have a role to

play in emerging markets. I think their role can be improved in

various ways, by greater transparencies and other things. But they

do have an important role, not just the IMF, but the Inter-American Development Bank and the World Bank. And what they do,

of course, not just with respect to Argentina, but with respect to

other countries, is to provide loans.

That’s what the IMF does, provide loans, to help bridge to better

times, if you like. And I think they do that in the context of actions

the countries take. So, for example, I just mentioned before, Turkey

has taken some actions, on that basis they got loans hopefully to

better times and things will improve and then the country can get

off the IMF program and proceed with its policies independently.

Mrs. MALONEY. You mentioned earlier that they’re not competitive in their exports, given their position as the third largest economy in South America, and that that’s one of their problems.

They’re not able to generate their economy. Could you elaborate?

What are they doing that—why aren’t they competitive? Are their

financial markets there controlling it too much, or what is happening? Running up the price? Or what’s happening with their exports? They have a lot of things they could export. Why aren’t they

successful?

Mr. TAYLOR. I think the main reason for the lack of so-called

competitiveness recently was the change in the currency in Brazil

and Europe, which basically—there was a lot of trade particularly

with Brazil, and the devaluation of the real.

Mrs. MALONEY. So it was really external actions?

Mr. TAYLOR. Yes. That’s what that term means as I was using

it. But it also means something internally about competition, and

I think Argentina and many other countries could have ways to

have their markets be more competitive. And ultimately, what’s

going to determine the degree of competitiveness for a country is

how productive the country is. That is, how rapidly productivity increases. And that’s a growth strategy, and that has to do with

doing things, greater competition, less——
21

Mrs. MALONEY. Are they implementing a growth strategy?

Mr. TAYLOR. Well, I hope so. I hope so.

Mrs. MALONEY. I thought Mr. Toomey’s comments earlier were

interesting. I was in Argentina in the mid-1990s and we met, the

International Relations Committee with then-President Menem,

and it was being touted as the economy to watch, the growth economy in South America, and that pegging the peso to the dollar had

been a smart move, and this was the whole talk internationally

and in Argentina at the time. And then to see complete reversal.

And you just say that’s increased uncontrolled spending that happened?

Chairman BEREUTER. The time of the gentlelady has expired.

The gentleman may respond.

Mr. TAYLOR. That was part of it. But I think the changes then

were important. They had some very good effects. The problems

now I think are not those changes, but moving away from those

changes.

Chairman BEREUTER. The gentlelady from Indiana, Ms. Carson,

is recognized.

Ms. CARSON. Mr. Chairman, I’d like to yield my time.

Chairman BEREUTER. The gentlelady may do that.

Mr. FRANK. Thank you.

Mr. Taylor, let me go back. Given the circumstances in which

they were at the time, do you think the freeze was a good idea?

The freeze on bank deposits.

Mr. TAYLOR. I think given that they were not going to make

other changes at the time, yes. Other changes that could have been

made.

Mr. FRANK. Like what?

Mr. TAYLOR. Well, they’re of course now moving to a different exchange rate system. That would have been a possibility.

Mr. FRANK. But, I thought they had moved—hadn’t they

unpegged? They had unpegged, hadn’t they, when they froze?

Mr. TAYLOR. They imposed the freeze before there was any move.

Mr. FRANK. OK. So you think if they had simply unpegged the

peso and let it float?

Mr. TAYLOR. Well, as I was saying before, moving away from the

peg toward solid dollarization or if you moved to a flexible—— Mr. FRANK. Would they then have not had to do a freeze? If they

had done the right currency policy, do you think the freeze would

have been unnecessary?

Mr. TAYLOR. I think so, yes.

Mr. FRANK. And which would that have been, in your judgment?

What would have been the best policy?

Mr. TAYLOR. Well, as I indicated, you can either——

Mr. FRANK. Pick one. Are they equally good?

Mr. TAYLOR. It would depend on the circumstances at the time.

But I’d say——

Mr. FRANK. This is not a hypothetical. This is like a real country.

So we know the circumstances at the time. Argentina, 2001.

Mr. TAYLOR. Well, as I said before, and I believe this—I’m not

dodging your question—that decision depends very much on what

the country’s history is like and their politics.

Mr. FRANK. But we know that.
22

Mr. TAYLOR. From an economic perspective.

Mr. FRANK. Yes, but we know that. Again, this is not a hypothetical, Mr. Taylor. It’s a real country. Argentina in 2001. And

what would have been your recommendation?

Chairman BEREUTER. I think the gentleman understands your

point. We’ll just let him respond.

Mr. FRANK. He’s not responding.

Chairman BEREUTER. He may. Give him a chance.

Mr. TAYLOR. I at that point in time thought that dollarization

would have been good for Argentina.

Mr. FRANK. I’m talking about—but couldn’t dollarization, we’re

talking about last year when they had to get off dollarization.

Mr. TAYLOR. They were not in dollarization and they’re not now.

They’re going in a different direction.

Mr. FRANK. You would have recommended that they move in

2001 to complete dollarization?

Mr. TAYLOR. I wasn’t recommending that. Because, as I said,

U.S. policy, it’s for the country to choose. But, if you’re asking my

view—— Mr. FRANK. That would have been your view?

Mr. TAYLOR. That would have been my view.

Mr. FRANK. That leads to another question, though, which is

what would the short-term social impact have been of dollarization,

do you believe? Would there have been any greater one way or the

other?

Mr. TAYLOR. First let me say the political side—I won’t address

that, because it depends very much on what the politics in the

country is. But from the economic side, dollarization can have advantages to a country. It removes the threat—— Mr. FRANK. I’m sorry, Mr. Chairman, if this bothers you. But

we’re not talking about a country. We’re talking about Argentina

in 2001. And the problem again, because I want to get back to this,

is that is there is this problem which I think you are enlightening

too easily and this is what we have to really deal with. I understand your tendency is to say if they had done better in the first

place, the problem wouldn’t have arisen. I agree with that. But almost always we only deal with the problems that have arisen.

There are a number of countries that have done good things. We

don’t have hearings about them. We don’t have to make policy

about them. We’re in the grief business. That’s what you do and

that’s what we do.

The question is, given that these mistakes were made by people

there, how do you deal with it? Because you acknowledge, you

agree with Mr. Toomey that excessive government spending and

deficits are part of the problem. The problem, though, is that what

you said could be done to alleviate the short-term pain adds to a

deficit. So that’s the complex of tough issues I think you have to

deal with.

If you’re going to take steps that are remedial, but increase

short-term pain, how do you do that? Or is that then an appropriate role for international aid? Should we come in and help them

with money to alleviate short-term pain if we’re convinced that

they are doing this as part of a program that’s going to provide

some long-term advantage?
23

Mr. TAYLOR. I think that’s the way that the programs are frequently put together. As I was saying, a bridge to better times to

give them some resources.

Mr. FRANK. But then let’s go back to the Meltzer Commission,

because they made it in a different context. Should they be grants

instead of loans? One of the arguments of the Meltzer Commission

that did seem to me to have some plausibility would be that we use

loans too often for people who are in terrible trouble when we

should be doing grants. But differing with them, is that I don’t

think they were ready to put the additional resources into that that

I think that calls for.

But, should we have considered in a situation like Argentina if

people are willing to adopt a policy that has long-term gain, shortterm pain, should there be on our part and on the part of the international institutions a willingness to provide some money, perhaps

through grants, to help them get over that?

Mr. TAYLOR. I think grants are an excellent way to proceed for

very poor countries.

Mr. FRANK. So they’re not Argentina?

Mr. TAYLOR. They’re not Argentina.

Mr. FRANK. So you would not propose grants for Argentina?

Mr. TAYLOR. I think the loans are just fine for Argentina. The

grants, however, for the poorest countries in the world—— Mr. FRANK. I realize we’re not talking about the poorest countries. Thank you, Mr. Chairman.

Chairman BEREUTER. The time of the gentlelady which was extended to Mr. Frank has expired. The gentleman from New Jersey,

Mr. Ferguson.

Mr. FERGUSON. Thank you, Mr. Chairman. I appreciate, Mr.

Chairman, your holding this hearing and I thank the witness, Mr.

Taylor for being here. I appreciate your understanding. I wasn’t

here the whole time. I didn’t hear some of the other questioning.

I have read some of your testimony, but my apologies in advance

if some of this is duplicative.

Obviously the situation that we’re dealing with Argentina is

tragic in many ways. People there are experiencing very trying

times. I appreciate what you have said and some of the principals

that the Administration and the President laid out in terms of

wanting to be friends and allies, to be there for our friends in their

time of need.

But I think something you also said was to try to reduce the frequency of financial crises such as this in the future. And I think

our reaction, and the actions that we take now in response to some

of these crises and some of the actions taken by those in Argentina

are gong to have a lot to do with avoiding these types of situations

in the future, because not only do we want to make sure that this

is a long-term and not simply a band-aid approach to helping Argentina during this time, but for their neighbors, for the rest of

Latin American, and frankly, for the rest of the world are going to

base their actions in some part looking at the reaction that we

have to this situation.

I certainly don’t want to take steps now to try and put a shortterm solution on this situation and create additional long-term

problems, and I’m sure you share this view. But that’s kind of the
24

mindset that I bring to this. And I certainly will not claim to be

an expert on this situation. I certainly would not claim or pretend

to know as much about the details of this situation as you do or

perhaps as Mr. Frank does.

But I just have a couple of questions. What is your understanding of the measures taken by the Duhalde government

against the United States companies that have invested billions of

dollars in Argentina, such as folks in the electric and gas sector,

the telecom sector, other sectors? What is your current assessment

of the actions that have been taken?

Mr. TAYLOR. What we’ve tried to do in talking with various firms

is to emphasize to the Argentine government that it’s important to

treat all investors fairly—foreign investors, investors within their

own country. And we’ll continue to do that.

They’re now going through this process of changing from dollars

to pesos. It’s part of a reform program. And that entails changing

valuations, basically devaluation. And they’re doing that in a way

that tries to address the fact that if you change a denomination of

a loan or a deposit, it has big impacts on individuals. It’s going to

sometimes force people into bankruptcy or to other dire situations.

So they’re looking for ways to smooth that out. And ultimately,

people are going to have to make adjustments to that. And I think

what we can do and we are doing is emphasizing to them is to do

this in a way that is fair and predictable and sensible, and when

we see they’re not going in that direction, we comment on it.

And I think there’s an important reason to do that in addition

to the ones that you’re indicating, and that is, that’s how they’re

going to have foreign investment and growth in the future.

Mr. FERGUSON. How do you feel, though—I mean, we’re talking

about making sure that the actions that they’re taking and the way

that they are addressing the situation is fair and equitable. And I

frankly have some concerns about what my understanding is the

way that they’re going about it. Do you share those concerns?

Mr. TAYLOR. We’ve received many phone calls from people that

are concerned about it. And we’ve in turn expressed those concerns.

They of course have received many concerns as well. And what I’d

say is, they’re now working on these concerns and trying to take

them into account. They haven’t finished. A program is being developed, and how the pesofication works is still being developed.

So, again, what I would like to do is to continue to work with

them, work with the private sector to give suggestions about how

to make it work. It’s not finalized at this point in time.

Mr. FERGUSON. Are we having conversations? Is Treasury having

conversations with IMF right now about the nature of trying to ensure some protection for U.S. investors in particular? I’m thinking

of the energy sector in particular. I mean, are we——

Mr. TAYLOR. What we’re having discussions with the private sector, with the government of Argentina, with the IMF is to argue

that all investors should be treated fairly—foreign investors, U.S.

investors, everyone else. So, yes, the answer to your question is

yes, we are.

Mr. FERGUSON. Are we prepared to take actions with regard to

that? I mean, are we prepared to insist that money being released

to Argentina through the IMF is withheld until a fair process can
25

be worked out or some agreements can be worked out? It’s the estimation of a lot of folks that they’re not going about it in a fair way.

Mr. TAYLOR. I’d say yes, that is a factor in any advice we would

give to the IMF about this, certainly.

Mr. FERGUSON. Where would you put it on a scale? I mean, are

we very high?

Mr. TAYLOR. Yes.

Mr. FERGUSON. Finally, what is your understanding of the protections provided to U.S. investors under the Bilateral Investment

Treaty with Argentina? And I’m thinking specifically about your

understanding of any recourse that may be available to these companies, to any of these investors, particularly when we’re talking

about actions tantamount to exappropriation.

Chairman BEREUTER. The time of the gentleman has expired.

The gentleman may respond.

Mr. TAYLOR. I want to make sure that that doesn’t happen and

work toward that. And if it does, then I’ll try to answer your question when it happens if that’s OK. But certainly, as I say, we’re

working very hard on that. We recognize the importance of the Bilateral Investment Treaty. We have lawyers who are looking at it

carefully and policy experts, and it is a concern. But at this point

the contacts we have both in the private sector and in the government say that they’re working on things right now. Your questions

to me and my responses I hope are helpful as well in terms of indicating how important we think this is.

Mr. FERGUSON. Sure. I thank you, Mr. Chairman. I appreciate

Mr. Taylor’s testimony. And I would just reiterate that some of the

concerns that I have—and you can see what I’m getting at through

some of my questions—still exist, and I’d be happy to continue to

work with you and as we have questions in the future, if you could

continue to be as cooperative as you have today, that would be

great. Thank you.

Chairman BEREUTER. As a matter of fact, we’ll permit the Members, by unanimous consent, to submit questions to the Secretary

for the Treasury to respond to for all Members.

I’d like to begin a second round and focus really on two things.

First of all, I appreciated your response about the reason we

haven’t had, fortunately, the degree of contagion that we might

have expected or that we saw in the Asian financial crisis.

I am highly critical of the IMF’s activities with respect to Thailand and Korea. I think they prescribed medicine that wasn’t appropriate and caused additional problems and plunged those two

countries into difficulties, but neither one were fiscal basket cases

and the IMF is accustomed to dealing with fiscal basket cases.

I liked Mr. Toomey’s comments about the structural and microeconomic changes that have been made in Argentina. But fiscal irresponsibility, it seems to me, is part of the problem. And much of

the problems that Argentina has in my judgment are self-inflicted.

And if you take a look at the fiscal policies or irresponsibility of the

provinces in particular, and of course the national subsidy to them,

there have been several economists that have written about the extraordinary corruption and flagrant expenditures by the provinces,

and they just got bigger and bigger.
26

Now hearing your comments about a middle type of peg which

you think was not advantageous instead of a free-floating currency

or a hard peg, do you think, if you know, the IMF loan extended

in 1996, the IMF loan in 1996 and then extended in 1998, do you

think the IMF gave a recommendation at that point about abandoning the type of dollar peg that they had in place?

Mr. TAYLOR. I just don’t know the answer to that question.

Chairman BEREUTER. Do you think it would have been appropriate at that stage, or do you have an opinion on that?

Mr. TAYLOR. I really don’t know the circumstances enough to answer it. My answer in general is the one I gave before, that there

are these two sides which work well, and for a long time I’ve

thought the one in the middle is questionable. And were I here at

the time, I probably would have said that. But the circumstances

are different.

Chairman BEREUTER. Thank you. We can go back and look at the

speculation and what was the advice at the time, but of course we

can’t exactly find out because of lack of transparency.

The second point, I think Mr. Frank and perhaps another Member was headed this way. At least I want to convey the view that

I think there are times when the patient is too weak to take the

prescribed medicine, and that you need to try to restore some of the

health of the patient. And Argentina is in that sick situation as

Haiti was, for example, in the past, and the IMF imposed such a

high degree of austerity measures that the political turmoil was

just beyond their ability to cope with it.

So it seems to me that we have an opportunity to permit them

to acquire more debt, or there’s some sort of grant program, and

then the question might be, is that grant program in the IMF or

is it in the World Bank and a regional development bank, InterAmerican Development Bank, in this instance. It’s always easier,

I think, if it was a part of the IMF rather than a coordination between IFIs. But they don’t have that history, as far as I know.

So do you want to say something about this issue that, in fact,

the austerity measures have to be tempered in certain cases with

some assistance to the people that are out of work and to the other

people that are in some degree of destituteness or problem?

Mr. TAYLOR. I think that’s correct, Mr. Chairman. And the philosophy behind the IMF’s engagement with countries is to support

that view, I believe, in the sense of giving more breathing time,

more room to make adjustments and therefore use resources to alleviate pain that might occur otherwise as Mr. Frank was indicating.

The other IFIs, the World Bank and the IDB, can give more direct loans for the social sector. And of course, in the very poor

countries, not Argentina, but give grants, as we’re arguing for that

purpose. The IDB and the World Bank have already indicated in

the case of Argentina the willingness to provide loans for the social

sectors which could definitely alleviate some of the pain that you’re

referring to.

So I think it is really part of the nature of the assistance that

they can give to countries. In the case of reforms, there’s this area

where the reforms may be difficult, may require some extra social
27

service payments or extra aid to people who are harmed by it. And

they can provide in those circumstances.

I think, just maybe add slightly to that, the concern that people

sometimes have is that the loans and the support goes beyond that

into more unsustainable things where there’s nothing to bridge to,

and then you get these series of problems that build up over time.

Chairman BEREUTER. The gentleman from Massachusetts.

Mr. FRANK. Thank you, Mr. Chairman. I’m going to pick up

where you left off, because I think this is very important and I

think we probably ought to acknowledge it. It’s good that the international financial institutions are now doing this. Not too long ago

they’re doing the opposite. The IMF’s response in situations like

this, and this is one of the reasons it became controversial and

many on this subcommittee were critical was in Asia and elsewhere

in 1998, they were basically pressuring governments to do exactly

the opposite; to cut back on those social measures which alleviate

pain. And I think we should count that as a successful change in

international public policy that the IMF now, and it’s very good to

hear you say that they have now reversed that and people understand that in the short term, some of these alleviation measures

have to go forward.

As I said, again, unfortunately, if you go back in 1998 in Asia,

they were prescribing exactly the wrong things. And I remember

the specific prescriptions in Indonesia and Thailand and elsewhere

that were exacerbating these kind of issues.

I was following very closely your debate—not your debate, your

colloquy with Mr. Ferguson. Obviously people who lend should bear

risk, but there are lot of tensions in this. One of the tensions is between telling all the foreign lenders that they’re entirely on their

own and don’t come to me, and then saying, oh, by the way, it

would be a good idea if you lent to those people. And I think if in

fact we have a national policy of encouraging lending, then there

is it seems to me some obligation to try and not bail them out completely, but to help. I do think this argues strongly for some form

of international agreement dealing with what you do when you’ve

got these kind of defaults.

But, let me ask from the Treasury standpoint, is there any concern—we’ve got a couple of large financial institutions. One of them

is obviously the major one in the State that I represent, that have

been heavily exposed there largely for good reasons. Is there any

concern in the Department that their exposure could become a

problem for us here domestically?

Mr. TAYLOR. Well, we’ve looked at the numbers, talked to them.

They obviously are very concerned with what’s happening, and relating to the discussion with Mr. Ferguson, communicating to us

how they see it.

Mr. FRANK. There’s another bankruptcy bill and——

Mr. TAYLOR. How they see it, and we listen and convey the concerns that we hear. But it’s not something that is large enough to

threaten their overall operations.

Mr. FRANK. OK. That’s good to hear. But it does seem to me

there’s a public policy interest in their not being discouraged over

and above there’s no public policy interest in whether they make

a profit or not. That’s their deal.
28

Let me ask you one other set of questions. I know that the Administration had identified as a very high priority this free trade

agreement with the Americas. It does seem to me that what’s going

on here is going to become more difficult there. In particular, what

are the implications? I mean, clearly as you’ve said, one of the

problems Argentina faced were the currency differences between

Argentina and Brazil, the two large economies there, and the disparity in the value of the currencies have very significant impacts

on trade. Does this mean that the currency question really has to

be better dealt with as a prerequisite before you’re going to get an

agreement on an FTAA?

Mr. TAYLOR. I think the FTAA can work well with various currency arrangements, as long as you don’t get to these ones that are

unsustainable. And if you think about what’s happening in much

of Latin America, it is moving into exchange rate systems that are

more lasting, and either through dollarization, as has occurred in

Ecuador, or through the flexible system that Chile has used for

quite a while, a dozen years. They were one of the first to start this

inflation targeting type of system with the flexible exchange rates,

and now Brazil and Mexico.

Mr. FRANK. The question, though, was—— Mr. TAYLOR. I think those all work quite well. When you think

about—— Mr. FRANK. I understand that. My concern is this. Is there going

to be a reluctance on the part of some of the countries further to

open their economies to trade if they are worried that currency differences might have more of an impact?

Mr. TAYLOR. I hope not. But I think an example is NAFTA. We

have I think a very successful North American Free Trade Agreement. We have a fluctuating exchange rate with both Canada and

with Mexico. None of this has happened with those.

Mr. FRANK. Do you think that Brazil and Argentina and the others think of themselves analogously to Canada, the U.S. and Mexico in that regard? I mean, my sense is that the hope may be father

to the conclusion here. And it does seem to me that the instability

and difficulty exacerbated by different, not just different exchange

rates, but different exchange rate mechanisms, and that’s contributed to this. And let me just ask you very simply, if you polled in

Argentina a year ago about a FTAA and you polled today, would

you think it would be about the same or do you think there might

be more resistance?

Mr. TAYLOR. Well, just guessing on my part, but I would say at

least the same, maybe more favorable.

Mr. FRANK. You think the Argentine public is more favorable to

an FTAA today?

Mr. TAYLOR. When I talk to my friends in Argentina, travel

there, talk to them here, they are so positive about trade as a way

to grow.

Mr. FRANK. Were any of your friends in Argentina out banging

pots a couple of weeks ago?

[Laughter.]

Mr. FRANK. I mean, you know, there are friends and friends. Do

you think that what’s gone on is a good thing for the public support

in Argentina for the FTAA?
29

Mr. TAYLOR. Well, I think the importance of FTAA is so important that we need to stress it further. In terms of what a particular

person banging pots says, of course I don’t know. But I think the

genuine feeling is, is a recognition that more trade, in particular

with the United States—— Mr. FRANK. Well, I envy you from your perspective your optimism. It must make life very cheerful. Thank you.

Chairman BEREUTER. Thank you. I think this is a question we

may not want the Secretary to answer in open session.

Mr. FRANK. I seem to have come up with a lot of those.

[Laughter.]

Chairman BEREUTER. I think we need to conclude the hearing.

But I do want to say that while I think that there are going to be

a lot of attempts within Argentina to blame everybody else, including the United States, and perhaps there are problems with the

IMF and the advice that they gave, perhaps there are, it’s I think

instructive to know that, unfortunately, Argentina, which was

among the top ten countries in the world in per capita income at

the turn of the 20th century, was one of the ten wealthiest countries in the world, a country that had relatively small amount of

racial tension, a country that had a highly educated population for

so long, has fallen to the problems that they have today for socioeconomic reasons or political reasons.

So I do think we have a responsibility to look at the IMF, but

I hope that, while we can provide some assistance as necessary to

people that are really hurting there, by our international financial

institutions, the country and the people need to look at themselves

in the mirror, too, and that’s my own view I just would offer at this

point for whatever it’s worth. But a country so rich, one of three

countries in the world that have the best agricultural soil, a country that hasn’t really focused on exports to a substantial extent, focusing on internal markets for the most part as compared to their

neighbors, well, you can only help people so much unless they’re

willing to help themselves. And that’s sad.

I would ask unanimous consent before Mr. Frank leaves, the only

Member, that subcommittee Members may be able to submit written questions to Dr. Taylor in the Treasury Department.

Dr. Taylor, thank you very much. I think it’s been a very beneficial set of questions, and your testimony was very much appreciated and appropriate, in my judgment. And thank you very much.

Mr. TAYLOR. Thank you, Mr. Chairman.

Chairman BEREUTER. The hearing is adjourned.

[Whereupon, the hearing was adjourned.]

(31)

ARGENTINA’S ECONOMIC MELTDOWN:

CAUSES AND REMEDIES,

TUESDAY, MARCH 5, 2002

U.S. HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON INTERNATIONAL

MONETARY POLICY AND TRADE,

COMMITTEE ON FINANCIAL SERVICES,

Washington, DC.

The subcommittee met, pursuant to call, at 1:33 p.m., in room

2128, Rayburn House Office Building, Hon. Doug Bereuter, [chairman of the subcommittee’, presiding.

Present: Chairman Bereuter; Representatives Oxley, Shays,

Sanders, Frank, and Sherman.

Chairman BEREUTER. The hearing will come to order.

Under the normal committee rules, we will permit the Ranking

Minority Member and the Chairman 5 minutes, as well as the

Chairman of the Full Committee, and others 3 minutes for opening

statements.

I will begin by stating the subject of today’s hearing. The Subcommittee on International Monetary Policy and Trade meets

today in open session to continue its examination of the financial

crisis in Argentina, including the activities of the IMF within this

country.

The subcommittee will hear from a distinguished panel of private

sector witnesses. Previously on February 6th, the subcommittee listened to the testimony from the Under Secretary of the Department of the Treasury for International Affairs, Dr. John Taylor, on

the subject of Argentina.

Before introducing our distinguished witnesses at this second

hearing on Argentina, I would like to remark upon the current fiscal situation in Argentina and call to the Members’ attention that

at your desk you have two updated products from the Congressional Research Service that are again provided, which I find instructive: A chronology of relevant events in Argentina; and a CRS

Report on the Argentine Financial Crisis. When looking at these

CRS reports, it is important to note that the events are changing

in Argentina on an almost daily basis.

As we discussed at our first hearing in 1991, the Argentine government established a currency board to set the peso’s value on a

one-to-one peg with the U.S. dollar in order to curb hyperinflation.

However, because the value of the U.S. dollar appreciated over the

past 10 years, it became increasingly difficult for Argentina to export its products. In fact, by the end of 2001, Argentina defaulted
32

on its total foreign debt of approximately $141 billion which resulted in an economic crisis that spiraled into deadly protests.

On February 3 of this year, the Argentine government declared

that the local peso would free float and all dollar debts would be

converted into pesos at a rate of one-to-one. Creditors and banks

have suffered as a result of this pesofication of debt. Furthermore,

this economic plan also turned all dollar deposits into the local peso

at a rate of 1.4 to the dollar. This devaluation of deposits has angered middle class demonstrators because of their loss in savings.

Since this subcommittee’s last hearing, the following main events

in Argentina have occurred:

On February 11th, the Argentine peso was free floated, as I mentioned. As of March 2nd, the local peso was trading at 2.15 to the

U.S. dollar.

Furthermore, on February 18th, unemployment in Argentina

reached a high of 22 percent. In addition, petroleum workers began

to protest a 20 percent energy export tax. Other protests continued

as a result of the strict bank restrictions on withdrawals.

On March 1, the lower House of the Argentine Congress passed

President Eduardo Duhalde’s budget bill for 2002 which included

a proposed reduction of spending by over 14 percent. This measure

importantly eliminated the monthly minimum of $650 million in

Federal grants to the provinces which has been draining the Federal budget. According to the most recent press reports, the upper

House of the Argentine Congress has yet to act on President

Duhalde’s budget for 2002.

As far as the role of the IMF in Argentina goes, we can remem- ber that they agreed to a 3-year, $7.2 billion arrangement with Argentina in March 2000. Moreover, in January 2001, the IMF augmented its earlier agreement by pledging another $7 billion to Argentina. However, the IMF withheld its $1.24 billion loan installment on December 5 of last year.

With regard to the recent budget for 2002 which passed the

lower House of the Argentine Congress, as I mentioned, the IMF

publicly welcomed this austerity measure that reduced the federal

deficit and addressed the federal/provincial relationship. The IMF

has said that it may send a negotiating team—in fact I am told

they arrived today. In fact, they will be directed by a person accepting a newly created position of Director of Special Operations, who

will lead an effort to focus on countries facing crisis situations.

Now, as for IMF preconditionality reform proposals as they relate

to Argentina, I think it will be interesting to see the thoughts of

the witnesses on the concept of preconditionality for IMF assistance

as it relates to Argentina. This recommendation was endorsed by

the majority report of the Meltzer Commission, whose Chairman,

Dr. Alan Meltzer, is testifying today. I take particular interest in

the Meltzer Commission as I am the original author of the legislative language, which created this 11-person bipartisan Commission

through the fiscal year 1999 Omnibus Appropriations Act. This

Commission, which completed its report in March of 2000, was

charged with studying the future of the IMF, the World Bank, and

the regional multilateral development institutions.

When Under Secretary Taylor testified before the subcommittee

last month, he seemed to endorse the concept of preconditionality
33

for IMF assistance as it relates to Argentina. Of course, there is

merit in insisting a country have a sound economic structure in

place before it receives IMF assistance. Yet, macroeconomic circumstances such as the political and economic repercussions on

global stability also need to be taken into account on a case-by-case

basis. A dissenting view of the Meltzer Commission, which was

signed by Dr. Fred Bergsten, another of our panelists today, makes

that point.

Let me say lastly that, with respect to the IMF, it is important

to acknowledge that there has been substantial criticism of the

IMF’s past performance. I have a strong concern about the advice

that the IMF initially gave to Thailand and Korea at the beginning

of the Asian financial crisis. The fact is that IMF’s demands of

Thailand and Korea were counterproductive, in my judgment. It

treated these countries like their ‘‘usual fiscal basket cases’’and

they were not fiscally troubled at the early stages of that crisis.

Whether or not that treatment was the demand or recommendations of the U.S. Treasury Department in the Clinton Administration is not clear.

At the same time, we in Congress need to candidly admit, I believe, that if we did not have an IMF or an institution somewhat

like it, perhaps a reformed one, we would have to create one. But,

we also need to recognize that the U.S. Treasury has a very large

role in influencing IMF policy and actions—some would say an inordinate amount of influence. And I take into account, of course,

that we are the largest shareholder of the IMF.

I would like to turn, before I introduce the witnesses at the table,

to the distinguished Ranking Member of the Subcommittee, the

gentleman from Vermont, for comments that he might have.

[The prepared statement of Hon. Doug Bereuter can be found on

page 106 in the appendix.]

Mr. SANDERS. Thank you, very much, Mr. Chairman, and thank

you for holding this important hearing, and welcome to all of our

guests for being with us today.

I look forward to the testimony of all of you. My understanding

is Dr. Weisbrot has recently returned from Argentina. Is that correct? So we especially look forward to what you have to say about

the current situation there.

I think we all know there is no debate that Argentina is in a

major financial crisis. Unemployment is above 20 percent. The poverty rate is above 40 percent. The economy is in its fourth year of

recession, and the country is now in the process of defaulting on

its $142 billion foreign debt.

I am confident that there is a lot of blame to be spread around

regarding the Argentine financial crisis. For example, corruption in

the Argentine government is a major factor that has to be looked

at.

But to place the blame for the crisis squarely in the laps of the

Argentine government is, in my view, shortsighted and inaccurate.

We also have to take a look at the failed IMF austerity program,

which I believe was a major contributor to Argentina’s economic demise.

Let me just quote from a couple of op eds that recently appeared.

Interestingly enough, one is from a progressive and one is from a
34

conservative, and I think there are very legitimate, strong concerns

about what the IMF has been doing for many years, including Argentina, from both the left and the right.

Robert Cutner is one of the editors of American Prospect, a progressive magazine. Quote: ‘‘Argentina followed the IMF model more

faithfully than almost any other nation. Its economy was opened

wide. Its peso was pegged to the dollar. For a few years this

sparked an investment boom as foreigners bought most of the country’s patrimony, its banks, phone companies, gas, water, electricity,

railroads, airlines, airports, postal service, even its subways. ‘‘As long as this money came in, there were enough dollars to

keep plenty of pesos in circulation. But the dollar/peso peg led to

an over-valued currency which killed Argentine exports. And once

there was little more to sell off, the dollars ceased coming in, which

pulled money out of local circulation. ‘‘As Argentina tanked, the IMF’s austerity program pushed the

economy further into collapse.’’ And according to a recent op ed in the Wall Street Journal, not

noted as a terribly progressive magazine, the IMF, and I quote:

‘‘austerity programs in Argentina contributed to the collapse of tax

receipts, sky high interest rates to compensate for currency uncertainty, and investment standstill, deadly riots, and the fall of the

government. ‘‘The IMF’s policy pattern is as clear in Argentina as in previous

collapses around the globe. It gives countries bad economic advice,

then lends heavily to them, allows them to waste the new funds,

and watches as the government’s popularity plummets. ‘‘When the economic crisis is deep, the IMF blames the government and pulls the plug, knowing that it always gets paid first and

in full. In Argentina, as elsewhere, the population and the private

sector are left holding the bag. The result is a country more deeply

impoverished than it would have been without IMF involvement.’’ Mr. Chairman, since its modest beginning 55 years ago, the IMF

has grown to become the most powerful financial institution in the

world. Amazingly enough, this secretive organization dominated by

a few wealthy countries, has effective control over the economies of

at least 50 developing nations.

This in itself is a problem of enormous concern for those of us

who believe in democracy. But there is, I think, not only in developing countries, but throughout the world, a growing sense that the

IMF is not doing the job it was established to do, and it has taken

on new jobs it is not able to do.

I think the bureaucratic expression is ‘‘mission creep.’’ The Argentine example is just the latest in a string of IMF failures in

Asia, Africa, Russia, and many other parts of the globe.

I was just in Russia a couple of weeks ago and we met with government officials there. They said, ‘‘Well, you guys in the United

States do not listen to your economic advisors. You send them to

Russia. We listen to you, and thank you very much for the disaster

that our economy is in. Keep them at home,’’ is what they said. So

I don’t know.

I think many of us, for many years now, have been urging the

IMF to stop prescribing one-size-fits-all austerity conditions that

inevitably lead to economic stagnation and poverty.
35

I think all of us in a world in which so many hundreds of millions of people are living in dire poverty should be keenly sensitive

to an institution which time, after time, after time tells some of the

poorest countries on earth: Cut back on health care. Cut back on

education. Cut back on food subsidies. That is a serious problem.

So I think there is a lot to be thought about in terms of the IMF

role in Argentina and many other countries.

Mr. Chairman, thank you very much.

Chairman BEREUTER. Thank you, Mr. Sanders.

Now it is my pleasure to recognize the Chairman of the Financial

Services Committee, the gentleman from Ohio, Mr. Oxley, for any

comments he might like to make.

Mr. OXLEY. Thank you, Mr. Chairman. Thank you for the opportunity to participate in this hearing. Thank you for your leadership

in this, and welcome to our distinguished panel.

We have seen over the past several months the third largest

country in Latin America on the brink of both economic and social

collapse. The situation in Argentina is tragic, but it is a good lens

through which we can examine changes that may need to be made

in the operation of the IMF.

Following last December’s decision by the IMF to stop lending to

Argentina, the government defaulted on its foreign debt and a succession of administrations attempted to govern the country. Some

stability has returned and Argentina has begun to make the tough

fiscal, money, and political decisions to begin the reform process.

Argentina is a valuable ally of the United States in South America, and I hope that they can get their economic house in order.

I am glad to see that the peso is now floating on the international market, and that the government has approved a budget

that attempts to control spending. In particular, the reform made

in the relationship between the provincial and federal government

is key to reducing deficits and reigning in spending. However, there

are parts of the economic reform package that are of concern. Specifically, the President of Argentina has announced a proposal to

levy a tax on all companies that operate privatized businesses.

I question whether additional taxes should be levied on companies that are currently struggling in the midst of this crisis. Many

of those companies are based in the United States, and additional

taxation could force them to abandon projects that they are developing or maintaining in Argentina.

Additionally, a proposal that contracts in pesos, contracts negotiated in good faith, be paid in dollars, is troubling. By changing

the terms of those agreements, Argentina casts doubts on the ability of U.S.-based companies to rely on assertions made by its government in the future.

I was encouraged by the Under Secretary Taylor’s testimony last

month that the Department of the Treasury was working to ensure

that U.S. interests are being treated on a level playing field with

other foreign interests. I trust those efforts are continuing.

As the largest shareholder in the IMF, the United States has the

responsibility to ensure that the resources of that institution are

being spent wisely.
36

I believe that the IMF must take a hard look at its lending policies and ensure it is not granting loans to countries simply because

they are in need of financing.

The IMF must ensure that the money it distributes is making

the greatest possible impact on improving the lives and economies

of developing nations.

Last week, the Secretary of the Treasury outlined before this

subcommittee efforts that the Bush Administration is pursuing to

ensure that the IMF cultivates growth and productivity in the regions where it operates.

I agree with Secretary O’Neill that increased communications

with the market, a narrowed focus, and a policy of not bailing out

countries that do not pursue sound economic programs are key

goals for the future operation of the IMF.

However, the IMF must also work with the recipient countries to

ensure that they know what policies must be addressed prior to

funding being cut off or being resumed. By establishing a blueprint

of economic reforms for recipient countries to follow, the IMF will

reduce the number of failures and encourage sound fiscal policies.

Finally, Mr. Chairman, the IMF has proposed a plan to encourage an orderly workout when there is a default by a borrower country. While this proposal is in the early stages, I am interested in

the opinions of our witnesses as to whether such a proposal is

needed and how it could be established.

I would like to welcome again our witnesses, and I look forward

to a very lively and interesting debate. I yield back the balance of

my time.

[The prepared statement of Hon. Michael G. Oxley can be found

on page 109 in the appendix.]

Chairman BEREUTER. Thank you, Chairman Oxley.

Other Members are entitled to up to 3 minutes for opening statements. The gentleman from Massachusetts, Mr. Frank, is recognized.

Mr. FRANK. Thank you, Mr. Chairman.

I want to express my hope that the witnesses will talk, either

today or at some future point, about one element of this that is

problematic.

Mr. Sanders referred to it: The question of democracy. That is,

it does seem to me we are too often in the position of advising

countries to do things which no democratic society could easily do.

Indeed, we are often telling them to do things that most of us

would not vote for.

We are telling them to impose on their own people-restrictive

policies, increases in sometimes a very regressive taxation, cutbacks in various levels of benefits, and I am struck at the absence

of understanding of the way democracy can and should function.

I worry that in various cases—and it may be happening in Argentina. One of the things that troubles me about Argentina, in addition to the economic reality, are the comments I see reported in

the press which are from people who have given up on democracy,

who blame elections, who denigrate politicians, and that means

they are denigrating the electoral process.

I think one of the defects in international economic policy all during the 20 years I have been watching it has been a failure to ap-
37

preciate this democratic element. It is too often that people neglect

the wisdom of John Maynard Keynes in the political field. Too

often, obviously, people are told that they should accept this or that

very distasteful, unpleasant, difficult public policy because in the

long run they will be better off.

As you all know, as Keynes pointed out, in the long run we shall

all be dead. That has a great deal of political wisdom. It is something that people in the particular situation understand.

So I would hope—and I must say, I do not see this sufficiently.

As far as Argentina is concerned, I am interested to see what people have to say. It is a difficult situation. But I am struck that

throughout the economic analysis that we get, too little is done to

integrate our understanding of the democratic process into that.

That is not simply a theoretical flaw. I think we run the risk in

various places and times of undermining democracy. I do not want

people to associate democracy with austerity, with that kind of

rigor, and as I said, I see some evidence just from what is reported

that one of the victims so far in the Argentine crisis is the respect

the Argentine people have for the democratic process, for the electoral process.

I would hope we would regard that as something also worth saving.

Thank you, Mr. Chairman.

Chairman BEREUTER. Thank you, Mr. Frank.

The gentleman from Connecticut, Mr. Shays, is recognized.

Mr. SHAYS. Thank you. I appreciate deeply that you are holding

these hearings, Mr. Chairman. I cannot think of anything—well I

can think of a number of things worse, but it is hard to imagine

what it would be like to live in Argentina now and to think your

life savings have disappeared, to not have a job, to not even know

how you can begin to feed your family, with so many middle-class

in that situation, a new experience for them.

I am also becoming more and more aware of how many countries

around the world are dealing with debt service that is far above 50

percent. I think of 14 percent, 11 percent in the United States, and

think of how we have found that a challenge. So I just am happy

to be here, and grateful you are having this hearing, and I know

we have expert witnesses and I thank them for their participation.

Chairman BEREUTER. Thank you, Mr. Shays. Without objection,

all Members’ opening statements will be made a part of the record.

And to the extent that the witnesses have written statements, they

will also be entered into the record in full.

I am pleased now to introduce the witnesses. They make a very

distinguished panel with what we expect to be diverse views on Argentina and the Argentine-IMF relationship.

First we will receive testimony from Dr. Allan Meltzer. Dr.

Meltzer is Professor of Political Economy and Public Policy at Carnegie Mellon University, and a former member of the President’s

Council of Economic Advisors. He is currently also a consultant to

the World Bank.

Second, Dr. Fred Bergsten, the Director of the Institute for International Economics, will testify. Dr. Bergsten has been the Director

of the IIE since its inception in 1981. He was an Assistant Secretary of the Treasury for International Affairs from 1977 to 1981.
38

Third, we will hear from Dr. Mike Weisbrot, the Codirector of the

Center for Economic and Policy Research in Washington, DC. Dr.

Weisbrot, who received his Ph.D. in economics from the University

of Michigan, specializes in international economics with a particular emphasis on the role of the IMF. He is also an author of

a weekly column on economic and policy issues that is distributed

to the newspapers of the Knight-Reiter-Tribune Media Services.

Finally, Dr. Steve Hanke, a Professor of Applied Economics at

the Johns Hopkins University in Baltimore, will testify. Dr. Hanke

has advised many different foreign governments on currency reform and privatization. With respect to Argentina, he served as the

advisor to the Minister of Economy at the Republic of Korea in

1995 and 1996. It is also important to note that Dr. Hanke is the

President of Toronto Trust Argentina, which is an emerging Market Mutual Fund in Buenos Aires.

Gentlemen, again thank you for coming. Dr. Meltzer, we will

hear from you. I would like to ask the panelists if they could restrict their comments to about 8 minutes, and you may proceed as

you wish.

STATEMENT OF DR. ALLAN MELTZER, PROFESSOR OF

POLITICAL ECONOMY, CARNEGIE MELLON UNIVERSITY

Dr. MELTZER. Thank you very much.

First I would like to say, Mr. Chairman, that I owe you a vote

of thanks, and also I guess I bear some scars for your having created, or helping to create, the International Financial Institutions’

Advisory Commission that in the usual way has been named after

its chairman, me. So I thank you for that.

Argentina is now suffering from a deep and prolonged social and

economic crisis. Its roots are political as well as economic. The political system seems unable to develop a coherent, consistent plan

to solve or improve either Argentina’s current position or its longer

term structural problems.

The need for a plan or program to restore growth and output and

employment without renewing inflation cannot have escaped the

leadership. They have received this message from President Bush,

Secretary O’Neill, the IMF, and others, including me, and Adam

Lerrick when we were in Argentina talking to many of the people

who are now in the government just before the new government

formed.

Without a plan that begins to resolve current liquidity, financial,

economic, and human problems, there cannot be a resolution of the

crisis. Additional financial assistance from the international financial institutions, led by the IMF, cannot solve Argentina’s problems

unless Argentina adopts a coherent, consistent plan. This is the

democratic solution that Mr. Frank discussed so fully a moment

ago.

Argentina has three fundamental problems that brought it to its

current deplorable position, with massive loss of wealth and increase in misery.

First, its debt could not continue to grow and be serviced by Argentina’s economy and exports. Astute observers recognized publicly more than a year ago, and privately as early as 1999 in my
39

experience, that Argentina’s foreign currency denominated debt

was unsustainable.

Second, Argentina’s budget deficit increased its debt and undermined its monetary policy. The convertibility law tied the peso to

the dollar and permitted unrestricted convertibility at a fixed exchange rate. This arrangement could not cope with an

unsustainable debt on one side and an over-valued exchange rate

on the other. The appreciation of the dollar and the depreciation

of the Brazilian real made Argentina an unattractive place for investment and a costly place to buy.

For example, when we were there, Argentine apple growers and

people with orchards said that the cost difference between their

product and Brazil’s was something on the order of 30 percent.

Third, Argentina made many reforms in the early 1990s, but it

did not develop a budget policy, or pass a fiscal responsibility law

that controlled provincial spending. And it did not remove some of

the structural impediments to growth.

The current Argentine government has not proposed a coherent,

consistent plan. Some of the actions that have been taken are

piecemeal efforts to solve a particular problem without regard for

the larger consequences. For example, the monetary authorities did

not have enough dollars to convert peso deposits into dollars, as required by its monetary regime, so the government declared that all

dollar deposits had to be converted into peso deposits at 1.4 pesos

per dollar. This increased the potential money supply by about 30

percent, raising concerns about inflation. To assure the public that

they would not lose from inflation, the government suggested indexing peso deposits to inflation. As inflation increased, the government or the central bank would print more money. This policy

would lead to hyperinflation.

Argentine citizens have had such miserable monetary and economic experience for the past 50 years that they understand better

than most the links between the central bank’s printing press and

inflation. Their response is to run from the peso before the inflation

reduces the value of their money. This response further drives

down the value of the peso, raising Argentine costs and prices.

Unions, anticipating inflation, have asked for a 40 percent increase

in wages.

The economy is collapsing. Construction activity in January was

44 percent below year-earlier levels. Because bank deposits were

frozen, January’s supermarket sales were 30 percent lower than

the previous month. The unemployment rate is above 20 percent

and rising as the economy sinks. The government announced that

it does not have enough money to pay the wages of government

workers. Meanwhile, it raised the incomes of those in the senior

brackets of the civil service and in the government.

No one can fail to be concerned with and distressed by the fate

of the Argentine public. People are fleeing the country. Lifetime

savings are threatened, and bankruptcy and joblessness are high

and rising. A decade after suffering the chaos that accompanied

hyperinflation, people suffer from renewed economic collapse.

What can the IMF and other international institutions do? What

should they do? The IMF has not ignored Argentina. In March

2000, it offered a $7.2 billion loan. In January 2001, when the sus-
40

tainability of Argentina’s debt was very much in doubt, it offered $7 billion more as part of a $20 billion official package. In August

2001, it advanced an additional $5 billion to prevent a banking and

currency run. It should be clear to all that more money without

policy changes did not work. The IMF announced new negotiations

last week.

Would more money now help Argentina or its people? Until Argentina has a credible, coherent plan, the public has no reason to

want to hold pesos. Giving money now would give the Argentine

government money to support its exchange rate and its budget.

That is another way of saying the holders of Argentine pesos would

be able to get dollars on more favorable terms, and the Argentine

government could maintain a larger budget deficit and avoid pressures to establish fiscal responsibility. This is not just conjecture.

It is a description of what happened to much of the aid Argentina

received in the last 2 years.

I favor assistance to Argentina once it has adopted a coherent,

consistent plan. Such a plan is needed to ensure that money advanced to Argentina is not used to support an exchange rate peg

or slide, to sustain budget deficits, or to permit creditors to avoid

losses. That is how additional support would be used in the absence

of a plan that the government adopts and implements.

In December 2001, Adam Lerrick and I discussed these issues

with members of the Argentine government, and with those who

were then in the opposition but are now in government. There were

seven problems that have to be addressed. Some are interrelated.

First, external debt has to be reduced to a sustainable level. The

debt is now in default. It has to be renegotiated. It cannot be renegotiated until there is some kind of coherent, consistent plan

that allows the creditors to get some judgment about what they are

likely to get.

Second, Argentina needs a credible exchange rate regime to replace the present blocked exchange system of currency controls.

Third, no exchange rate regime can remain credible or be sustained unless the monetary system produces low inflation or stable

prices. The government must make the central bank independent

and adopt a rule that prevents the central bank from printing

money to finance the budget deficit.

Fourth, a stable fiscal regime, with budgets close to balance sustains credibility of the monetary system and exchange rate stability. The fiscal system should also encourage efficient use of resources to increase living standards, and the government should

adopt the fiscal responsibility law applicable at all levels of government. Many of Argentina’s fiscal problems, as many of you have

pointed out, result from excessive spending by the provinces financed by the central government.

Fifth, adjustment of the Argentine monetary and exchange rate

system should avoid asset and liability mismatch. Argentina’s current government has wiped out the capital in the banking system

and crippled the payment system.

Sixth, any policy today must convey unpleasant news. It should

also convey some good news by reducing the 21 percent valueadded tax as much as possible to stimulate private spending and

to shift spending from the informal to organized markets.
41

Seventh, there is a pressing need for liquidity. Adam Lerrick and

I proposed a way to reconcile an increase in liquidity and spending

with safety and soundness of the financial system. The government

adopted a version of this proposal.

The Argentine crisis affects not just the IMF, it poses a challenge

for the World Bank with 8 to 10 percent of its outstanding loans

to Argentina, and the Inter-American Development Bank, with 20

percent of its loans to Argentina. An Argentine default on these

debts would severely impact the capital of these institutions. The

lesson from this problem should not be to send more money; it

should be to reform these financial institutions.

In summary, I support the IMF’s current program. It is a major

step forward from the open-handed bailouts of the 1990s. The new

policy is exceedingly painful for Argentina because the government

has failed to make adjustments and reforms necessary for growth.

Financial support is wasted when the economic structure is unsound. I urge the Members of this subcommittee to support the important steps toward reform that Secretary O’Neill and Managing

Director Koehler have underway. I urge them to continue with

their effort to reward performance and to insist that promises must

be kept.

Thank you.

[The prepared statement of Dr. Allan H. Meltzer can be found on

page 111 in the appendix.]

Chairman BEREUTER. Thank you, Dr. Meltzer.

We will now hear from Dr. C. Fred Bergsten, Director of the Institute for International Economics. You may proceed as you wish

with 8 minutes.

STATEMENT OF DR. C. FRED BERGSTEN, DIRECTOR,

INSTITUTE FOR INTERNATIONAL ECONOMICS

Dr. BERGSTEN. Thank you very much, Mr. Chairman.

I largely agree with the analysis and presentation that Dr.

Meltzer has just put forward. So in my remarks I would like to

focus on the relationship between what has happened in Argentina

and the role of the International Monetary Fund and what implications the Argentine developments have for the functioning of the

international monetary system and, likewise, what changes or reforms in the monetary system have meant for the effects of the Argentine situation outside Argentina itself.

Let me first talk about the interaction between Argentina’s travails and the functioning of the International Monetary Fund. I

think the IMF is in severe danger of whipsawing itself over Argentina.

The problem for a very long time was not that the IMF was too

tough on Argentina, but rather that the IMF was much too soft on

Argentina.

All during the period of Argentina’s boom in the late 1990s, the

IMF did not insist that Argentina tighten its fiscal policy and develop the kind of responsible underlying measures that would have

sustained its boom.

There was no pressure on fiscal policy during that period. There

was tolerance of a currency board arrangement that was bound to

become unsustainable and lead to a crisis.
42

The IMF, in short, tolerated unsustainable debt and exchange

rate situations over an extended period of time. Then, with its two

large rescue packages in 2000, and particularly in the summer of

2001, the IMF threw huge financial packages into the support of

unsustainable policies.

In short, the IMF was much too soft. Indeed, when the IMF went

to its second rescue package in August of last year, it seemed to

be gambling for redemption. When its first package did not save

the day, it went for a bigger second package, just like we sometimes say private banks facing bankruptcy try to gamble for redemption. It is almost like the IMF was doing the same thing.

The IMF then was viewed as too harsh once the situation exploded and the crisis hit. But I want to underline that it was too

soft for much too long. And only belatedly did it begin to suggest

the kind of policy changes that are needed.

My fear, however—and this echos something that Mr. Frank said

a moment ago—is that the IMF might now become too harsh. If it

sits back too long, if it fails to accept a responsible program that

is the best the Argentines can do within the context of their democracy, as Mr. Frank mentioned, then it will become too harsh, will

fail to help the Argentines recover from their own circumstance,

and will further discredit the IMF.

In other words, if the IMF goes from being too soft to too harsh,

it will be just like the private commercial banks who lend too much

when a country is booming, and then back out when the country

is hurting and make the situation worse by increasing the gyrations on both sides of the seesaw.

That, I think, is the problem that faces the IMF now. Dr. Meltzer

is, of course, right that there has to be a solid program that gives

a prospect of recovery. But if the IMF, the U.S., and everybody else

insist on that program being too harsh after they have failed to insist that Argentina tighten its belt back when it could have done

so without huge costs, they will make the situation worse and it

will implode further.

My second point is that the U.S. Administration, much as I hate

to say it, has performed even worse because they already have

whipsawed themselves.

They came into office indicating that they would not support,

quote: ‘‘big bailout rescues of emerging-market economies,’’ yet they

did it. They supported rescues for Argentina, which have clearly

turned out to be unsustainable, as I and others and Dr. Meltzer per

his testimony, were saying as long as 2 years ago.

They did the same thing in Turkey. They have already whipsawed themselves by saying they would not go for big

unsustainable rescue packages, then going ahead and doing it.

They have gotten the worst of all worlds. Their credibility has suffered.

They too have to get back on track in the same way as I suggested the IMF has to.

Now having thrown some brickbats, let me note that the good

news is that the Argentine situation has generated much less contagion now than we would have expected in recent years.

And I think the really good news is it is because of some basic

improvements in the functioning of the international monetary sys-
43

tem, the kind of reform that many of us have called for over the

years.

In fact, I would note not only has there been very little negative

contagion, there has actually been some positive contagion.

The Mexicans, for example, will tell you that they have gotten

capital inflow as a result of money moving out of Argentina.

One reason the Mexican peso has been the only currency in the

world stronger than the U.S. dollar over the last couple of years is

because money moving out of other emerging markets has moved

into Mexico.

As the Mexicans have performed well, their policies have been

strong, they have been linked to our own strong economy, they

have gotten positive contagion.

The reason there has been much less negative contagion is of

course partly because the Argentine crisis had been anticipated for

a long time. But so was Thailand in 1997. So, to a large extent,

was Mexico in 1994. So that is not the sole explanation.

I think the key differences are changes in the functioning of the

international monetary system indicating there have been improvements in the architecture.

First of all, markets are learning to differentiate among different

countries. It is not like in 1997 when everybody ran for the exits

from all Asian countries when Thailand had its crisis.

That differentiation has been helped by the increased transparency of the system, the increased requirements for data submissions, the greater knowledge and sophistication of appraising the

individual countries, which that have come with the attention paid

to the international financial architecture over the last few years,

fueled by things like the Meltzer Commission and other efforts to

pursue improved performance.

Second, many of the other emerging markets, especially in Latin

America, have strengthened their domestic banking systems. Their

reforms are not yet complete by any means, but they have

strengthened their system extensively in response to the call for

such reforms dating back to at least 1997.

The creation of the Basel core principles that year really began

to put the pressure on individual emerging markets to strengthen

financial systems.

The weakness of those systems was of course a common cause of

all the crises in the mid-1990s from Mexico through East Asia. And

the strengthening of those systems is one reason we have less contagion today.

Third, and I think probably most important, is the nearly universal adoption now of floating exchange rates—not free floats but

managed floats. Indeed, how to manage the floats is now one of the

most important reform issues. However, practically every developing country has now moved away from the currency pegs of the

past is whether it was a currency board, an adjustable peg, or

whatever else, to floating rates which provide important buffers

against crises, particularly buffers against contagion from crises in

the neighborhood as in Latin America now, and that helps mightily

to avoid contagion.

So the really good news is the lack of contagion at least so far

in the traditional economic sense.
44

I share some of Mr. Frank’s concerns about political contagion.

That depends on how fast Argentina resolves its situation and how

effective and responsive the outside world is in supporting them.

Finally, since I was the leader of the minority of the Meltzer

Commission, as you mentioned, Mr. Chairman, I cannot fail to note

that, at least in my judgment, the Argentine situation reveals the

shortcoming of Dr. Meltzer’s majority’s recommendations for

prequalification for IMF programs.

You will recall that those prequalifications focused almost solely

on domestic financial systems. As I go back and read what the majority wrote, under its proposals Argentina would have qualified

fully for IMF aid when the crisis broke.

Indeed, as I suggested in my original comments and criticism at

the time, the Meltzer majority proposal would have underwritten

the profligate fiscal policy of Argentina by authorizing IMF credits

without any effort to correct it because the majority said that they

do not believe in conditionality. We do not believe in going after

countries. If they have got their financial system in order, then go

ahead and lend.

It seems to me that what has happened in Argentina clearly indicates the mistake that would have resulted. I am therefore pleased

that the recommendations of the majority were not accepted. I

think the Argentine case suggests the wisdom of that outcome.

Chairman BEREUTER. Thank you, Mr. Bergsten.

Next we will hear from Dr. Mark Weisbrot, Codirector, Center

for Economic and Policy Research. You may proceed as you wish,

Doctor.

STATEMENT OF DR. MARK WEISBROT, CO-DIRECTOR, CENTER

FOR ECONOMIC AND POLICY RESEARCH

Dr. WEISBROT. Thank you, Mr. Chairman. I am going to go

straight to these five points in my prepared remarks, because I

hope we can actually look at some of the numbers having to do

with what people have been saying about Argentina’s fiscal situation over the last few years.

So the first point is that the IMF must acknowledge that it

played a large role in causing the current crisis of Argentina’s economy. This is much more than setting the historical record straight.

It is necessary to prevent the Fund from causing further damage.

For example, Argentina has been in recession for nearly 4 years.

During this time, the Fund has supported, with lending and political encouragement, fiscal tightening of the central government

budget. This is something that economists in the United States

would never recommend for our own economy during a recession,

and it has undoubtedly worsened and/or prolonged the downturn in

Argentina.

The Fund has also contributed enormously to the crisis by arranging tens of billions of dollars of loans to support the convertibility plan, which was clearly not a viable exchange rate regime.

The result was an insurmountable debt burden, which ended in default last December. As shown below in the appendixes attached

hereto, it is this debt trap, not overspending by the government—

and I have to emphasize this—it was the debt trap that caused the

crisis.
45

Basically, the interest payments of the Argentine government increased consistently without the government increasing its primary

spending, beginning with the Fed’s decision to raise interest rates

in 1994 and then on through the Mexican peso crisis and the Asian

financial crisis, and the Russian and the Brazilian devaluation.

That is explained in the appendix.

But we should come back to that, because it is very important

to get the causes of this straight and not pretend, as so much of

the press and popular discussion does, that this is a crisis caused

by the overspending by the Argentine government.

Second, the IMF, the World Bank, and the Inter-American Development Bank and other official creditors should declare a moratorium on Argentina’s debt service payments until the economy has

recovered from the recession and achieved solid growth for at least

a year. I think this is the very minimum these institutions can do

to avoid worsening the crisis. Since the Fund presently functions

as the leader of official, and often private, creditors, its decision— and therefore the decision of the U.S. Treasury Department—to declare a moratorium on debt service would help remove much of the

uncertainty that now hangs over Argentina’s financial future. Furthermore, the Fund could persuade private creditors to observe a

similar moratorium.

An official moratorium on debt service is extremely important,

because this is the biggest cloud that hangs over the Argentine

economy. The government has been running a primary budget surplus, and the economy has a trade surplus. This is very important,

because it means that there is no ‘‘adjustment’’ of the economy,

usually referred to as structural adjustment, which is necessary if

debt service payments are suspended.

Further adjustment along the lines historically pursued by the

IMF would likely only prolong the recession.

Third, the IMF and U.S. Treasury should not try to impose austerity conditions on Argentina, and they should not take advantage

of the crisis to impose other conditions for opportunistic or ideological reasons.

By dragging out the negotiations of the government of Argentina

insisting on unnecessary austerity, the Fund is adding to the uncertainty that undermines economic recovery. And I spoke with Argentine businessmen who told me that Spanish banks want to open

lines of credit to Argentine companies in spite of the default, but

they are waiting for the IMF to reach agreement with the government.

This is just one example of how this creditors’ cartel, which is

headed by the IMF, can impair economic recovery in a time of crisis.

And I want to get back to this, too, because this is really relevant

to the question raised by Congressman Frank—I hope we can pursue this—of democracy, which is the most serious, or very serious

political problem here.

During the Asian financial crisis, the Fund imposed more than

140 conditions on Indonesia as part of the loan package. As a result, the Fund’s main impact was to get the government to guarantee private loans, rather than to promote economic recovery.

More than 4 years later, Indonesia still has not reached its pre-cri-
46

sis level of GDP. It would be a tragedy if the IMF led a similar socalled ‘‘bailout’’ in Argentina.

Fourth, the first priority of any economic program must be to revive spending and production and pull the economy out of the depression. I emphasize this because many people have pointed to

this, all the long-standing problems, corruption, the deep distrust

of politicians, lack of confidence in the banking system as the root

causes of the crisis.

But these problems may exist, but it is not necessary or sufficient to cure them in order to get the economy going. And we can

talk more about that if there is time.

Finally, the most important question, I think, facing us right

here is the IMF should state publicly what it is demanding from

the Argentine government. The complete lack of transparency in

the negotiations between the IMF and the government of Argentina

invites abuse and corruption, and thwarts democracy in Argentina.

This is something, if they cannot put forward what they are demanding, I do not see why economists and journalists and so many

people just say, ‘‘Well, the IMF is demanding a sound program, a

responsible program.’’ Clearly they have gotten it wrong. They got

it wrong for the last 9 years in Argentina. They got it wrong in

Brazil when they poured tens of billions of dollars into the Brazilian government and saddled them with debt to maintain a fixed

exchange rate that was not viable there, and the economy recovered only after the currency collapse.

They got it wrong in Russia a couple of years ago.

So clearly, they are not necessarily the best judge of what is a

sustainable plan. If we allow them to determine in secret what the

government of Argentina’s policy is, we are inviting serious trouble.

Now just to return to the question of the provincial spending

which has been raised—and that is the latest thing that people are

pointing to—I think we should understand that the provincial

spending did not contribute to Argentina’s crisis.

There was overspending in the provinces, and it did rise very

rapidly in the last couple of years, but it was not absorbed by the

central government.

So, for those who were loaning money to the provinces, it is the

same as if they were loaning money to California or Illinois in the

United States where the Federal Government does not guarantee

their debt. Those lenders did not have to loan to them, and we

should not allow the Fund or anyone else to just point to the provinces as a problem, or the source of the problem, because the central government of Argentina did not increase its revenue sharing

with the provinces while they were increasing their spending.

So this really was a problem of a debt trap. Argentina had a debt

that was barely payable going into 1994, and they were hit by a

series of external shocks. And I know Mr. Bergsten says, well, they

should have cut more out of the budget. They cut 2 percent. According to the IMF, they cut 2 percent in fiscal 2000. That is the

equivalent of $200 billion in the United States being cut from our

budget in a deep, deep recession.

How much more could they have cut? We could get rid of our

$450 billion current account deficit in the United States, if we

wanted to, by going through another Great Depression, but that is
47

not how it is going to happen, right? The dollar is eventually going

to fall, and that is how it is going to be reduced, probably gradually.

That could not happen in Argentina because they fixed their currency to the U.S. dollar. So you see this was a major set of mistakes that destroyed the Argentine economy, and it is unfair and

counterproductive, I think, to try and blame it on the Argentine

government’s spending as though there were some kind of fiscal

policy that might have saved this economy from the disaster that

it is facing today.

Thank you.

[The prepared statement of Dr. Mark Weisbrot can be found on

page 118 in the appendix.]

Chairman BEREUTER. Thank you very much. You finished in only

one second over. Good timing.

Next we will hear, finally, from Dr. Steve Hanke. Dr. Hanke is

a Professor at Johns Hopkins University, and President of Toronto

Trust Argentina. You may proceed as you wish.

STATEMENT OF DR. STEVE H. HANKE, PROFESSOR, JOHNS

HOPKINS UNIVERSITY; PRESIDENT, TORONTO TRUST ARGENTINA

Dr. HANKE. Thank you, Mr. Chairman.

I have prepared some remarks that I would request be put in the

record, and I will make just a few comments here particularly motivated by your opening statement as well as some of the statements that your colleagues made.

It is very difficult to make any sense, really, out of this whole

Argentine mess: what happened, how to diagnose it, as well as prescribe what should be done.

I think most of the commentary is confused and very confusing.

I would commend the current issue of The Economist Magazine.

They have one of the leaders on Argentina and then a several-page

analysis of Latin America. It contains everything but the kitchen

sink. If you can make any sense out of it, you can go to the top

of the class, I think. And this is just typical of what you have to

contend with when you are trying to grapple with the problems.

One example of this, by the way, Mr. Chairman, you mentioned

what I call the overvaluation story. Some of my co-panelists have

also alluded to it. Argentina tied the peso to the dollar in 1991. The

dollar appreciated, was very strong; the peso became overvalued,

the economy became uncompetitive.

The problem is, the story just does not hold water. It is an interesting story. It has been repeated ad nauseam. But to be uncompetitive, your exports have to be weak and declining.

Ever since 1991, in each full year, with the exception of 1999, exports have grown in Argentina. And in fact, in the first 11 months

of last year exports increased by 3.2 percent. Last year, world trade

only went up 9/10ths of 1 percent in the world.

So the relative performance of Argentina on exports has been

very good. In fact, if the economy would have been growing at the

rate exports have been growing, that debt service burden probably

would not have overwhelmed them in the end.
48

So you can cut the overvaluation story a number of different

ways. If you want to get, shall we say, more scientific, we can use

the Big MAC Index, and the Big MAC Index said in 1999 that the

peso was overvalued by 3 percent. In 2000, it was not overvalued

or undervalued. In 2001, it was undervalued by 2 percent.

But, that did not stop The Economist Magazine from producing

26 major articles in that timeframe in which they claimed that the

overvalued peso was making the economy uncompetitive and dragging the economy down in Argentina.

So, those are the kinds of issues, and we have a long list, that

we really have to get through if we are going to analyze Argentina.

What made Argentina unique, I think, has really been missed.

That is, their monetary setup really was unique. The U.S. dollar

was legal. The peso was legal. They circulated in a bi-monetary

system at a 1-to-1 exchange rate. That was one part of it.

The other part that made it unique is that the peso holders had

property rights in U.S. dollar reserves held in safekeeping by law

by the central bank. Those were the two aspects that really made

the system unique.

This means that the devaluation is not a normal devaluation in

Argentina. It was a totally unique devaluation. It was not Brazil.

It was not Russia. It was not Southeast Asia. What made Argentina’s devaluation atypical was that the peso holders had property

rights in those dollars that were backing—100 percent—the pesos

that were outstanding.

And when you did away with the convertibility system, you did away with those property rights to the tune of $17.8 billion. And,

Mr. Frank, this is the issue of the rule of law and why you do not

have any respect for the politicians in Argentina. They have sticky

fingers and a long history of sticky fingers. So when you did away,

through the devaluation, you really confiscated $17.8 billion worth

of property.

But of course, then we have gone on with pesofication of the

economy. That has also rapped the rule of law on the fingers and

created this governance problem and democracy problem.

To have democracy, Mr. Frank, you have to have the rule of law.

And of course, they do not have this in Argentina now. With the

pesofication, what do you have?

Loans were pesofied. This meant the banks lost $23 billion. Deposits were pesofied. This meant that depositors lost $12 billion

and banks gained, of course, $12 billion.

And also in the middle of the night, the central bank sent out

armored cars and confiscated, seized, $1.6 billion in federal reserve

notes in the banks.

In addition to that, you have had many contracts that have involved U.S. citizens and U.S. corporations that have been torn up

in the process of pesofication.

Now as far as the IMF’s role, let me just quickly go through that.

From 1990 to 1994, GDP grew on a per capita basis by an amazing 72.8 percent. This is when they put the convertibility system

in and did some of the big privatizations. The IMF had virtually

nothing to do with that.

Post-the Mexican peso crisis in December of 1994, the IMF became very involved, and reforms, in effect, stopped in Argentina.
49

In 1999, President Menem wanted to dollarize the economy and

fix the currency problem once and for all. The IMF poured cold

water on that.

In 2000, de la Ru ́ a came in, and the IMF, in the middle of a

slump, encouraged three very large tax increases. And these tax increases put Argentina in a very unusual situation with a large and

mounting tax wedge the difference between gross labor costs and

net wages. In other words, this is how much labor gets taxed: 42

percent. There is only one country in Europe where the tax wedge

is higher—that is France at about 43 percent. This is almost double

the tax wedge in the United States.

Then you wonder why unemployment is so high and the underground economy is so vibrant.

Then in 2001, as the situation went out of control, the IMF essentially turned a blind eye to the whole thing. The meddling with

the convertibility system, the further tax increases in the middle

of a recession, and meddling with a monetary system that had the

effect of tightening monetary conditions. So you tighten monetary

conditions and increase taxes in the middle of a recession.

So what shall we do?

Many people think that the move toward floating has been a

good thing and they heap praise on it. I do not think we are going

to see the peso floating on a sea of tranquility. We have had a long

history of sinking pesos.

I think, in closing, it is very interesting that, thanks to Congressman Frank, Under Secretary Taylor finally fessed up that the best

thing they should have done—and what they should have done in

early December—was to dollarize the economy to give it a positive

confidence shock.

I think it is too bad that these things were not articulated by the

Administration in a clearer game plan that could have been somewhat helpful in the situation in early December, but in any case,

what they should do is dollarize the economy, point number one.

And point number two, the U.S. Government should respect U.S.

laws. If you look at Title 22, various provisions in the U.S. Code,

it states that if property is seized or contracts are nullified in a foreign country involving U.S. citizens or U.S. corporations, U.S. foreign aid should not be forthcoming and the President should instruct the executive directors of the IMF, World Bank, and InterAmerican Development Bank to vote no for any disbursements

from those organizations to the country involved in trampling on

the rule of law and property rights.

Thank you.

I know I went over, Mr. Chairman, but I will shorten it up in

the Q&A session.

[The prepared statement of Dr. Steve H. Hanke can be found on

page 129 in the appendix.]

Chairman BEREUTER. That’s all right.

The three of you went over equally. Actually, we could probably

stand back and just let you throw verbal arguments at each other,

but I am going to recognize Chairman Oxley for 5 minutes, and the

5-minute rule will proceed in the normal fashion.

Mr. OXLEY. Thank you, Mr. Chairman. I appreciate that.
50

It is tempting to follow that advice and just have a jump-ball

here among our distinguished panelists, and we may get to that if

I have time.

Let me ask you, Secretary O’Neill was here last week, Thursday,

and testified regarding contagion. He basically pointed out that in

his estimation contagion is simply a man-made phenomenon and

that he saw little if any contagion with other countries because of

the Argentina crisis.

I am wondering if our panelists agree with that assessment from

Secretary O’Neill? Or is it perhaps too early in the game to make

that kind of a statement?

Let’s try Dr. Meltzer and then move on down.

Dr. MELTZER. Well, sir, it has been a very interesting experience,

because not only, as Fred Bergsten has said, has Mexico received

an inflow of capital, but Peru went to the capital markets and was

able to borrow at 9 percent interest for 10 years. It is the first time

they have been in the capital markets in 70 years. They did that

after the Argentine crisis, just 2 weeks ago.

Brazil has been cutting its interest rates. In all the countries in

that neighborhood, for example Chile, most of those countries have

not had a problem. And the reason for that, I believe, goes to the

fundamental part of what contagion is about.

Contagion was big in Asia because there were many countries

that had similar problems, or appeared to have similar problems.

It is just like the experience we are having right now.

People look at Enron and say it has a bad balance sheet. They

then go to look at all the other companies that have bad balance

sheets.

When they looked in Latin America, they saw that most of the

other countries did not suffer from the Argentine problem, and that

is why they left them alone. And, in fact, in many cases they received more capital, or they have been able to borrow in the capital

markets. So no contagion.

Mr. OXLEY. OK. I knew Enron would come in here somehow.

Dr. Bergsten.

Dr. BERGSTEN. As I said in my testimony, I agree with Secretary

O’Neill on this one. I think there are three basic reasons why there

has not been contagion in this case.

First, the markets do differentiate better, partly because of greater transparency in the markets, and better information in them.

Second, because the countries in Latin America in particular

have strengthened their banking and financial systems so they do

not have the same underlying structural difficulties that was the

case even 5 or 6 years ago.

And third, the move to floating exchange rates, which does provide a very important buffer.

There was one other important reason for the contagion in Asia,

and it was certainly man-made. It was the role of the Japanese

banks. It is still not widely known that the Japanese banks were

the major source of contagion in Asia. When the Thai crisis hit and

weakened the already weakening balance sheets of the Japanese

banks, they then pulled their loans out of other countries in the region—out of Indonesia, out of Malaysia, out of Taiwan, out of

Korea.
51

The contagion from the withdrawal of Japanese bank funds went

right around the horn of the region and was an important factor

in the contagion. Fortunately, we do not have that now, for the reasons I indicated, and I think that is likely to continue. I do not

think it is a transitory phenomenon.

Dr. WEISBROT. Well, you might actually get agreement here. If

you put all the economists end to end around the world, they are

never supposed to reach a conclusion. But I think on this one there

is basic agreement.

The only thing I would add about the—and I think O’Neill was

right about this, too—is if you look at the contagion from Asia to

Russia and then Brazil in the 1998-1999 crisis—well, it actually

started in August of 1997—that was really the profound irrationality in the financial markets.

The part that Fred just described that’s different: That is the

Japanese banks pulling out their loans. But, investors pulling their

money out of Brazil after the Russian devaluation is more of just

an irrational phenomenon where they looked around and they said,

‘‘Well, where is the next emerging market that other investors

might think is in trouble?’’ even if there was no solid economic

basis for that.

So, that kind of thing is really fundamentally irrational. It is

part of the functioning of financial markets. It could happen again,

but it does not look like it is happening here now.

Dr. HANKE. I think one reason that we have not realized a lot

of contagion from Argentina is their unique currency board like

convertibility system. It is an extremely tough system that, in fact,

surprise, did not fail.

They had 100 percent reserves covering the monetary liabilities

of their monetary authority at the end of the day when they threw

in the towel.

Usually when we have contagion motivated by an exchange rate

crisis, what happens? The central bank loses all of its reserves. It

cannot defend the exchange rate anymore. And the thing blows up.

This was the Asian case. This was the Russian case. This was

Brazil, and so forth.

If we want to really eliminate the possibility of contagion being

motivated by foreign exchange rate problems, we should dollarize

these emerging market economies. We should not be floating.

Floating is not the way to go.

If we look at Argentina, they had a central bank. It was established in 1935. The peso has depreciated against the dollar by a

factor of 6 trillion since 1935. They have had one crisis after another with the only decade of exception being the decade of convertibility.

So, if you think that a floating exchange rate is going to solve

your problem, I think you are whistling in the wind, given the Argentine case. You can anticipate all kinds of problems and chaos,

and ultimately, I think, official dollarization will see the light of

day.

We know everyone prefers dollars in Argentina, and you have a

lot of unofficial dollarization, and will see more of that. I think ultimately when they really hit the wall they will go to official

dollarization.
52

Mr. OXLEY. Thank you, Mr. Chairman.

Chairman BEREUTER. Thank you, Mr. Oxley. I say to the Chairman and all Members that since the House is not going to be voting until 6:30, we will not be interrupted. That is the positive side.

So we can proceed with the second round of 5-minute questions, if

that is the desire. I think it is probably desirable.

The downside, of course, for witnesses’ information and for the

audience, is that we do not have many Members back yet until

6:30.

The gentleman from Vermont is recognized under the 5-minute

rule.

Mr. SANDERS. Thank you, Mr. Chairman.

I do not claim to be an expert on Argentina, but I find this discussion to be extremely curious. In Nicaragua today, which is a

small Central American country, unemployment, I think at last I

heard, was 60 or 70 percent. Nobody really cares anymore. Leftwing government is gone. The New York Times does not care. It

doesn’t matter. People go hungry. It’s OK.

I suspect that the situation economically in Guatemala, El Salvador, total disaster. Who cares? Doesn’t matter. Poor countries.

Suddenly there is great concern about Argentina. And I detect a

bit of arrogance on the part of some people. Some people suggest

Argentina is a bad country. They do not respect the rule of law.

Well, all of us believe in the rule of law. But that is what they

do. And yet, billions of dollars have been invested in that country

by very, very smart people—by U.S. corporations, by banks, by all

these people, in a country that does not respect the rule of law.

So what interests me, first of all, is why all this interest in Argentina? Are you guys worried about the children in Argentina

today who are hungry? Are you worried about the educational system, which is collapsing? Are you worried about the health care

system in Argentina? Are you really worried about the people in

Argentina? Or maybe, just maybe, is there something else involved

in here?

I think Dr. Hanke was perhaps most up front about this when

he talked about how the IMF should perhaps not fund countries

which do not respect the rule of law and are doing terrible things

to American corporations.

So, are we here because we are interested in protecting the investment of American corporations? Or are we concerned about the

people of Argentina?

Now again, I do not claim to be an expert on Argentina. I am

aware that there has been massive corruption in that country, as

well as other countries around the world. So what? So what? Why

do American taxpayers or American citizens stay up nights worrying about that? That is their business.

But, I detect that all of this interest in Argentina really has to

do with something else. Not the people of Argentina, but corporate

investments and the need to protect those investments.

Now in that regard, I note that an article, March 2nd, KnightReiter Tribune News Service, quote: ‘‘After more than 18 hours of

debate, the lower house in Argentina passed and sent to the senate

a budget that slashes spending by 14 percent compared to 2001 levels.’’
53

Now, my guess is that will mean less health care, less education,

less affordable food, and other basic necessities of life.

Question to all of you: What is the reason for concern about Argentina? Is it the people of Argentina? Or is it American corporate

investments in Argentina and the dangers that they are incurring?

And second of all, in your economic judgment, if a country in the

midst of a major depression cuts spending, unlike what we do when

we have a recession, how will that impact on the poorest people in

that country?

Let me start off with Dr. Weisbrot and then go to the others,

please.

Chairman BEREUTER. Try to answer the gentleman’s questions,

both of them, but we need to be relatively brief.

Dr. WEISBROT. Sure.

Chairman BEREUTER. For all of you. I understand.

Dr. WEISBROT. Obviously, we are concerned about the people of

Argentina. I have written recently about Nicaragua and the situation there as well. They are the only country in Latin America

whose income per person is lower than it was 40 years ago.

There are also a lot of failed policies promoted by the IMF and

the Bank in that country. These policies had something to do with

its decline.

When I was there, I spoke with a doctor who is running a health

clinic in the neighborhood of Matanza, which is about 26 kilometers

outside downtown Buenos Aires, and he told us that the malnutrition rate among children there was about 30 percent. The infant

mortality rate was about 35 per 1000, which is very high.

He said everything was getting worse because hospitals were

running out of supplies. It is a very severe crisis. It is affecting the

poor, and I think it is horrible that the government is cutting their

hospital budgets.

I have not focused on the human side at this hearing, because

I think the economic side is what people here need most to understand, because it is because of the widespread misunderstanding

that our government is supporting, and, in fact, the IMF is pressuring, the government of Argentina right now to make those budget cuts.

I feel that is wrong from an economic point of view, and it is terrible in its impact on the people there.

Mr. SANDERS. Thank you.

Dr. Meltzer, in a country in which children are suffering from

malnutrition and their economy is collapsing, is it your economic

judgment that they should cut back on subsidies for food, health

care, and education?

Dr. MELTZER. I think those are questions that are best left to the

government of Argentina.

Mr. SANDERS. Really?

Dr. MELTZER. Yes.

Mr. SANDERS. But, what we are talking about here is the power

of the IMF over that country. Can that country make decisions

independently anymore?

Dr. MELTZER. In fact, that’s, I believe, what we have been fighting for, is to give those countries—put them in the position where
54

the IMF does not dictate to them, where the World Bank does not

dictate to them, but where they choose their own policies.

I want to say that in response to your question, I do not share

the dichotomy that you have set up. I do not think that there is

a conflict between American corporations and local people.

American corporations in most places are one group among many

foreign corporations. There are many, many Spanish corporations,

and indeed, many more Spanish dollars invested in Argentina than

American dollars invested in Argentina.

What was the Argentine government’s first response? It was to

put a tax on the foreign corporations in order to pay for the mistake, in my opinion, that they made in adjusting the banking system. That was a mistake. They blew a hole in the banking system,

and then they said, ‘‘Well, we will just make up that money by taxing oil companies.’’

Now, you may think that is a good idea. Let me just say the immediate reaction of the Spanish government was, ‘‘we are going to

protect our corporate citizens.’’ So they went to Argentina and they

negotiated that down, and that left a hole in the banking system.

Mr. SANDERS. No, no. I am not saying whether it was a good—

it does not sound to me like good economic policy, but the point

is——

Dr. MELTZER. It wasn’t good any kind of policy. It was a stupid

thing to do.

Mr. SANDERS. Let’s assume that if you were an advisor to the Argentine government you say ‘‘this is a stupid thing to do.’’ What

does this have to do with the average middle-class taxpayer in the

United States that the Argentine government does stupid things?

Dr. MELTZER. Let me answer it this way. I think that there is

a human problem, and I talked about that human problem in my

testimony. I think that we have tried hard, and, in fact, even

though Fred Bergsten and I disagreed on many things about the

so-called Meltzer Commission Report, one of the things we agreed

on very much was on the use of grants in place of loans so that

we could help people in poor countries, and the President’s program

has been to push that.

So, I am not against humanitarian aid. I am for humanitarian

aid. But in the case of Argentina, we have provinces where 50 percent of the population in the province works for the government.

If you go to an Argentine office, you see obvious signs of overmanning. Just lots of people standing around doing nothing. There

is room to cut some of those budgets.

Their tax rates are very high.

Mr. SANDERS. If I could——

Dr. MELTZER. So it is possible to make major fiscal changes without cutting education. That is a democratic decision of the Argentine government.

Mr. SANDERS. Here is my point, and then I will——

Chairman BEREUTER. Just a brief comment, Mr. Sanders, and

then we will come back to you.

Mr. SANDERS. Everything you are saying may well be right. So

they have a bad government.

Dr. MELTZER. Yes.
55

Mr. SANDERS. What does this have to do with what the IMF does

and whether we punish them or not?

Dr. MELTZER. Well, there are two ways you can go on this, as you

and I both understand, Mr. Sanders.

You can say let’s give them the money and help them, and allow

them to continue to do the things that they do; or take away the

money and get them to do some sensible things which will make

it better in the future for both the children and the grandchildren

of those people.

And people, you and I, can disagree about where the line between those two things are without necessarily disagreeing that

both of those cases exist.

Mr. SANDERS. Thank you.

Chairman BEREUTER. We can come back to that if you would

like, Mr. Sanders.

I would like to move to Mr. Frank who Mr. Shays is willing to

let go ahead of him.

Mr. FRANK. I appreciate it, Mr. Shays.

Chairman BEREUTER. The gentleman is recognized.

Mr. FRANK. I have an ambassadorial appointment I have to

meet, and so I apologize, too, because I would have liked to have

stayed.

When we talk about cutting back and everything, one of the

things—could I ask, some of you are more expert in Argentina than

others, and maybe I am missing something—is Argentina under

any significant danger of attack?

Does anybody know of any physical enemies menacing Argentina?

Mr. BERGSTEN. Mr. Frank, Argentina is sometimes characterized

as a dagger aimed at the heart of Antarctica.

Mr. FRANK. Yes, well——

Mr. BERGSTEN. It has no national security threat whatsoever.

Mr. FRANK. That reinforces my view that we should amend the

First Amendment and ban the use of metaphors in the discussion

of foreign policy.

[Laughter.]

Dr. MELTZER. Yes. But in fact, they have cut back considerably

on their military.

Mr. FRANK. Have they cut back on the military?

Dr. MELTZER. Considerably under both the Menem government

and——

Mr. FRANK. But, one of the things that bothers me is when I look

historically at the outside advice that is given, rarely are military

expenditures among the items that other governments and the

international financial institutions tell them to cut back. I think

that is an indication of the kind of bias. People are told to cut back

on other things.

We have many of these poor nations, it seems to me, overarmed,

overairplaned, over-a-whole-bunch-of-things, and in the list of

items that we are told, I can look at the IMF’s list of things in the

past and we’re hoping to change these, and the military is rarely

on the list to be cut back.

Dr. Hanke, do you want to comment?
56

Dr. HANKE. Yes. I was going to remark that President Menem

and President Pinochet sorted out the last real potential conflict

that they had on the border with Chile and Argentina in 1989.

Mr. FRANK. Well I——

Dr. HANKE. But at any rate, this gets back actually to your point.

You can almost answer your own question. You raised the issue

about democracy in your opening statement, and isn’t this democracy at work? This is the whole problem with foreign aid. If you

give them money, you know what happens.

Mr. FRANK. No, Dr. Hanke, I do not follow that at all. Your restatement of my point I do not recognize. I do not understand how

the problem——

Dr. HANKE. Well I——

Mr. FRANK. Excuse me, but it is particularly my turn to say what

I said.

I must say, you did seem, to me, disturbed, at least my sense of

your reaction was that you were somewhat unhappy with my discussion of democracy——

Dr. HANKE. I agreed with it.

Mr. FRANK. As I was with your definition of it, and I will get to

that in a second. But, I do not understand how, if you give them

foreign aid, you know what is going to happen. That just does not

follow.

In fact, what I am objecting to has been an excessively interventionist position by the international financial institutions and others in which they were told to make changes that I thought were

unsustainable, both in terms of raising taxes, and cutting various

kinds of spending.

I was struck, because when you responded you seemed to me to

define democracy down to basically observing the sanctity of contracts. Now I am all for that. And given John Locke, obviously contract law has a great providence in democratic theory. But you

seem to me to restrict it almost only to that, and particularly you

said that, well, no wonder there was all this distaste for democracy

in Argentina given the way they devalued, and so forth.

But, in fact, we went through three presidents before they got to

devaluation. I mean the rioting and the troubles, it was not until

Duhalde was in, which was two resignations already, or three, before he became president.

So, I did want you to elaborate on your view. It seemed to me

you were attributing the lack of respect for politicians there largely

to the failure to recognize the sanctity of contract, and things like

economic inequities and people feeling they did not have enough to

eat, or unemployment being too high did not seem to count.

Dr. HANKE. Well, those issues do count. I think what you have

to do to put the—I was not looking at it in a narrow context—if

you go back to the Federalist Papers and look at those, for example, or particularly Hamilton’s view on the rule of law, it is really

broad-gauged. And so I would put my remarks about the rule of

law, governance, and democracy in the context of the Federalist Papers, I believe.

Mr. FRANK. Well, OK, then I would——

Dr. HANKE. Broaden it out——
57

Mr. FRANK. OK, I would say that I think that is not sufficiently

broad today. The people who wrote the Federalist Papers and the

Constitution were very smart guys for their time, but I think they

had an insufficient understanding of the importance in a modern

capitalist society of a more positive role for government.

And I must say, I did kind of detect—let me ask one question,

if I could. It is one of the dilemmas I have. Yes, I understand we

have got debts that are contracted. They cannot all be paid.

And there has been a lot of focus on the problem of moral hazard

of encouraging people to lend improvidently, and I think that is

something we have to deal with. But this seems to me one of those

dilemmas, because if we are too harsh here, what is the impact on

a flow in the future?

How do you deal with the problem of reducing moral hazard

without getting to the point where you discourage people from

lending in risky situations?

Let me say, if I could have 30 seconds, Mr. Chairman, I see that

analogy domestically. Sometimes my colleagues and I object to people who engage domestically in predatory lending, and lending to

people who will be too much in debt.

Then the next day we are upset because of red-lining. And if you

never do any predatory lending, you will probably get involved in

red-lining. Or at least if you do not lend to people who are shaky.

What about that dilemma? How do we deal with the problem of

moral hazard without discouraging people in the future in the private sector? I assume we want them to continue to make loans.

Start with Dr. Meltzer.

Dr. MELTZER. Yes. That is a subject I have thought about a lot,

because we have proposed various kinds of preconditions. So, one

of the ways to deal with that problem is to try to get countries to

reform.

We believe that the incentive system, which would occur with

preconditions including, of course, one of the preconditions to correct something that Fred said, was that there be fiscal rectitude in

a country, or fiscal stability in the country, which Argentina did

not have.

So it wouldn’t——

Mr. FRANK. Fiscal rectitude. Now we have got from the Federalist Papers to Dickens. You have got to find another word other

than fiscal rectitude.

Dr. MELTZER. Whatever. You use the word. But we will both

know what we mean.

Let me just say that the bulk of the money that comes to countries comes from the capital markets. Something like 15 to 20

times as much as from the international institutions.

If a country adopts solid policies like Mexico, like Brazil now, like

Chile, then they get large amounts of money on much better terms

because they are a better country from the standpoint of the lender.

So, the way we deal with the moral hazard problem is, one, we

put the responsibility, the onus, on developing the incentive to do

that on the country. We want them to choose the set of policies.

That was the whole purpose of precondition, that they would

choose the policy.
58

We would not get a laundry list from the IMF about things that

countries should do, that maybe they would do and maybe they

would not do, and most of the time did not do. What we would get

was that the minister of finance of the country would go to his parliament and say ‘‘we’re going to do this because it is going to be

good for our country.’’ Second, we would get—one of the preconditions was—we are

going to have foreign banks in the country. Now we have seen in

Brazil, in Argentina, and elsewhere, that that really works quite

well.

Third, we want to do something which says let’s get less of the

money out of the short-term capital market, which is the way the

system worked before, and let’s get it into long-term lending and

private capital flows. That is, foreign direct investment.

Those are ways we reduce moral hazard.

Mr. FRANK. That last point, in particular, is very interesting to

me. If you could give us something in writing as to how we could

do that.

The last thing is the volatility, getting it into longer term would

be a very good thing.

Any of the others?

Dr. MELTZER. I will write to you.

[The reply from Dr. Meltzer can be found on page 115 in the

appendix.]

Dr. BERGSTEN. Yes. I would just like to add, I think the moral

hazard problem is vastly overstated. It is one of my least worries.

This was one of the debates between us on the Meltzer Commission.

There is virtually no empirical evidence that moral hazard has

been a source of any of the crises of the recent periods.

If you want to do something about it, one way is to limit the

magnitude of IMF support programs. A concern has been that

countries, and particularly lenders, will lend excessively, build up

excessive risk, because of the fear of an IMF bailout.

Therefore, one remedy is to roll back the size of IMF rescues to

the normal kind of quota arrangements, rather than the excessively large packages in the recent past.

A second issue that has now come up is private sector involvement. Mr. Oxley mentioned the IMF proposal for more orderly debt

workouts. I happen to support that, not every line in the Krueger

proposal, but I think it is the right way to go. I think it does need

to be worked out.

The main fear about that is that it will limit the flow of private

capital in the future as creditors fear that they might get stuck in

a workout position.

I actually think it will work the other way around: A more orderly, regularized procedure will lead to a steadier and probably

more proper level of flow, reducing somewhat the huge seesaw—the

excessive lending in good days, excessive pullouts on bad days—

that I mentioned in my opening statement.

Chairman BEREUTER. Your time has expired. Well, go ahead, but

make it a quick one.

Mr. FRANK. Well, I just wanted to listen to what Dr. Hanke said.

I have to leave, but I would be glad to hear it in writing.
59

Dr. HANKE. Related to your moral hazard point——

Chairman BEREUTER. Use your mike.

Mr. FRANK. Microphone.

Dr. HANKE. Related to your moral hazard point, I think it is important that the U.S. enforce and follow its own laws, and that gets

back to the U.S. Code Title 22.

If foreign governments engage in activities in which contracts are

nullified and property is seized, it is fairly obvious to me, if you

look at the Code it should be triggered. And I think that would

help reduce moral hazard problems.

Mr. FRANK. I would just add on that, if we got uniform enforcement with the things we have put into the various IFI replenishments about labor rights, and poverty and human rights, maybe I

could buy that as a package. But I would not want to see selective

enforcement.

Dr. WEISBROT. Could I respond? It is a really good point, I think,

and I think first of all the balance now is tipped very overwhelmingly toward bailing out, in terms of the tradeoff, bailing out reckless international creditors. And that is what happened in the

Asian crisis, for example, as the Fund basically coerced the governments of Indonesia and South Korea and the others to absorb the

debt of the foreign lenders.

I think that is where transparency really comes in. If we could

know right now what the IMF is demanding from the Argentine

government, for example, we might find out what most of the people that I talk to there believe: that there are some bad things happening involving the guaranteeing of foreign lenders.

Now in terms of striking a balance, capital controls have been

shown to be helpful. Chile, for example, used capital controls very

effectively and it did increase the time, the average time of investment.

Mr. FRANK. It would be the short-term problem.

Dr. WEISBROT.And finally, we also should have some perspective

on what is really being provided to countries when foreign lenders

are loaning at 19 and 20 and 25 percent, which has been the average returned in the last year or two. Is there any investment in

those countries that is producing a return higher than that?

In other words, is there a net gain to those countries?

I would say in many cases there is not. This is just a speculative

bubble of some sort, and it is really a drain on those economies.

Mr. FRANK. But, not forced on them. I mean we do have——

Dr. WEISBROT. No, No, I’m just saying that it is not

something——

Mr. FRANK. They make the decisions.

Dr. WEISBROT. We have to worry about if that kind of lending

does not continue at its present rate.

Chairman BEREUTER. Dr. Bergsten, very briefly. I want to get to

Mr. Shays.

Dr. BERGSTEN. Dr. Weisbrot has twice said that the IMF’s demands on Argentina should be made public and I want to pick up

Mr. Frank’s point about democracy. That is one of the worst ideas

I have ever heard because then any proposal they made would

have to be rejected by any Argentine government. No democratic
60

government could accept the dictate of the IMF no matter how reasonable it was.

So you cannot make it public.

Chairman BEREUTER. Mr. Sanders.

Mr. SANDERS. That is rather an amazing statement.

Chairman BEREUTER. You will have Mr. Sanders’ attention here

shortly.

[Laughter.]

Chairman BEREUTER. The gentleman from Connecticut, Mr.

Shays, is recognized for equal time. You will probably get about 8

or 9 minutes.

Mr. SHAYS. Well, given that I am going to stay to the end, I do

not really care. Thank you.

I am doing a lot of wrestling, because I was grown up by strict

parents who say you make obligations, you abide by them. And I

happen to, unlike Mr. Sanders, I do not think you can repeal the

law of gravity.

By that I mean there are just some basic economic principles

that come into play. What I would first like to know is, I do not

know what the debt service to their entire budget is, the percent

of their entire budget is debt service. What is it?

Dr. WEISBROT. I have that.

Mr. SHAYS. Mas e menos.

Dr. WEISBROT. The percent of their current spending is debt

service as a—— Mr. SHAYS. Yes, yes.

Dr. WEISBROT. Let’s see. I think it was—— Dr. MELTZER. They pay about an 11 percent average interest rate on about $130 billion worth of debt, and—— Mr. SHAYS. And you are going to make me figure it out. All I

want to know—— Dr. MELTZER. Well, I am just trying to do it in my head.

Mr. SHAYS. Why don’t you do it in your head and then tell me

the answer?

[Laughter.]

Dr. WEISBROT. I can’t give you an exact number. I mean all— what I can tell you is that—— Mr. SHAYS. No, I don’t even want an exact number.

Dr. WEISBROT. Yes, yes.

Mr. SHAYS. This dialogue means nothing if it was 10 percent of

their overall budget. If it——

Dr. MELTZER. It is about 15 percent, maybe.

Mr. SHAYS. Fifty?

Dr. MELTZER. Fifteen, twenty maybe.

Dr. WEISBROT. Yes, that sounds about right.

Mr. SHAYS. That’s all?

Dr. MELTZER. Yes, but that is not their problem. The problem,

briefly, is it is not the amount of interest payments they have to

make, it is those interest payments compared, not to their budget,

but to the amount of exports, because the debts are all dollar or

euro denominated, and they have to import.

Their problem was that they exported about 8 percent of their

GDP, 9 percent of their GDP, and their debt service was something

like——
61

Mr. SHAYS. You know, you’ve got to talk a little bit slower for me,

because—— Dr. MELTZER. They exported 8 to 9 percent of their GDP. That

is where they earned the dollars. And they had to pay something

like 5 percent of their GDP to service the debt. All right? So that

left them very little room for other things.

Dr. WEISBROT. It was even more than that. I mean, it got up to

8 or 9—it got up to the full level of export earnings. So, it basically

became impossible for them to pay off their debt.

Dr. MELTZER. Yes. The heart of their problem was not that their

debt was so big relative to their economy or relative to their GDP,

it was that they did not export a lot, and their exports were going

up, but not very rapidly, and they did not have any room to import.

Because they had to pay debt service.

Mr. SHAYS. And would you say that the condition in Argentina

is a crisis? Catastrophic? Desperate? How would you define it?

Dr. MELTZER. Terrible.

Mr. SHAYS. Terrible doesn’t do it for me.

Dr. MELTZER. Just desperate.

Dr. WEISBROT. It is a very desperate situation.

Dr. BERGSTEN. All three of what you just said.

Mr. SHAYS. Yes, that’s kind of what I think.

Dr. BERGSTEN. All of the above, yes.

Dr. WEISBROT. It is a severe depression.

Mr. SHAYS. I mean, from the stories I am getting, people who

have had assets have seen them wiped out, if they are financial.

What I am hearing is that they literally go to the bank and are

only able to take out $150 a week.

Dr. MELTZER. That is because of the banking rule. I mean, that

is the rule they imposed on themselves.

Mr. SHAYS. And that, basically, there has just been extraordinary

capital flight, and that people who have called Argentina their

country for generations and generations are leaving.

Dr. MELTZER. Yes. So they are losing not only their money, but

their hope.

Mr. SHAYS. They have lost their hope, it appears.

Dr. MELTZER. Yes.

Mr. SHAYS. So, and then I get kind of pulled over to where Barney is, because it just seems to me like the regular rules do not

apply.

Yes, sir?

Dr. HANKE. I think that is the point. There are no rules of the

game. The whole structure of property rights and the rule of law

has completely collapsed.

Now, to show you how catastrophic the situation is, normally, if

you have bank runs what happens? People go to the bank and they

draw the money they have in the bank out of the bank.

Well, during the bank runs in Argentina, they were running

their safety deposit boxes. And the reason they were running their

safety deposit boxes is they did not trust the crooks in the government to keep their fingers out of the safety deposit boxes.

So, that is the level you are getting at. And I can tell you, if they

continue with this lack of rule of law, no respect for property

rights, a floating exchange rate, you are not going to have banks
62

in Argentina for 10 or 20 years. They have had a long history of

this.

This is not the first time around for them. Who would put money

in an Argentine bank, given what has happened to them in the last

2 or 3 months? There is just no way.

Dr. BERGSTEN. Could I compound your ambivalence in another

way? Because, I too have a lot of sympathy for what Barney said.

But here is the problem:

Argentina does have to get its fiscal house in order. Your parents

were right. Because unless they do, they will fall back into hyperinflation.

The people who lose the most from hyperinflation are the poorest. It is the poorest people that Bernie cares about, and Barney

cares about, who will be the victims if Argentina relapses to the

hyperinflation of a decade ago.

The fiscal problem is an important part of that and unfortunately, you have to include interest payments. You cannot just say

the primary budget is in surplus. Correct, but irrelevant.

So, they have to do fiscal tightening. The question is then: How

do they do fiscal tightening?

One huge problem in Argentina is they do not have a tax revenue. They cannot collect taxes. There has been a history of that.

So they have to tighten up on the revenue side.

But on the expenditure side, the question is: Do you worry about

the safety nets? Or do you go after other things like military spending? You should cut that further. There is absolutely no doubt

about it.

But the basic point is that there does have to be fiscal tightening.

I pointed out in my statement it should have been done 5, 6, 7

years ago when Argentina was booming. It had this wonderful

record we all talked about.

Mr. SHAYS. I am just going to say, to show my ignorance, which

I seem to do at hearings, but I learn from it. I do not even know

why it even matters if what we are talking about is their ability

to export.

Dr. WEISBROT. Could I respond to that? Because I disagree completely. I don’t think any country should cut back on spending during a deep depression.

You know there were people who recommended that during our

Great Depression, too, and they turned out to be overruled.

Mr. SHAYS. I am going to come back around——

Dr. WEISBROT. I think it’s they have a debt problem. That is why

I kept emphasizing that at the beginning. Because the IMF kept

pouring, piling more and more, arranging more and more loans for

them to support the convertibility system as it was falling apart,

they ended up with a debt that is completely unpayable. And because interest rates kept rising and they were tightening their

budget. They were cutting. As I said, the IMF recognized they cut

2 percent of GDP out of spending in 2000. This is big.

Mr. SHAYS. OK.

Dr. WEISBROT. This contracts your economy.

Mr. SHAYS. My time has run out. I am going to come back for

round two. But I am just going to say, the law of gravity works
63

both ways. And if Argentina does not have the capacity, then it

ain’t gonna get paid.

And so, round two, I will look forward to round two.

Dr. BERGSTEN. Could I just put one fact on the table, because it

is very important. The debt-to-GDP ratio in Argentina rose from 23

percent in 1993 to 50 percent last year.

There was a huge increase in budget deficits and deficit spending

over this time. They then cut $2 billion out. It was much too late.

They should not have done it in the face of a recession. They

should have done it earlier.

They got into a position that was untenable, which had to be cut,

or else the hyperinflation risk is there.

Dr. WEISBROT. See, that’s very misleading. That is very

misleading——

Dr. BERGSTEN. All of which was compounded by——

Dr. WEISBROT. You’re saying the debt was increased, but it

wasn’t because of spending by the government. It was because

their interest rates and interest payments exploded. Those kept rising. But the government itself was cutting its spending on goods

and services——

Dr. BERGSTEN. Well, all this——

Dr. WEISBROT.——And on salaries, and everything else. So they

were caught in a debt trap, and the debt was piled on them. What

you call being too lenient was actually a curse. It was a terrible

thing what the international lenders did to them. They kept piling

more debt on them, and that is what happened to them. And the

interest rates kept going up——

Mr. SHAYS. Mr. Chairman, you are in charge.

Dr. WEISBROT. Because nobody believed that the currency was

going to hold.

[The gavel is heard.]

Dr. WEISBROT. But that was not a spending problem.

Chairman BEREUTER. I want you to go.

Dr. BERGSTEN. The problem was with Hanke and his currency

board because that added integrally to what you are talking about.

Absolutely right.

[Simultaneous speakers.]

Chairman BEREUTER. The Chairman has not had any time yet,

and I am about to take it. I am going to throw out three pieces of

red meat here, one of which is the currency board.

Several, or two of you at least, mentioned what we have to be

concerned about now after too permissive a policy—I will use that

term, you did not use it, I have forgotten what you used—on the

part of the IMF.

Now the problem is that we may be too harsh. The IMF may be

too harsh. I would like to ask you if they are to have a coherent,

consistent economic plan, what will be the indication that it is too

harsh?

Second question: Dr. Weisbrot specifically, you said something to

the effect that the austerity programs do not work in Argentina because of the particular circumstances. But I would ask you this

question: Without such a program, won’t Argentina continue to run

deficits and never escape from the debt burden it currently carries?
64

And third: Two or three of you must have something substantial

to say about currency boards that Dr. Hanke has discussed. If not,

I would be surprised, because I thought there was a major element

of controversy between at least some of you.

So, having used only less than a minute to ask my three questions, I would just like to see who wants to tackle any one of those.

Dr. Weisbrot, you are first. I mentioned you by name.

Dr. WEISBROT. If I could take the second one first, because you

addressed that to me, you said without austerity won’t they continue to run deficits?

This is in the appendix to my testimony. You can see the actual

numbers. No, they will not, if they have a moratorium on interest

payments, which I think is the least they can do to a country that

has reached this crisis at least partly because the Fund encouraged

and arranged this borrowing to support an inviable exchange rate

regime.

Chairman BEREUTER. Dr. Weisbrot, aren’t you concerned at all

about the message that sends to other countries?

Dr. WEISBROT. No, I think this is an important thing. First, it

sends a message that these institutions are finally for the first time

in decades going to take responsibility for their actions.

They were wrong. They made a mistake. And I think most of

all—OK, Steve won’t agree, necessarily—but everyone else will

probably agree that this was wrong, everyone here on this panel,

everyone else, and so why shouldn’t there be a—we’re not even asking for a cancellation here. We are just saying roll over it, restructure it, and the Fund has already agreed to postpone $936 million

interest debt service payment for a year.

They need to just say this, and then they can—because what is

the alternative? The alternative is to keep cutting the spending of

the government during a recession and push it further into depression, and hurt the people who are hurting the most.

Chairman BEREUTER. Dr. Meltzer.

Dr. WEISBROT. This is, to me, completely unreasonable and the

alternative of a moratorium is very minimal.

They don’t have an overspending problem. They have a debt

servicing problem from the past. And this has been true since 1993.

Chairman BEREUTER. I will see if Dr. Meltzer agrees, or perhaps

he has another——

Dr. MELTZER. I want to answer your hard question. I will answer

the currency board question in a moment.

You asked how do you know when the austerity is too tough. The

answer to that question, my answer to that question, the answer

of the majority of the Commission was, you put the problem back

into the country.

You do not have a bunch of rules sent down from the IMF. You

say to the country, ‘‘come with your coherent, consistent plan and

if it is a good plan, we will support it. But you decide. It is your

country and you have to sell, just as you would have to sell here,

you have to sell the idea to your constituents that this is the plan

that is going to work for your country’’; that they have to make

some sacrifices now, cut some tax rates, and that would at least—

because the tax rates are so high that 40-, 50 percent or more of
65

the transactions take place outside the market economy with no

taxes collected.

Chairman BEREUTER. I guess the government policies were being

tested rather demonstrably on the streets.

Dr. MELTZER. Right, so those were the bad policies. So do it in

a political way. It is a democratic country, and let the people decide

through their representatives what it is that they can stand to

have.

That is why the Commission majority, one of the problems, get

rid of conditionality; put the burden back within the country. All

right? Let them decide.

Second, on the currency board very briefly, the currency board is

a form of fixed exchange rate. Fixed exchange rates work well.

Floating exchange rates work well. They all work well if you have

good policies. None of them work well if you do not have good policies.

So my answer is: It was not the currency board that was the

source of the problem. It was the combination of the currency board

and the policies.

Now, in Argentina, they also had the appreciation of the dollar

and the depreciation of the Brazilian real, which made the currency board difficult to sustain. But, they did also add a policy

which made their debt unsustainable and threatened their currency board.

Chairman BEREUTER. Was the fact that the four economies had

become increasingly more integrated a problem so that when Brazil

had its change in currency, this had a greater impact on Argentina?

Dr. MELTZER. Yes, but Argentina only exports about 8 percent of

its GDP. So it is not a big integration with the world. It was integrated in the world in another sense in that it depended upon capital flows to build its economy, and those disappeared. That is one

of the ways in which the currency board got threatened.

Chairman BEREUTER. Thank you.

Dr. Bergsten, you would like to comment on any of the subjects?

And then I will move to Dr. Hanke.

Dr. BERGSTEN. Yes. I, of course, agree that almost always you do

not want to cut budgets in a recession. I yield to very few people

in having hammered Japan, and even Europe in recent months and

years for doing exactly that and making their situation worse.

Chairman BEREUTER. So that would apply to the construction

program of highways in this country, too, during a recession, right?

Dr. BERGSTEN. And I certainly agree that the U.S. erred in the

1930s when it cut the budget in the face of the Depression.

However, in none of those cases did the country face a risk of

hyperinflation.

Argentina is different from all those cases, because with its history, with its psychology, with its lack of a solid financial underpinning—and there I agree with Hanke—they do face a risk of return

to hyperinflation.

Avoiding that requires, first and foremost, a new and sensible

and efficient monetary policy. And I think there is some hope that

they are headed in that direction. They ought to adopt inflation
66

targeting. They have got a good man now to run the central bank

like Brazil did.

But in addition, they have to have a fiscal policy that spends

within their means. You do not do it overnight. You do it in ways

that protect the safety net, not make it worse. But they do have

to bring their fiscal policy back into order.

Let me just say very quickly, we did a major study on currency

boards 5 years ago. It went through every case of currency boards

that had existed to that time. What it shows is there are two cases

where currency boards do make sense. One is in very small, very

open economies that essentially do not have autonomy over their

exchange rate or monetary policy anyway. The second is in countries that desperately need some kind of external anchor to get rid

of hyperinflation. That was the Argentine case.

The problem is that it inherently produces an overvaluation in

the currency if left in place over time. You must have an exit strategy to get out of it. Argentina did not. That was the problem. Not

being, to put it mildly, a small, open economy, it was not a case

for a long-term currency board.

Chairman BEREUTER. Do all of you agree with Dr. Weisbrot’s

comments earlier that the federal contributions to the provinces did

not go up, therefore that was not an increase?

That is contrary to some op ed pieces that have been written,

and factually, I do not know which is correct. Do all of you agree

with his assessment that on this revenue sharing program it did

not go up? Even though they may have been prolifigate in the way

they were spending it in the provinces, it was not something that

continued to go up?

Is that correct as far as all of you know?

Dr. MELTZER. I don’t know.

Dr. BERGSTEN. But I’m not sure it’s relevant, because the issue

as I mentioned is that the debt/GDP ratio, just to take that commonly used measure, went from 23 percent in 1993 to 50 percent

a year ago. it was a huge explosion of domestic, as well as foreign

debt.

That included revenue sharing with the provinces. Cuts had to

be made somewhere. I am with Mr. Sanders. I do not want to cut

the safety net. I would much rather cut the transfers to the provinces for road spending, and so forth, and so forth.

So that, I think, is a very important part of the package. You

cannot ignore that, whether it went up or down.

Chairman BEREUTER. I am well beyond my time, too, but if we

can take maybe one minute for Dr. Hanke who deserves to speak,

and then we will go to Mr. Sanders.

Dr. HANKE. I agree with Dr. Meltzer about letting the country

come up with their own game plan.

The problem is, I remain quite skeptical about these possibilities

with the current government. They have only had one clear idea.

That is, to destroy the convertibility system, to pesofy the economy

and get the dollar completely out of the picture officially and

unofficially—— Chairman BEREUTER. ‘‘They’’ meaning the IMF?

Dr. HANKE. No, I am talking about the government. So you have

to have these policies homegrown. There is no successful reform or
67

economic prosperity program, Mr. Sanders, that has ever been

rammed down somebody’s throat. These are homegrown. You can

go right across the border. There has never been one that has been

imposed from the outside.

So, it has to come from the inside. My problem is, the current

government completely is on a one-track rampage, getting rid of

the dollar. Therefore, they have no ideas about how to go forward.

All their effort has been essentially how to destroy the convertibility system, how to pesofy the economy, and they are left holding

an empty bag. They have no idea of what to do, and they are not

going to come up with any coherent game plan.

Chairman BEREUTER. We are going to go to Mr. Sanders now,

and we will do an 8-minute round for the two of us, or anybody else

that arrives.

Mr. SANDERS. What I find interesting about this discussion is I

keep thinking the issue is not currency conversation or peso/dollar

peg, it is a lot deeper than that.

There have been some statements that Dr. Bergsten and Dr.

Hanke have made that disturbed me a lot.

Dr. Bergsten said, basically, if I got it right, if the people knew

the truth in Argentina about the IMF agreement with the government, essentially they would be panicked. There would be an uprising. Is that what you said?

Dr. BERGSTEN. No. You totally misunderstand me.

I said that any program that the IMF or an external force published would have to be rejected by the Argentine government—— Dr. MELTZER. In advance.

Dr. BERGSTEN.——In advance, whether it was the perfect—— Mr. SANDERS. Why?

Dr. BERGSTEN. If it was a program—— Mr. SANDERS. Why?

Dr. BERGSTEN. Because, it would be imposed by the foreigners.

If you—— Mr. SANDERS. Well, first of all——

Dr. BERGSTEN. ——Designed the program—— Mr. SANDERS. First of all—hold on. Hold on.

Dr. BERGSTEN.——They would reject your program.

Mr. SANDERS. I am asking the questions. Two points.

If that is the case, if you are saying that the average person in

Argentina did not want a program imposed by foreigners, then you

have got a problem in the first place. Why are foreigners imposing

a program on the people? If they do not want to be—that is the

first thing.

But, second of all, implicit, the program that the IMF usually imposes works disastrously for the average people. All right? So the

truth is, people in Argentina are saying, ‘‘Let me see. We’re being

dominated by big money interests from abroad, and their prescription for us will raise unemployment, lower wages, cut health care

and education. Hmmm.’’ You know what, if I were one of those people, I would say: ‘‘Yeah,

I don’t want that program either.’’

Now the conclusion is, therefore, we can continue to do this thing

in secret so that the people do not know it, or maybe we say this

type of negotiation is not good and we should not be doing it.
68

That is exactly what the issue is.

Dr. MELTZER. But, that is not what is happening.

Mr. SANDERS. Let me finish.

Dr. MELTZER. That is not what is happening.

Mr. SANDERS. Hold on one second. Let me ask Dr. Hanke, who

is very concerned about contract law and making sure the governments respect the agreements that they sign, and I think that is

fair enough. That is fair enough.

But, American corporate interests have invested billions in Indonesia, and Suharto’s corrupt, illegal, undemocratic regime. Now,

am I correct in understanding—so we get the record clear, and I

want to be blunt on this; I do not want to be rude—you basically

represent, as President of which bank?

Dr. HANKE. Toronto Trust Argentina.

Mr. SANDERS. You represent, correct me if I am wrong, people

who invest in Argentina? Is that correct?

Dr. HANKE. No. That is an Argentine Mutual Fund.

Mr. SANDERS. OK.

Dr. HANKE. Now back to your question about is anyone—— Mr. SANDERS. Who do you represent in that capacity?

Dr. HANKE. Just a minute.

Mr. SANDERS. No. I’m asking you a question. Wait a minute, you.

Who do you represent?

Dr. HANKE. Argentine citizens. Foreigners cannot invest. It is an

Argentine Mutual Fund. All our employees are Argentines. All the

investors are Argentines.

Mr. SANDERS. OK. Thank you.

Dr. HANKE. Now that gets back to your question, though, about

who is concerned about the people. I lose a lot of sleep, I have lost

a lot of sleep worrying about people, OK, with a small ‘‘p’’. Our clients are all Argentines. All are families of people who work for me.

We have maintained our group. No one has been let loose. We do

not want to let anyone loose. They are good people and have been

with us for a long time.

So, I do worry about people on that scale, Congressman, but on

the larger scale, I worry about the well-being of Argentines when

you have a situation where in dollar terms, the GDP per capita has

been cut more than 50 percent in Argentina.

They have gone from the highest GDP in Latin America to something that will come in lower than Chile. And I, probably unlike

you, think that as the tide goes up, all the boats come up. This is

consistent with the work of David Dollar over at the World Bank.

The poor benefit when prosperity is booming.

Mr. SANDERS. OK, but the issue here is: Are we really discussing

how the United States and the IMF can improve the standard of

living of people in Argentina and other developing countries? Or

are we primarily concerned about how we protect the investments

of the wealthy and large multi-national corporations?

Now, Dr. Hanke, a moment ago you talked about the rule of law

and respect for the rule of law. That is a fair point. I certainly

agree with that.

I would point out that the United States today protects the interests of companies that invest in China. Does China respect the rule

of law? Billions of dollars were invested in the Suharto dictator-
69

ship. Pinochet of Chile, who was recently indicted as a war criminal, is a violator of very fundamental human rights.

The United States Government supported American companies

that were investing in there. We invested in apartheid South Africa. Saudi Arabia, we have very close business ties with Saudi Arabia. Are those countries which respect the rule of law for their own

people?

Dr. Hanke?

Dr. HANKE. Well, the question is, without making too broad a

generalization, I think the standard should be uniform, and that is

what the U.S. Code requires in Title 22 that I was referring to.

Mr. SANDERS. I understand.

Dr. HANKE. So, that is all I have to say.

Mr. SANDERS. But, do those countries that I mentioned, does

China respect the rule of law? Does Saudi Arabia respect the rule

of law?

Dr. HANKE. According to all the studies that have been done, the

ranking is rather low in those places and that is why economic

growth has generally been lower in countries that have a lower respect for the rule of law and property rights.

Mr. SANDERS. Well actually, China’s rate of growth has been

pretty good.

Dr. HANKE. China has been an outlier in those studies. But generally, and they are statistically robust, the stronger the rule of

law, the stronger private property rights, the more rapid the rate

of growth, the higher the level of prosperity.

Mr. SANDERS. But the United States Government has supported

many, many countries who do not respect the rule of law. I happen

to have real problems with that. I don’t want to say I have problems with that, but the recent Administrations apparently do not.

Dr. HANKE. Back to your point, though, about the IMF, getting

back so we are on the same wavelength here for a moment, I indicated that in the big boom years of 1990 through 1994 in Argentina, the IMF had virtually nothing to do. They had nothing to do

with setting up the currency board, economic policy, and so forth.

The Argentines did it. They had a boom. After the Mexican devaluation in December of 1994, the IMF got in there big time with

a lot of policy advice and money and screwed the thing up. And it

has been a bloody disaster ever since.

Recently, if the IMF has not given the lead, it has turned a blind

eye. So either way you look at it, all these policy errors have either

come from Washington, DC, or Washington, DC. has looked the

other way when it has been convenient and let them go ahead

blundering away with bad policy.

Mr. SANDERS. So your conclusion is perhaps that we should leave

them to run their own government, and if people want to invest in

it that is fine.

Dr. HANKE. That’s right. That’s why I say I think we’re on the

same wavelength on this particular issue.

Dr. MELTZER. May I make a very brief statement?

Mr. SANDERS. Sure.

Dr. MELTZER. I think the IMF is in the process of transition to

a system. They are not sending a lot of messages, and they are not
70

sending a lot of conditions down to Argentina. They are sending a

message which says come with a plan that is coherent.

The people you should be aiming at, if I may say so, are the

World Bank. They are the ones that are down there to do structural reforms. They are the ones that are supposed to be concerned

about poverty alleviation. They have a miserable record.

I mean, Congress, the U.S. Congress when it passes the next IDA

appropriation, should ask for a performance audit by an independent agency of how the development banks do. Because they

have many, many programs and their success rate is awful.

Dr. WEISBROT. Can I say something, too, on this because I really

think that if the IMF really wants to let Argentina decide, then

they should state publicly what they are asking of the government,

and not just say a sustainable plan.

I am kind of shocked sometimes how many people are willing to

accept from them, to accept when it is reported in the press that

the IMF is holding out for a sustainable plan. Well, what is a sustainable plan?

They did not have a sustainable plan the last few years that the

IMF supported them. The IMF has clearly supported many plans

that were not sustainable and ended in disaster.

So, why should we just have a blind trust? We question Members

of Congress. We question our President. Why should the IMF be

taken completely at its word?

I do not accept Fred’s idea that the people of Argentina are so

blindly nationalistic and irrational that they will reject any proposal from the IMF. If the IMF proposed a moratorium on debt

payments for the next 4 years. And in fact they did, right? They

proposed—— Mr. SANDERS. Dr. Bergsten, can you respond to that, please?

Dr. WEISBROT.——A moratorium on the first—— Mr. SANDERS. Let him respond to that.

Dr. WEISBROT.——Billion dollars in those loans. The people—— Mr. SANDERS. Dr. Weisbrot, let him respond to that, please.

Dr. BERGSTEN. Sure. I don’t mean to single out Argentina. The

United States, including its Congress, would reject any dictate to

its economic policy from abroad.

Mr. SANDERS. So? Fine.

Dr. BERGSTEN. Therefore, if you are serious about trying to get

a better program in Argentina and get a constructive role for the

IMF. The last thing you want is for the IMF to publicly say what

it is it wants from Argentina.

Mr. SANDERS. You are saying what I said you said. Then it

should be kept secret, hidden from the people because the people

would reject it?

Dr. BERGSTEN. No. I didn’t say——

Mr. SANDERS. Until it is adopted.

Dr. BERGSTEN. No. It shouldn’t be kept secret.

Mr. SANDERS. I’m sorry?

Dr. MELTZER. Until it’s adopted.

Dr. BERGSTEN. No, no, no. It shouldn’t be kept secret until it’s

adopted either. The IMF should not just publish it and say here is

what you must do. That is obviously the opposite of domestic ownership, which we all want.
71

However, the IMF now publishes on its website all the letters of

intent. They leak to the public in every country they negotiate with

when it is being negotiated.

There is no secret. It is well known to people.

Dr. WEISBROT. We do not know what they are demanding right

now. That is the big problem.

Dr. BERGSTEN. They are not demanding any specifics right now.

Dr. WEISBROT. Oh, come on. How much you want to bet that

budget cut had something to do with what they were pressuring

the government to do, that 14 percent they cut out of their budget?

Chairman BEREUTER. A little interchange is good, but we also

have a recorder here who is probably struggling. We have a disagreement right there, Mr. Sanders, you may have noticed,

between——

Dr. MELTZER. More than one.

Chairman BEREUTER. Do you want to resolve it?

Mr. SANDERS. I don’t think we can resolve it. Let me finish.

Dr. HANKE. Mr. Chairman, on that point, you see the Administration, neither the Administration nor the IMF has laid out what

the general—not the detail of the game plan, but what the general

coherent game plan might be. So there has been, I would say, very

little direction from Washington, DC. in general.

Now that might be fine, because as I indicated earlier, if you try

these top-down approaches you are not going to be able to force

something down somebody’s throat.

That said, the IMF has been involved. Dr. Krueger did indicate

that it was not feasible to dollarize the economy, for example, on

the 11th of January, she said this when they were still going

through the process trying to figure out what they were going to

do.

Dr. BERGSTEN. And she’s right.

Dr. HANKE. She is completely wrong, and I have written about

this on several occasions in The Financial Times. But at any rate,

that is not my point, Fred.

My point is that she did intervene. She made a public statement

about something that is very sensitive in Argentina. And that is,

what kind of currency regime they are going to have going forward.

So maybe that was not some official big blueprint that was laid

out in a comprehensive way. It was something that was in the

headlines of all the papers in Buenos Aires and had a huge impact

on the direction things were taking, and the dynamics down there.

So the idea that the IMF is not intervening, is not saying anything, is just nonsense. It is not true.

Dr. WEISBROT. They are just hiding the things that they do not

want people to know about. They are announcing the things——

Dr. HANKE. They selectively take their shots when they want to.

And they have an enormous influence, because I can tell you even

in the last Administration when Larry Summers was at Treasury

in February of 1999, President Menem wanted to dollarize the

economy, had proposed it.

Well, it was a little bit ambiguous, but if you read what Summers said, it was technically correct and carefully stated. The headlines the next day in Buenos Aires? ‘‘Summers Against
72

Dollarization.’’ And that almost deep-sixed the thing completely

right there. Just a series of headlines.

So, these things are all quite important, and I think we have to

be very careful.

Dr. MELTZER. It is my understanding that the IMF is giving no

direction to the Argentine government. It is asking the Argentine

government to come with a coherent, consistent plan.

When I was in Buenos Aires and talked to people who are now

in the government, I presented them with a plan very much like

what I have in the paper that I prepared for this subcommittee.

But we told them, over and over again, ‘‘this is our plan. You have

to develop your plan. Here are the problems you have to solve. It

is up to you to come up with solutions that are satisfactory within

your democratic arrangements.’’

That is what the IMF—that is the position, as I understand it,

that the IMF has taken. They have taken the position of saying

that certain things would not be acceptable to them.

For example, a dual exchange rate. A dual exchange rate is a

source of corruption. It would be a very bad policy for Argentina.

Now, they did not say you cannot have a dual exchange rate;

they said we cannot support a dual exchange rate.

Dr. WEISBROT. Which means they would not get the loan if they

didn’t get——

Dr. MELTZER. That seems to me to be a perfectly sensible thing

to do. Just as any lender has a right to say ‘‘we think that your

policy is bad and we are not going to lend you money. But we are

not going to tell you you cannot do it.’’

The IMF is taking the position, that kind of position. That seems

to me to be a far step forward from where they were 5 years ago,

or 3 years ago, where they came in with a blueprint for the country, which often did not work, and that had many, many conditions

on it that had nothing to do with the crisis.

Dr. WEISBROT. I agree with Allan that this is a step forward. I

mean, it is not like the list of 140 conditions that they gave to Indonesia. But there’s still—and that is fine. That is progress.

But, it is still a major problem that they are making demands

on this government that are secret and may well hurt the economy

very much.

Now, if I could just address the one economic issue I think of importance that we missed, which Fred raised, on the hyperinflation.

That was his argument that, even though we would never cut our

budget in a depression, that Argentina should.

This is a serious argument. I take that very seriously because

hyperinflation is a real danger. But the question is: Do they really

need to slash their budget in a depression in order to avoid hyperinflation?

That is a question—that is why I think this discussion should be

out in the open and it should not be done secretly and pressured

secretly, because that is a tough question. I don’t think they have

to. And I think if you look at the last two situations like this of

devaluations in Brazil and Russia, in both of those cases the Fund

said very clearly ‘‘you cannot let the currency fall in the first place.

You will get hyperinflation.’’
73

That was their only reason for supporting these fixed exchange

rates to the abyss. And, in fact, they turned out to be wrong. In

both of those cases, inflation was very mild and manageable.

Now, I am not saying that is guaranteed here. But one of the

problems is, one of the biggest threats of hyperinflation comes if

people do not want to hold the peso. And the more the IMF drags

out this process, the more likely that risk increases.

Chairman BEREUTER. I would like to thank you, Mr. Sanders.

I would like to finish with three questions that I think might be

easy to answer, although there may be disagreement among you.

First of all, Dr. Meltzer, I think you made reference to a liquidity

proposal. I do not know if you have that available to us, but if you

do I would appreciate knowing more about it. It does not have to

be stated at this point, but I would like to see that, if that is possible.

Dr. MELTZER. I would be glad to.

Chairman BEREUTER. Thank you.

Dr. MELTZER. I have it here, and I will leave it with you at the

end of the hearing.

[The information supplied can be found on page 117 in the

appendix.]

Chairman BEREUTER. Thank you very much.

Dr. Bergsten, I will start with you on this one, and perhaps others of you have an opinion. I would think Dr. Hanke would.

The U.S. and Argentina have a Bilateral Investment Agreement.

In your opinion, was this agreement violated when the Argentine

government declared that contracts that had been negotiated to be

paid in dollars are now to be paid in pesos?

Dr. BERGSTEN. I actually do not have a strong opinion on that.

Chairman BEREUTER. OK.

Dr. BERGSTEN. I have asked my staff, who know about the issue,

to research it. We are doing that. If I could send you a note on it

in a couple of days, I would like to.

Chairman BEREUTER. All right.

Dr. BERGSTEN. I think it is a very serious question, but I am not

sure legally what the implication is.

Chairman BEREUTER. Dr. Hanke, my guess is you do.

Dr. HANKE. I think that they have violated, yes.

Chairman BEREUTER. Other opinions on that question, if you

have them formed at this point?

Dr. Meltzer.

Dr. MELTZER. It is a sovereign right.

Chairman BEREUTER. It is a sovereign right to change them,

therefore it is not a violation of contract.

Dr. MELTZER. Everyone who lends in those circumstances—it is

a violation of the contract, but everyone who enters into those contracts understands that they are entering into it with a sovereign

and a sovereign has the power to change the contract after the fact.

Dr. WEISBROT. I agree with that also. I mean it is a change of

currency regime. There is nothing they could do.

Chairman BEREUTER. It is not good for future investment climates, at least.

Dr. MELTZER. Indeed, it isn’t.
74

Chairman BEREUTER. The Washington Post op ed today noted

that a consensus is emerging that the current government after

two months in office cannot put together and execute the necessary

reforms.

[The article referred to can be found on page 158 in the

appendix.]

Is that too pessimistic? Or do you have an opinion you want to

share, any of you?

Dr. WEISBROT. Yes, I think that is overwhelmingly too pessimistic. Again, the government is—I want to emphasize this—they

are not facing the structural problem that other countries have

often faced. They are not overspending except for interest payments. That is the only overspending by the government.

That is not always the case in crisis situations. They also do not

have a balance of payments problem, which is another problem

that would be much harder to reverse and would take much longer.

So they really only need—I mean, the main thing they need now

is to not have to pay these interest payments on the debt until

their economy recovers. So that is very different from many of the

other crises that you can point to.

Obviously the Asian crisis had different causes, but this is not

as much a systemic problem as it is being made out to be. And if

I can offer just a slightly——

Chairman BEREUTER. But they do reference the current government. And of course——

Dr. WEISBROT. What——

Chairman BEREUTER. The question is whether or not the current

government can do this.

Dr. WEISBROT. Well, they could, but again they would need——

Chairman BEREUTER. And all——

Dr. WEISBROT. They would need some kind of relief from their

debt service payments to do it.

Chairman BEREUTER. Ultimately of course——

Dr. WEISBROT. And that’s exactly what the Fund does not want

to provide.

Chairman BEREUTER. Ultimately, of course, some government

will have a plan that is acceptable. It might take a long time.

Dr. BERGSTEN. I might just say that I share the view that it is

too pessimistic to write off the current government. They have done

some good things, like the deal with the provinces. We will see if

it holds. But that is a step in the right direction.

Hanke had his horror list of things they have done, but they

faced an untenable situation. They came into the midst of a crisis.

They had no money to pay all these debts. How could they not violate contracts? So they had to make some changes.

I think it is too soon to say whether they will be able to pull out

of it, but I certainly would not write them off at this point.

Chairman BEREUTER. Our staff is going to have a very interesting and difficult time trying to develop a consensus on this. At

least we have not had a dull panel. We’ve had lots of interaction

and lots of disputes.

Dr. MELTZER. May I say to that last question, I am very pessimistic. I am pessimistic not because I think the situation is unten-
75

able or unresolvable, but it isn’t certainly going to be easy to resolve.

I am pessimistic because most of the moves that have been made

by the current government have, many of them have been in the

wrong direction. That is, there is a strong tendency, having met

with these people and talked to them, there is a strong tendency

to want to blame foreigners and to try to extract the solution from

the foreigners.

That was the purpose of the tax on oil companies. That was the

purpose for the new tax. They came back from Washington. They

didn’t get the $20 billion they wanted. So they immediately put a

tax on foreign corporations.

I mean, that is their view of how to operate. I think with that

mindset, it is going to be very difficult for them to come with a

package that is going to work.

It is not entirely difficult, nor is it easy to come with such a package, but it is not going to be easy if you start with a mindset that

says we are going to try to get the foreigners to pay. And the main

question that we get from Argentine radio, television, newspapers,

is: Why doesn’t the IMF just give us the money?

That mindset has to change.

Chairman BEREUTER. I guess that is what we did the last two

times, meaning the IMF.

Dr. MELTZER. Thank goodness we are making some progress

with the IMF.

Dr. WEISBROT. I think it is reasonable, because the oil exporters

do get a windfall from the devaluation. I don’t see anything unreasonable about taxing that.

Chairman BEREUTER. Dr. Hanke, you are going to have the last

word on this series of questions.

Dr. HANKE. I remain quite pessimistic about the possibilities of

the Duhalde government coming up with something, because what

they have to do—it has nothing to do with, I think, these things

Mark has been talking about, macro economics and everything.

You need a massive confidence shock in a system.

And, Fred, yes there was something they could have done in the

middle of the crisis. They could have done what Ecuador did in

early 2000, when they dollarized the economy, gave it a huge confidence shock.

They were in the same kind of mess exactly in Ecuador as Argentina. What do you have today? Ecuador is the fastest growing economy in Latin America. The unemployment rate has come down

from about 15 percent to 9 percent. 30-day deposit rates have come

down from 60 percent to about 3.5 percent.

A complete turnaround in the thing.

So, you have got to come up with something that gives a big confidence shock to the system, and this will be virtually impossible

for a government that has ignored the rule of law, destroyed property rights, torn up contracts until there’s no tomorrow.

I see virtually no hope that they can pull any rabbit out of the

hat at this point in the game, given their initial behavior.

Chairman BEREUTER. Thank you. This panel has been very patient and is very much appreciated. We have let a lot of discussion
76

go on among you, and I think that is appropriate given the sharply

different opinions on a few subjects.

Mr. Sherman has just arrived from California, no doubt, and I

would say we will put a statement of yours in the record, and if

you have a question or two for the record you would like to make

in a minute or two, why, you will have the last word.

Mr. SHERMAN. Why, thank you, Mr. Chairman.

My heart goes out to the Argentine people, but I would like to

address my questions to how this affects the United States. Let’s

say Argentina simply renounced all its debt to all agencies of the

United States Government and any agency in which we have an interest.

How much does the U.S. Government lose? Does anybody have

an answer?

Dr. BERGSTEN. I don’t know the amounts.

Mr. SHERMAN. Can it be $10 billion? $50 billion? Does anybody

have a guess?

Dr. BERGSTEN. They would be a tiny share of any——

Dr. WEISBROT. It is nothing that big.

Dr. BERGSTEN. It is a tiny share of any denominator you care to

put in there. The Eximbank undoubtedly has some outstanding

credits.

Mr. SHERMAN. Let me——

Dr. BERGSTEN. The international loans——

Mr. SHERMAN. I have a limited amount of time.

Dr. BERGSTEN. The loans from international agencies are about

$40 billion, and the U.S. share is about a quarter of that.

Mr. SHERMAN. So it would be over $10 billion, then?

Dr. BERGSTEN. Somewhere in that range.

Mr. SHERMAN. And what shocks me, and what I hope that this

will be a case study of, is why so many agencies are so anxious to

loan money to foreign governments that are obviously bad credit

risks, but do not want to loan to small businesses, at least in my

district, if not in Nebraska, as well. And the way that the too-bigto-fail bailout system, you know, when a bank loses money on a

loan to a small business in my district, we don’t have hearings here

as to how to bail them out.

And the tendency of our Government to insulate banks from

moral hazard when they ship tens of billions of dollars overseas

leads to some very bad lending decisions. And perhaps the Argentine people have a right to be angry that we loaned—that our financial institutions, or first world financial institutions, made

loans to them that were far beyond their ability to repay.

Dr. MELTZER. I think we have made a big improvement. I think

the Commission that I headed pushed in the direction that you are

talking about. I think we have made substantial progress, because

for the first time now we have seen Ecuador, Pakistan, Ukraine,

and Argentina where the lenders take a loss.

I think one of the big, big improvements that has come in the

last year has been that lenders who lend to sovereign countries

now understand a lot more about risk than they did before because

the IMF has not been there to bail them out, as they have over the

last 25 years.
77

I think that is a great step forward that is going ultimately to

make a much improved international capital market.

Dr. BERGSTEN. Yes, I agree with that. Note that there are huge

losses that private lenders and investors are now taking in Argentina. So it is not a bailout to put it mildly.

Mr. SHERMAN. Thank you, Mr. Chairman.

Dr. MELTZER. I mean, they are going to get 20 or 30 cents on the

dollar.

Dr. WEISBROT. I agree with that, as well. But I do think that

there is still a lot of negotiation taking place, and we do not know

how much of those bad loans they are going to force the Argentine

government to absorb.

Chairman BEREUTER. Thank you very much, gentlemen. I very

much appreciate it. I have not had a chance to talk to all of you

ahead of time, but I will come down there and meet Dr. Meltzer,

who I have not met yet.

The hearing is adjourned.

[Whereupon, at 3:55 p.m., the hearing was adjourned.]

(79)

A P P E N D I X

February 6, 2002
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